Selling An Operating Business and Real Estate - Who's The Broker?

An Operating Business Isn't Real Estate and Shouldn't Be Sold Like It

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Selling a working business, even when the real estate is included, requires a very different approach to valuation.  Too often real estate agents and brokers don't realize the difference, as they don't get that many requests for this type of transaction mix.

When a business owner also owns the real estate, they will want to either close down the business and sell the real estate, or sell both. Real estate agents and brokers are tempted to list both together, and that can be a mistake.

An operating business is a very different animal from the real estate where it resides. There are also very different contractual agreements necessary to transfer business assets. They aren't like real property, and can actually contain guarantees of volume and existing client/customer base demographics.  The valuation parameters are very different, as a working business had "good will" considerations as well as existing contractual and possibly supplier agreements.  Sometimes they can't pass to a new owner.

Real estate professionals, particularly those in the commercial niche, have the knowledge and expertise to analyze rental income and expenses, presenting them to their client/customer for decision-making. Where they can fall short is in analyzing a business from a financial perspective. There is a lot under the surface, and examination of a Profit & Loss and Balance Sheet doesn't begin to get at the true facts.

In the rural area in which I practice, a real estate broker had listed a business for sale, and this was without the real estate. The building was rented. As I had an interested customer, I called and asked for the financial data, receiving a P&L and Balance Sheet. I called back and asked for a Cash Flow breakdown.

The broker didn't really know what I was requesting.

The P&L of a business is often very different from the cash flow; just ask an IRS agent.  One of the benefits of owning a business is getting some breaks by deducting expenses as business that would be personal otherwise.  We're not talking necessarily about illegal or tax-dodging activities.  An example would be deductions for a vehicle and its cost of operation, as it can be used for both personal and business activities.

It was a disservice to his client to list his business when the most basic of requirements wasn't within his knowledge base. Any good business broker will require a cash flow analysis from their client as one of the most important financial documents. Adjustments to the value of the business are made based on items in the Cash Flow, including:

  • Detailed spreadsheets of all income
  • Detail of all expenses
  • What expenses are actually going to the benefit of the owner
  • An adjustment back to income for those owner-benefit expenses that will go away (not be expenses to new owner)
  • An addition to expenses for owner-benefit costs that will require new buyer to increase expenses (owner managed/buyer will hire manager)

In a previous life career, I sold a business to a company going public on the New York Stock Exchange.

They sent in a team of auditors who spent several weeks, mostly verifying my cash flows. An example of an owner expense that was going away was my truck expense. The company provided me with a vehicle, all expenses, maintenance and fuel included. They added back that expense and increased the value of my business, as it really wasn't a true expense that they would have to pay after purchase.

As I stated in the item list, if the selling owner also managed the business, and didn't pay themselves a market rate salary, then the buyer would need to adjust their valuation of the business downward due to the necessity of hiring a manager at market salary.

As you can see, there are a number of factors that make the valuation of an operating business much different from the sale of real estate. And we haven't even gotten into inventory.

Another thing about business valuation is the different ways that it is calculated depending on the industry or business type.

It is clear that most real estate professionals should not be engaged in the brokerage of operating business enterprises, unless they have the experience and expertise to do it. A far better approach would be to partner with a business broker who doesn't do real estate brokerage. It will be a mutually beneficial relationship, with each of you bringing maximum experience and value to the client/customer.