How much time is left on your lease?
The World Series is about to begin. Football season is going strong and basketball is starting up. I love this time of year. After going through many days of extremely hot weather the cooling down is greatly appreciated.
Sounds great, doesn’t it? One big problem popped up. The lease on the property had one year left on it.
Please read this carefully. Your business is not worth anything unless you have a minimum of five years left on your lease. Ten years with two five-year options would even be better.
The business owner who had only one year left on the lease owned a company that was worthless. The owner and his wife had worked many years building the company.
The plant owner next approached his landlord. The cleaner told the property owner he wanted to extend the lease because he had a buyer. The property owner saw dollar signs light up. This was an opportunity for the landlord to make money the easy way. He told the cleaner he wanted a percentage of the sales price for the lease renewal.
Talk about greedy people, but a case like this is not unusual. The cleaner and the landlord did not have a great relationship. This was due to the fact the location was sold within the previous five years. The tenant and property owner never were able to develop a working relationship.
There were three mistakes on the part of the drycleaning business owner.
Mistake number one was to let his lease get down to where there was only one year remaining. This couple worked hard all their lives and now have nothing to show for their endeavors. The rule of thumb should be when your lease gets down to five years consider approaching your landlord. If you have three years left on the lease, you must sit down with the landlord and get a lease extension with options. If you do not do this, you are cutting your own throat.
Mistake number two was his original lease did not provide a right of first refusal in the event the property is put up for sale. This provision is considered a CYA clause. If possible, have a right of first refusal as a provision in your lease. If the cleaner had that right of first refusal, he might have been able to purchase the property.
Mistake number three was telling the property owner he had a prospective buyer. Had the cleaner sat down with the landlord and asked for a new long lease that had a lease assignment provision in the event of a sale plus a right of first refusal the cleaner would have been in good shape.
Put yourself in the business owner’s shoes. The business owner is now under the control of his landlord.
Rule number one: Always attempt to buy the property where your business is located.
Rule number two: If the property owner will not sell the land, have a right of first refusal in the lease, and the ability to assign the lease to a buyer.
Rule number three: Never let your lease get down to one year. Some people are renting their business location on a month-to-month basis. I hope that you are not in that position.
While discussing his lease problems, I inquired as to whether he was skimming. He said, “Just a little.” I did not ask how much a “little” meant.
This presented another issue. If you are considering selling your company, declare all sales at least a year prior to putting the company on the market. I suggest this because you really should not carry the loan for the sale of the business.
If a prospective buyer wants to make a bank loan to finance his purchase of your company, it is imperative that you have all sales reported. Your business is only worth what is declared on your company tax return.
You could get lucky and find a stupid buyer who is willing to pay for undeclared sales. That would be lovely. If your prospective buyer wants you to carry the loan, be aware that you are jeopardizing yourself and your family.
I know of a couple of cases where the cleaners carried the loans. The buyers in both cases milked the plants dry and then declared bankruptcy.
At one location, not only did the buyer declare bankruptcy, he pulled out all the equipment in the middle of the night, leaving just the racks with the clothing. No computers, no customer records, nothing was left to give the location any value. That was a tragic turn of events for the seller who was counting on the income for his retirement.
Do you want to loan your money to a stranger and then lose it all?
I next asked the seller what solvent he used. I was told that he was using perc but had switched to petroleum about eight years ago. I inquired as to whether he was familiar with a Phase 1 or Phase 2 environmental test of the business. As he was not a member of any trade organization, he was ignorant of what those tests were. He was fortunate the new property owner was able to pay cash for the land and did not demand either of those environmental tests.
This cleaner then asked me what a fair price should be for his business. Talk about doing things ass-backwards! This poor man should get an Olympic gold medal for running in reverse.
I told him to get out his adding machine, or computer, and enter the following information: The amount of income he declared on his personal tax return; the “little” amount of money he skimmed; the value of everything else he ran through the business including, but not limited to, cell phones, personal insurance, gasoline and even the free cleaning and laundry.
He sent me the number $165,000 and asked me again to provide a value for the business.
I explained that it was zero because of only one year left on his lease, but if he had ten years left on the lease and the equipment was purchased within the last ten years, it could vary from four to six times $165,000. His exclamation was, “Six times, that is over $900,000!” I asked him what his agreed on selling price was.
His response was, “$500,000” with 20 percent down and he had to carry the $400,000 loan.
This kind of situation happens when a business owner is burnt out. Had he done his homework, and prepared his company for sale, I would never have received his email.
The bottom line to this terrible story is this: prepare yourself and your company for selling. Join your local and national trade associations. Meet with other people in the industry and learn from them. Whatever you do, do not let your lease get down to one year and then let the landlord know you have a buyer.
Harvey Gershenson operates Sterling Drycleaning Consulting and is a former owner of Sterling Dry Cleaners. A second-generation drycleaner, he has been in the industry since he was in high school. He has served as president of the Cleaners and Dyers Guild of Los Angeles and has served on the boards of directors of the Drycleaning and Laundry Institute and the California Cleaners Association. He is also a guest lecturer for the California Department of Corrections. He can be reached by e-mail at firstname.lastname@example.org or phone at (310) 261-2623. His web site is drycleanerconsulting.com.