This has been a strange year so far with many moving businesses struggling in the face of lockdowns the world over. Desperate times sometimes require desperate measures and if the cash runs out, the need to raise money quickly becomes an imperative. Here, James Polo-Richards of Wright Hassall Solicitors looks at sale and leaseback strategy for property and how it can play a major role in fundraising efforts.
What is sale and leaseback?
Through a sale and leaseback deal, owners of a property sell to another party, agreeing to take a lease of the property back immediately. This process gives businesses an alternative way of raising finances, instead of having to turn to the banks for support. In addition, many property investors, including large funds, private equity houses and smaller individual investors, are looking at a range of opportunities.
Many funds, unless they can negotiate or revise terms, may be bound by covenants to spend cash they have raised by a certain date; and individual investors may see little value in the interest rates offered by banks or not be prepared to risk the current volatility of the stock market. Accordingly, there are people in the market who have cash to spend.
As with every transaction there are advantages and disadvantages as outlined below.
Release of cash and existing debt
For many businesses a sale and leaseback allows them to convert an asset into cash without losing control of the business. In the same way, where bank debt is secured against the asset, the sale of that asset should enable a company to repay that debt and remove the ongoing need for interest repayments.
Lower costs compared with traditional refinancing
While engaging with a bank to secure debt against an existing asset may be an option, there are usually higher transactional costs associated with such deals, including being responsible for valuation, arrangement, legal and bank commitment fees. Theoretically, a sale and leaseback deal should see each party bearing their own costs.
Providing certain conditions are properly met, the leaseback aspects of a sale and leaseback deal may be exempt from SDLT (Stamp Duty Land Tax) meaning that the business will not need to pay any SDLT on the grant of the lease. The sale element is still likely to attract SDLT for the buyer.
Loss of value to the business and directors’ duties
The sale of an asset is obviously a key consideration for directors as it could reduce the value of the business in any future business sale.
It is important to remember that while directors owe a duty to the company, where a company falls into financial difficulties and the risk of insolvency is real, those duties can then extend to creditors. In exercising these duties, they need to ensure they are minimising losses.
Before any decision to enter a sale and leaseback arrangement is made, it is best practice for companies to seek professional advice and ensure the approach they’re taking is beneficial considering their current position.
Financial covenant and security
An investor buying any asset wants to try and build in a level of certainty that the rent due under the lease they grant will be paid. In uncertain times there may be a feeling amongst investors that some companies looking at sale and leasebacks are struggling financially and a commitment to pay rent over a long term may not be realistic.
In such circumstances, parties will need to consider whether any rent should be held back in escrow (money held by a third party) or in a rent deposit deed. This would give the investor certainty that an element of the rent is already held securely if the new tenant does not perform.
Depending on how much rent is held in this way the seller/tenant may be quite relaxed: from a cashflow perspective they will know that they won’t actually have to pay any rent for a prescribed period if it has already been escrowed. If they have been able to negotiate a rent-free period as part of the deal this could leave the seller/tenant with a couple of years to focus on other parts of their business.
As with any transaction it is important to consider a number of factors, but sale and leaseback might represent a sensible option for many.
James Polo-Richards is a real estate lawyer with Wright Hassall Solicitors in the UK. He works alongside clients to help find practical solutions to problems so that they can achieve their goals and realise the value of their assets in a timely and cost-efficient manner.