Understanding Real Estate &

Private Equity Roles in

Sale/Leaseback Transactions

By: Jonathan W. Hipp

The Basic Private Equity Business Model

Deal Sourcing

Continuous Process

Transaction Due Diligence

Pricing / Structuring

6 weeks 6 months

Post Transaction Portfolio

Company Management

18 months 9 years

Portfolio Company Exit

6 weeks Continuous
Process

Deal Sourcing Basics

Targeted Deal Sources:
Targeted Calling Efforts
Industry Research / Due Diligence
Existing Co-Investors
Professional Service Advisors
Seeded Start-Up Opportunities
Potential Deal Sources:
Investment Bankers
Business Brokers
Real Estate Brokers
Attorneys

Due Diligence Basics

Facets Of Due Diligence:
Financial
Management Team
Key Company Stakeholders
Industry
Undisclosed Liabilities
Due Diligence Tools:
Proof to Cash Book Cash Tax
Boots on the Ground
Due Diligence Philosophy:
Triangulate to the Truth

Investment Criteria
Service Businesses with good profit and cash flow margins
Proven Business Model:
Revenues $20+ million.
Enterprise value of $20+ million.
Currently profitable - at a minimum profitable at the
operating level.
Proven Management:
Complete, competent, battle tested
Both industry specific & general management experience
Team has a significant ownership post closing
Operational / Tactical / Quantitative focus vs. Big Picture
or Visionary

Investment Criteria - continued

Recurring Revenue Model:
Contractual Recurring Revenue
High Customer Retention Rates
Growth:
Is there growth opportunity?
Does it have a History of Sustained Growth?
High Margins:
Gross margins & EBITDA
Indicative of a well-run business with sustainable
competitive advantage.
Systems & Controls:
Can the Company Produce Accurate and Timely
Operational and Financial Data.
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Investment Criteria - continued

Return On Invested Capital (ROIC): Is it high (+20%) and can
it be sustained? Does the Companys business model and
growth plans support the additional deployment of capital at a
high ROIC?
Strategic Competitive Advantage: Has the Company
differentiated itself from the competition? What are the threats &
opportunities?
Multiple Expansion: Do current industry conditions or
transaction pricing lend itself to multiple expansion?
Potential Return: Is the Company capable of producing 3x
5x invested capital over a 3 5 year period?
Last Man Standing Test: Is this a business you would be
comfortable owning personally, forever?
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Private Equity & Real Estate

The View from the Private Equity Side of the Table

The Private Equity View of Real Estate

No Love for Dirt, Sticks,

Bricks or Steel
Main Reason: Usually Holds Hostage a
Lot Of Capital in a
Low(er) Return Asset Class

Private Equity & Real Estate

The View from the Private Equity Side of the Table
Question: How do you get an asset class (Real Estate) that
produces annual returns in the 8% to 12% per year to produce
private equity type returns 25% to 35% per year?
Answer: You Dont!
Solution: Dispose of lower return assets & reallocate capital
toward higher return assets. A $10 description for this exercise
is Capital Allocation.
This solution is applicable to select private equity folks /
transactions as well as select business owners with desirable
real estate and high return growth opportunities.

Private Equity & Real Estate

The View from the Private Equity Side of the Table
An Example of Capital Reallocation:
The Return on Invested
Capital (ROIC) for Store A
increases from 24% to 136%
once real estate is sold
Transaction proceeds of
$455,000 can be deployed to
open new locations or
reallocated toward other high
return pursuits.

Revenue

Store A
$520,000

Rent

Store A
Sans Real Estate
$520,000
$52,000 (C)

EBITDA (A)

$120,000

$68,000 (D)

Investment
Land
Building
Equipment
Total Investment (B)

$185,000
$265,000
$50,000
$500,000

$50,000
$50,000

Estimated ROIC (A/B)

24.00%

136.00%

Notes:
Assumed Real Estate Disposition
- Rent @ 10% of Unit Revenue
- Priced At An 8% Cap Rate
Gross Transaction Proceeds

$52,000
8.00%
$650,000

Est. Net Transaction Proceeds

$455,000 (E)

(C): Assumes rent factor @ 10% of Revenue sold at an 8% Cap Rate

(D): Post Closing EBITDA $120,000 less $52,000 rent
(E): Assumes 30% effective tax rate.

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Private Equity & Real Estate

The View from the Private Equity Side of the Table
What if a business owner simply wants to cash out or sell & has no
interest in reinvesting in his/her business?
Disaggregating the real estate from the business and selling it in a
separate process still may make sense: Split Sale.
Most financial buyers will not ascribe a Market Value to real estate
that tags along in a business sale. At most 1.0X to 2.0X additional
turns of EBITDA are given by the Financial Buyer.
Splitting the real estate and selling via a sale-leaseback transaction
to a 1031 Buyer or real estate investor may do a better job of
maximizing seller proceeds.
You are effectively pulling rent from EBITDA but selling it to a
different investor (a real estate investor) for a higher multiple.

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Private Equity & Real Estate

The View from the Private Equity Side of the Table
Selling a Typical Business:
Multiple range with real estate increased from 3X 5X to 5X 7X
as real estate assets are sold along with the Business.
Revenue

$5,000,000

$5,000,000

$5,000,000

EBITDA

$1,000,000

$1,000,000

$1,000,000

5.00

6.00

7.00

$5,000,000

$6,000,000

$7,000,000

Exit Multiple
Business Value W/ Real Estate

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Private Equity & Real Estate

The View from the Private Equity Side of the Table
Transaction #1
Sell the real estate.

$5,000,000

$5,000,000

$5,000,000

EBITDA

$1,000,000

$1,000,000

$1,000,000

5.00

6.00

7.00

$5,000,000

$6,000,000

$7,000,000

$500,000

$500,000

$500,000

Exit Multiple

A 10% rent factor & 8.5% cap

rate is assumed for the real
estate sale.

Business Value W/ Real Estate (X)

Transaction #2
Sell the business.

Cap Rate

The business multiple range is

reduced from 5.0X - 7.0X to
3.0X 5.0X to account for the
absence of real estate from
the Business Sale.
The Split Sale Methodology
yields more proceeds to seller.

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Revenue

Transaction #1 - Real Estate Sale

Rent

8.50%

8.50%

8.50%

Real Estate Value (X)

$5,882,353

$5,882,353

$5,882,353

Transaction #2 - Business Sale

Revenue

$5,000,000

$5,000,000

$5,000,000

Rent

$500,000

$500,000

$500,000

EBITDA

$500,000

$500,000

$500,000

3.00

4.00

5.00

Business Value

$1,500,000

$2,000,000

$2,500,000

Total Value Of Enterprise =

Business + Real Estate Values (Y)

$7,382,353

$7,882,353

$8,382,353

Imputed Value Of Split Sale

(Y-X)

$2,382,353

$1,882,353

$1,382,353

Exit Multiple

Private Equity & Real Estate

The View from the Private Equity Side of the Table
Other Possible Benefits of Sale Leaseback Funding:
Accretion: A sale-leaseback transaction maybe mildly accretive for the
business in the near term.
Example Sale-leaseback proceeds where used to retire debt.
The reduction in debt service exceeded initial rent by $80,000 /
year. Using a business valuation of 3.0X 5.0X EBITDA, this
incremental cash flow increases the enterprise value of the
business by $240K $400K.
As a Funding Source: Sale-leaseback cash may be a cheaper and
more stable source of financing:
Initial Lease Payments maybe < Debt Service
Rent Increases every 5 years vs. Monthly for variable rate bank
debt
Leaseback financing (Lease) usually has less reporting & operating
restrictions than bank debt.
In troubled times a real estate investor maybe easier to work with than
a bank.
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Private Equity & Real Estate

The View from the Private Equity Side of the Table
Selling the real estate in a sale-leaseback transaction does
not necessarily mean the business needs to be sold. Nor
does it mean all cash proceeds need to be reinvested into the
business. As long as the Seller continues to have significant
value or stake in the underlying business, proceeds from the
real estate sale can be used for a variety of recapitalization
activities.
Provide Liquidity to the Owner Chips Off the Table
Cash Out an Inactive Partner
Make the business more affordable for the next
Generation of family members or tier of management

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Private Equity & Real Estate

The View from the Private Equity Side of the Table
Real Estate Disposition Highlight Reel:
One transaction enabled a Company to pay off 1/2 of outstanding
indebtedness and distribute all invested capital back to investors.
A second transaction enabled a Company to pay off all outstanding
indebtedness and created an additional $1,000,000 to $1,600,000 of
equity value for investors.
A third transaction allowed a Company to retire 100% of outstanding
indebtedness, increase cash from operations by $600,000 per
annum and raise a $5,000,000 funding commitment for new unit
development.

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Private Equity & Real Estate

The View from the Private Equity Side of the Table
The Realities of the Sale Leaseback Transaction:
It is Not All Sunshine & Lollipops
Sale Leaseback transaction is not for all business / real
estate owners.
Using the Split Sale Leaseback transaction takes much
longer to exit a Company.
There are many transaction derailers to frustrate the
process.

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Private Equity & Real Estate

The View from the Private Equity Side of the Table
Questionable Sale Leaseback Candidates:
Real Estate that would be a Challenging Investment regardless of the Tenant:
Environmental Issues
Title Issues
In Need of Significant Capital Improvements to Remain Serviceable
Currently Clouded by Litigation
Easements Need to be Renegotiated
Businesses with Volatile Revenue & Cash Flow
Businesses with Variable & Large Maintenance CAPX Requirements
Businesses with Large Working Capital or Seasonal Working Capital Needs
Businesses that have Employed Too Much Leverage
Businesses that are Not Well Run/Run to the Detriment of Other Stakeholders
Businesses in Industries/Markets that are Undergoing Significant Changes

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Private Equity & Real Estate

The View from the Private Equity Side of the Table
A Split Sale Leaseback / Business Sale takes much longer to
execute. In a strong market expect the real estate disposition to
take an extra 90 days. In a struggling market, it could take a full
year. Not all Stakeholders will find this acceptable.
Potential Transaction Hazards:
Bank Covenants

Bank Yield Maintenance Provisions

Bank Prepayment Penalties

Hedging Arrangements

Syndicated Bank Loans

Uncooperative Minority Investors

Franchisor(s) Rights /
Agreements

Inexperienced Professional Advisors

Accountant / Legal / Tax

Special Permits / Licenses That

Tack To The Real Estate
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Private Equity & Real Estate

The View from the Private Equity Side of the Table
Sale Leaseback Issues A Personal Perspective:
Working a transaction with syndicated debt can be
challenging.
Focus on projected net after tax proceeds not gross
proceeds.
Get in front of issues with line employees and other
stakeholders.

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Private Equity & Real Estate

The View from the Private Equity Side of the Table
Sale Leaseback Issues Business Owner Post Closing
Considerations:
Fewer Fixed Assets = Less Debt Capacity
Lease must be structured to guarantee long term access to site hosting
business activity. Landlord #1 maybe low maintenance but subsequent
landlord(s) could have agendas. ROFR in lease preferred construct for
dealing with this.
If Sales Leaseback is used as a debt refinancing tool, at some point lease
expense will surpass debt service will the host business support this added
cash outflow?
Maintain flexibility to exit business with favorable lease assignment language.
Sale Leaseback tenant guarantee(s) inhibit business owners ability to have
complete access to funds in asset sale. There is an continuing contingent
obligation.
May limit exit opportunities with marginally capitalized business buyers
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Private Equity & Real Estate

The View from the Private Equity Side of the Table
Sale Leaseback Factors Critical to Success:
Clear and Realistic Client Expectations:
Value / Transaction proceeds
Time to close
Experienced legal, accounting & tax counsel engaged at the front end.
Pre-Packaged & up-to-date due diligence. Costs more on the front end but in
a strong market saves time
Form legal documents (PSA & Lease) that balance seller/buyer interests:
Helps with portfolio sale(s)
Assists with identifying serious buyers
Keeps ongoing legal fees to a minimum
Helps preserve seller sanity

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Private Equity & Real Estate

The View from the Private Equity Side of the Table
Sale Leaseback Factors Critical to Success:
Last, but not Least:

Competent Transaction Advisors

from Start to Closing!

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How to Contact Us
If you would like feedback regarding a transaction of interest or if you come
across a transaction that might be of interest, please feel free to contact me:

Jonathan W. Hipp
President/CEO
11150 Sunset Hills Road | Suite 300 | Reston, VA 20190
T: (703) 787- 4714 | F: (703) 787- 4783
jhipp@calkain.com
We will act quickly to provide you feedback. Every transaction is treated with
the highest level of confidentiality.

THANK YOU!!
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