For many businesses the financial packages offered by the UK Government, trying to keep the economy afloat during the coronavirus pandemic, will provide much needed support and respite. Nonetheless, if the stories being reported are to be believed, for many companies the money cannot come quickly enough with the Business Secretary acknowledging over the Easter weekend that ‘more money needs to go out faster’.
The real estate property world has been exploring alternative ideas for raising cash quickly and, in doing so, has dusted off an old favourite – the sale and leaseback.
What is sale and leaseback?
A sale and leaseback deal does very much what it says on the tin – the owner of a property sells a property to another party and, as part of the transaction, agrees to take a lease of the property back immediately. Indeed, as an example, Next Plc is one of a number of high-profile companies that has announced plans to market a number of their assets.
A sale and leaseback can provide an alternative means of raising finance for a business which may prefer to free up cash in the business rather than approaching a bank for the money.
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 which we outline 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 to 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 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 director’s 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. Accordingly, any decision to enter into a sale and leaseback arrangement, where the company is perceived to be struggling, should always involve professional advice and a clearly documented decision-making process why the company took this approach.
Financial covenant and security
This is a key one for any investor. 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 or in a rent deposit deed. This would give the investor certainty that an element of the rent is already held securely in the event that 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 at the moment. For more information or advice on how sale and leaseback might help your business, please contact a member of our commercial property team.