How to Screw Up an Acquisition

How to Screw Up an Acquisition

Acquisitions often focus on just a handful of items: synergy, talent, perhaps geographic coverage and/or technology, and revenue of course. The investment bankers and attorneys that orchestrate the deal generally do a great job of ferreting out the business issues that need resolved. Except for the real estate.

In the grand scheme, real estate is probably not the top issue, or even in the top five for that matter. However, it can represent a huge financial liability. Especially if your firm will take over a lease(s) and the acquired principals are the building owners, there is significant risk. That risk can be eliminated or at least minimized. You just need to take action before the merger is complete, not after.

There are three primary risks associated with the real estate in a merger:

  1. Utility
  2. Marketability
  3. Unfavorable Terms

The first is easy enough to to determine with inspection, and more easily mitigated after the fact. Most companies will identify and plan for disposition or elimination of the location(s) as part of the acquisition negotiations.

Ditto for marketability, or determining fair market value, although we sometimes see acquirers look the other way on above market valuations or lease terms because they’re more focused on the operational terms of the deal. Sometimes this is because it is either a special use facility or in a very small market where market comparables are non-existent.

This often results in money left on the table, rather than a disastrous financial situation.

The greatest risk, and surprisingly the most common when a lease-back from a principle is involved, is the Unfavorable Terms risk. Here’s why: Closely held private firms frequently enter situations where the principal(s) purchase and own a building and lease it back to the company. This type of arrangement, which is generally presumed to be at arm’s length, may only actually be fair market terms on the surface. They are almost never memorialized with a lease document that would be found between an open-market sophisticated landlord and tenant, so the business terms and potential liability can also be far from typical.

While it is reasonable for legitimate costs of operation to be passed through, many closely held properties provide for much more liberal applications. For example, we have seen net leases which allow for all costs of ownership including financing costs. This could obligate the lessee to pay for refinancing expenses, and perhaps even allow the property owner to withdraw equity and require the increased payments to be absorbed by the lessee. They may also require capital replacements and/or improvements, remediation of environmental issues, or require return of the property at the end of the term in original condition (and not subject to “reasonable wear and tear”). This can add hundreds of thousands or even millions dollars of unplanned expense.

By including a corporate real estate professional as part of the acquisition team, a firm can 1) confirm that no unfavorable market lease terms exist and 2) renegotiate any terms on facilities where a principal of the target may have an interest in the property.