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Property in M&A transactions

In this conversation, Justin Levine and commercial property expert, Johanna Hammersley discuss selling property owned by a company as part of an M&A process. They explore whether it is typical for property to be sold with the company, the typical issues that can arise in such situations and the complexities of structuring deals involving the sale of property including potential tax implications.

They also touch on issues such as occupational leases, raising debt on the target property, dilapidations and environmental concerns. Overall, they emphasise the importance of thorough pre-sale due diligence and clear communication between all parties involved in the transaction.

Watch the video below for the in-depth discussion.

Quick find timeline:

00:00 – Introduction Property in M&A transactions
01:03 – Will a strategic buyer want to buy the property as well as the company?
01:38 – Why might a seller want to retain a property?
02:12 – Occupational leases in a company sale
02:37 – Mechanism options and implications for transfer of freehold property
02:53 – Complications for carving out the property prior to completion
04:23 – Timing is everything!
04:47 – Tax considerations for property in M&A
05:17 – Complications for property owned by pension funds
06:07 – Issues arising on bank finance
06:33 – Potential issues if buyer is raising debt on the target property
08:26 – Review property implications early to avoid delays downstream
09:39 – Delays caused by banks’ due diligence
10:18 – Dilapidations and why they are important
10:55 – How schedule of conditions limit your repairing obligation
12:44 – What if dilapidation value in P&L is lower than property valuation?
13:34 – What if property’s original condition is unclear?
14:47 – Legislation on environmental issues, EPCs, asbestos
15:06 – CPSE replies to inquiries
17:24 – Heads of Terms considerations on property; breaks, rent reviews, repairing obligations
18:46 – Summary Property in M&A

Series 3 – Topics

  1. Pre-Sale Due Diligence in M&A
  2. Property in M&A transactions
  3. Trends for M&A Warranties and Indemnities
  4. Looking to Sell Your Business – Where to Start


Series 1 – Topics

Discussions to learn M&A basics in our first introductory series of videos, include:

  1. Introduction to the M&A Deconstructed series of videos
  2. What is EBITDA?
  3. What are Heads of Terms?
  4. Equity Share vs Asset Sale
  5. Completion Accounts vs Locked Box
  6. What is Due Diligence (DD)?

Series 2 – Topics

The conversations in the second more technical series of videos include:

  1. What is a Sales & Purchase Agreement (SPA)?
  2. M&A Warranties, Representations & Indemnities
  3. Getting Paid: Earn-Outs, Deferred Payments & Vendor Loans
  4. What could Derail a Company Sale?
  5. How much does it Cost to Sell a Company?
  6. 5 Insider Tips: A Successful Company Sale

Meet your M&A experts

Johanna Hammersley Senior Associate Solicitor | Commercial Property, Steele Raymond
Johanna has significant experience in advising on a wide variety of commercial property work including freehold / leasehold acquisitions, landlord & tenant matters and also specialises in property pension investment transactions.

Justin Levine – Managing Director, TheNonExec M&A Boutique
Justin leads a boutique exit advisory firm specialising in manufacturing, technology, IT, digital, healthcare, wholesale and distribution markets. With the support of a 15-strong virtual team of analysts and researchers, he helps private business owners with growth and exit strategies.


TheNonExec Limited
Contact us here to chat about your business exit.

Steele Raymond LLP
Richmond Point, 43 Richmond Hill, Bournemouth, BH2 6LR

Transcript for M&A Deconstructed

Transcript for video: Property in M&A transactions

Introducing Property in M&A transactions

Justin Levine:
Jo, you work for Steele Raymond, you look after the property, you are specialist in property should I say.

Johanna Hammersley:
Yes. Commercial property team, that’s right. Yep.

Justin Levine:
Excellent, excellent. So today is a conversation piece around property, but really specifically property that is owned by a company. That’s right. Yeah. So the conversation piece is, is it typical that property is sold with the company, yes or no? And if looking at each of those two angles, what type of issues typically tend to come up? So I’ll just start briefly from my side. I mean, from what I would say is that probably half the clients we deal with have a property, a freehold property in the business owned by the company, and the owner at the end of the journey coming to sell wants to sell the company and the property. It’s interesting, I’m seeing a greater trend in that, and I suspect it’s age driven. People are looking as they get towards the latter period of their life to liquidate all of the assets.

Will a strategic buyer want to buy the property as well as the company?

But the conundrum, if you like, is not all buyers want to acquire the property. It’s very simple. They have an investment case based on buying a company, trading company. They’ll base it on the profit that’s made by the company and they’ll have what they think is good and bad. Property is often seen for strategic buyers, at least as being a non-essential item. So they prefer to buy the company and have a lease in place but not have the property itself. What’s your experience? How many times do you find companies selling property? Is it something that happens frequently?

Why might a seller want to retain a property?

Johanna Hammersley:
It is something that happens frequently, but also there are reasons, not just also from like you said about the buyer not wanting to take on the property, but you also have situations where the seller may want to retain the property because they may be, for example, thinking of their pension or they’d rather lease it as well so they get some sort of income or put it into a pension scheme. So we come in with scenarios like that as well.

Occupational leases in a company sale

And the other important thing to note is we don’t just see, for example, situations where there is a freehold property. We also see quite often situations where we are dealing with purchases, where there are leases, occupational leases in place. So we’re not just dealing with sort of the transfer of a freehold property interest. We’re dealing with the occupational leases that we need to look at and advise upon, which can often actually be a bit more problematic and we’ll come to that in a bit than actually dealing with freehold properties.

Mechanism options and implications for transfer of freehold peoperty

Justin Levine:
Yeah, so from my side is that when I sit with my clients, I’ll offer a couple of, let’s say routes to follow. Yes. So one is to say. Well, okay, if they want to sell the property, that’s okay. We need to think about the mechanism by how that happens. So typically a seller won’t understand and will normally guide and suggest that from a tax point of view, it’s slightly disadvantageous for them because what it means is that if we construct a deal and the company has an enterprise value, let’s put it at £5 million. Let’s say the property is worth £2 million. So what has to happen unless the owner wants to purchase the property from the company before the deal’s done, what it means is the buyer has to effectively buy the total assets. So it has to buy the enterprise value at 5 million plus the 2 million. And then effectively is you have to have a back to back agreement whereby the, let’s say the seller, the shareholders acquire the property from the company out of the proceeds and carve the property out. Now of course, the disadvantage to that is tax because of course number one is that the seller is paying the tax on the total proceeds, capital gains tax. So that’s number one. Number two of course is the that seller. The shareholders typically have to pay stamp duty on repurchasing the property

Johanna Hammersley:
Back. Yeah, exactly.

Complications for carving out the property prior to completion

Justin Levine:
Typically that’s the only mechanism to get that property out of the company if A the seller wants to keep the property or B, the buyer does not want the property. Yeah. So let’s talk about actually taking the company or the property out of the company before a deal is done. Are there any complications surrounding doing it a deal like that?

Timing is everything!

Johanna Hammersley:
It’s all timings. And I think with all of this it’s about preparations and making sure the key is sort of knowing what you want to do at the outset and getting the wheels in motion as soon as possible because it’s obviously the delay to the bigger picture. So I think so long as everyone’s prepared and they sort of know what is going to happen and that transfer happens quite early on, then it’s all possible to do it.

Tax considerations for property in M&A

But as you say, one of the most fundamental things is the tax concerns and how that’s all going to work. So I think at very early stages a conversation needs to be had with a tax advisor as to what are the implications, what needs to be thought about, and obviously bringing solicitors on board to deal with the transfer if title transfer needs to happen or whatever. That needs to happen at very early stages. So there is no delay with the bigger picture, which is ultimately the acquisition later down the line.

Complications for property owned by pension funds

Justin Levine:
Yeah, I mean one of the complicating factors, and I’ve come in my experience is when the building is actually owned by pension and it needs a pension fund, the trustees to approve a transfer. So if people ask me what will slow down a deal, that’s one of those things that always raises a flag from my side saying, yeah, well we can go as fast as we want. The buyer can go as fast as we want, but the trustees of the pension fund might not go at the speed of it.

Johanna Hammersley:
And that’s true. It is true. It can cause a delay. I mean, recently, I mean obviously I also specialise in SIP and SaaS work. I’ve got a lot of experience from the pension point view. And I would say that recently things have improved the delays that we used to encounter with waiting with trustees approval on things like that. It has actually got better over time.

Issues arising on bank finance

I would say the biggest issue is if it’s subject to bank finance or something like that, then that obviously causes further delay. And that’s almost, I mean that’s got worse in my opinion, waiting for approvals from banks and things that will significantly delay transactions. But I would say dealing with pension schemes now shouldn’t really cause so much concern as it did previously. So yeah.

Potential issues if buyer is raising debt on the target property

Justin Levine:
You raise one point, which is always raises, if one flag’s gone up, the big one’s gone up and that’s when a buyer has to raise debt on the target property. And what I mean by that is that, so we’ve had transactions where the buyer will write in the heads of terms, it’s conditional. Our offer is conditional on as raising a mortgage on let’s say the freehold property owned by the company. So it seems innocuous, seems innocuous. You’re going, well, okay, that sounds okay, but you have to unpack it and say, well, what do you mean by that? So very often what it means is the buyer a wants to raise a mortgage on the property pre completion, so it wants the company to enter into a debt arrangement. Raise money very often is number two is it wants to have that money in the company account by the time the deal is complete.

In other words, the mortgage is in place, the company’s raised the debt, the money’s put in funds for the mortgage if you like. And number C is that often the buyer will want to use that money to acquire the shares. So how does it do that? Well, it has to then loan, the company has to loan the money to the buyer to consummate the transaction. Hugely thorny hugely thorny of course is that if anybody was on the receiving end of this advice saying, well, you are a seller and you’ve got to go raise a mortgage, the deal hasn’t happened. Hopefully it will, but you’ve got to go raise some money. You’ve got to put the money in your bank account. I know you don’t want to have a mortgage, but hey ho. And number three is you’ve got to lend that money to the buyer before the deal’s happened to consummate the deal. You can imagine just how much of an alarm that would cause. So I think what I’m saying here, this is one of the areas which on the face of it, an innocuous offer seems okay, but on the flip side of it, you think actually to make it happen requires a lot of legal work to make sure the seller doesn’t end up with having a mortgage lent the money and the deal doesn’t happen.

Review property implications early to avoid delays downstream

Johanna Hammersley:
Exactly. Yeah. Yeah. No, that’s completely true. And just as an aside, also, I think sometimes property is sort of that extra headache that sometimes gets forgotten. I always find whenever from a property lawyer’s point of view coming into these sort of transactions, I always feel like we are brought in to have a look at the property side of it, but it’s almost like we cause unnecessary headache because the property’s just a side issue. Do you know what I mean? And it is often, but often it can have these big headaches such as any lending arrangements or we’ve come across transactions recently where there’ve been big title issues that buyer doesn’t want, but they have to be resolved beforehand but holds up the whole deal. And everyone’s like, why is it taking so long? But I think that’s sometimes from a property solicitor’s point of view is the property part is important and the key is to make sure that any of those issues are sort of ironed out at the start. We know what they are, we do the full due diligence at the start, so it doesn’t become an issue, doesn’t hold up the bigger picture of getting the deal across the line. But unfortunately with funding, it is one of those big headaches that I think,

Delays caused by banks’ due diligence

Justin Levine:
I wonder whether it’s, my sense is because I’ve seen a number of these where it’s been really problematic when large banks have been the, let’s say the debt provider and are coming into the deal to finance the property and will not only want to do their own due diligence on the property suddenly at the last minute they want to do due diligence on the deal. And we’ve seen that time and time again and we’ve seen deals extend from completion dates of three months in one case went out to a year because the bank took so much time to get the administration into place.

Dilapidations and why they are important

So dilapidations, this is something that obviously comes up time and time again. When a property is being sold, for the uninitiated, what does dilapidations actually mean?

Johanna Hammersley:
So basically if you enter into a lease, you’ve got a repairing obligation in there, and very often it may be a fully repairing obligation, which basically means you need to put the property back into repair. If it is in disrepair, it needs to be in repair.

How schedule of conditions limit your repairing obligation

Now the issue is obviously you may have taken the property and it may not have been a great state to begin. And that’s obviously at that point you may have been ill advised that I wouldn’t have recommend anybody probably to do that if the property is not in a great state, we would always recommend that you have a schedule of condition that would limit your repairing obligation. So you were only obliged to put the property back into the condition it was at the start, at the date that you took the lease. But irrespective of that, you must always look at what the repairing obligation is because at the end of the term, your landlord will come around and say, right, I need you to do such and such in order to comply with that repairing obligation.

And that basically is your dilapidations, the dilapidations is the work that you have to do to put the property back into the condition either into repair or in accordance with the schedule of condition. So that’s what it is. So in this scenario where, for example, you were taking a property on as part of a business acquisition, it’s very important to sort of work out what potential liabilities are in the future because in some occasions with dilapidations you could be talking hundreds of thousands of pounds of work, basically even more depending on the type of property it is. So it’s incredibly important to think about that at this stage when you’re in the position of negotiating what the purchase price is. So that can be factored in. We do have scenarios where you may turn around to the seller and say, actually, can you carry out these works for me? I mean, I would say that would probably only be advantageous if, for example, you’ve got a year left on the lease or you were going to exercise a break clause or something like that. But I would definitely say it’s something that you need to consider and sort of deal with before you take on the liability of the lease itself. Yeah,

What if dilapidation value in P&L is lower than property valuation?

Justin Levine:
I see with clients that I’ve had, the only fly in the ointment, if you like, is often where the company will accrue for a dilapidations value in its profit and loss account. So it will estimate to saying to put the building back into repair is going to be 1 million. So over the life of the lease, we’ll accrue 200,000 every year, five years, for example, and suddenly a deal comes about they want to sell. Professional surveyors come in, they examine the contracts very carefully, they suddenly realise that the dilapidations value was not enough. And of course is that whatever the difference is, if it’s negative, has to come off the price of the deal.

Johanna Hammersley:

What if property’s original condition is unclear?

Justin Levine:
So it comes back to your point is if there’s one thing, and I don’t know how, maybe you can give me some guidance. I suppose the key is to have a very crystal clear idea when you have a lease as to what the original condition is. But what happens if you don’t? What happens actually if it’s vague?

Johanna Hammersley:
Well, that’s the thing. Sometimes we do come across this and it’s because the lease is in some way defective because they may say, I mean we often, we come across leases where it says to put the property in the condition it was at the start, but there’s no schedule of condition. And that’s the point where you don’t know the answer is in the nicest possible way. We don’t know. It depends what the landlord’s view is on that as well. And it becomes a bit contentious to be honest. But I think if you were acting for a buyer, your view would always be, well, we need to put it into the condition in the repair condition. So you go for the most onerous sort of position that you could do. And that would be my starting point would be like, well, I would expect you to cover the lapse in order to put that property back in to repair. So that would be my, so

Justin Levine:
It’s a negotiation.

Johanna Hammersley:
It is exactly, but it’s definitely something very important to factor in. And this is one of these points that often can cause issues in transactions. And although it seems a very minor point in the bigger picture, it is incredibly important because you are talking about huge sums of money that can be detrimental to business moving forward. So yeah,

Legislation on environmental issues, EPCs, asbestos

Justin Levine:
Moving gears slightly, I want to just examine a little bit, and it’s a bit off piste from my side as it doesn’t tend to come up, but that’s when selling property, the environmental issues, EPCs, asbestos, I don’t know whether legislation is any tighter or what typical concerns come up when selling properties on those typical fronts?

CPSE replies to inquiries

Johanna Hammersley:
Yeah, so generally, so as part of our due diligence, we will raise things called CPSE replies to inquiries. And within those we will ask questions about asbestos. We will ask about EPC if the seller is aware of any previous environmental issues, things like that. Very often we don’t get a lot of responses. They’re very lengthy replies and you don’t often get a lot for them. But you do essentially find out if there is an asbestos report in place, EPC and things like that. They are very important. And obviously as a buyer it is important to be aware because when you’re taking on the property, you are taking on the liabilities that come with that property. And that would mean, for example, that you are the duty holder when it comes to asbestos. EPC regulations have changed and likelihood is things are going to get tougher and tougher in that respect.

So it’s very important to find out what the rating is in case you might be prevented in the future from letting out if you want to, depending on what the rating is or whether you have to carry out works to improve the energy rating. And those are all things to factor in because obviously they have business consideration, the cost to the business, things like that. Again, environmental issues are incredibly important because the property might’ve been built on, I dunno, an old petrol station or whatever it is. And there may be things that may come out of the woodwork later on. So you sort of want to identify what are the potential issues and whether you can limit that liability moving forward. And that’s sort of where we step in when it comes to our participation in an SPA in the share and purchase agreement, what the warranties and what we tend to look at will very much depend on the results of all that due diligence that’s being carried out.

Justin Levine:
Yeah, thank you. Conversely, property is kept or is carved out of the balance sheet and is either the shareholders own that property or they put it into a pension or SIP or such like putting leases in place. What type of issues tend to come up, if any, when putting an arm’s length commercial lease in when you have a new buyer? Do you tend to see issues arise or is it generally fairly transactional? People know roughly what they’re looking for?

Heads of Terms considerations on property; breaks, rent reviews, repairing obligations

Johanna Hammersley:
Yeah, generally people should know what they’re looking for. The key to that, if there’s a situation where the property’s being carved out is again agreeing those heads of terms so everyone is clear what the expectation is. There’s no nasty surprises. There shouldn’t be, I mean, generally you would expect an arm’s length lease to be fairly similar. I would say the keys are the buyer thinking about what’s their future plan for the business, the term they want break dates, rent reviews, so they’ve got certainty as to the rent. When are those rent reviews going to take place? When are those increments going to happen? Repairing obligations are very important. What is the state of the property at the moment? Does it need a lot of repair? So those kind of things need to be thought about. Generally you would hope that everyone is sort of singing off the same hymn sheets, song sheet, whatever the expression is. Sorry. But I think that the fundamental key is, again, it’s preparation. I think with all of this, it’s sort of everyone saying, right, we’ve agreed the heads of terms not for, I think the danger is if it’s almost being forgotten, well, we’ll enter into a lease. Okay, well we get to the point of entering to a lease, but what’s going into that lease? And I think that’s the issue. That’s when you have disagreement and complications happen. So it’s just at the outset being very clear what’s going to go into that document. Yeah, okay.

Summary Property in M&A

Justin Levine:
Yeah, thank you. So I think in terms of summary, I mean certainly where I sit commercially is I’m seeing more business owners selling property as part of the offer to take their business to market. The appetite to buy property and businesses is in the minority rather than majority. In other words, most of the strategic buyers, trade buyers are large companies are not wanting to buy property. But if you were to sort of push me into a corner, I’d say 25% of buyers will consider it. So it is possible to sell property as part of a company deal, number one. Number two is that I think as a takeaway is when a buyer wants to raise money, debt on the target property to consummate the deal, get your lawyers involved, get your commercial and corporate finance people involved to unpick it to be very, very certain as to what that actually means, because it can be interpreted different ways. Some are fairly benign and some can be, gosh, actually that’s going to be quite tricky. So those are the takeaway points from my side. And of course, as ever, get yourself a good lawyer that can actually help you unpick any demands that are required of the due diligence.

Johanna Hammersley:
Yes, exactly. Okay. Yeah.

Justin Levine:
Thanks Jo.

Johanna Hammersley:
Yeah, that’s okay.

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