There’s more than one way

ForSalesmto sell your club

Adult nightclub sales have come a long way from “handshake deals.” Realtor and club broker Winston Hines explains several modern ways for buyers and sellers to both walk away satisfied.

Last issue we talked about curb appeal as your first shot at making a good impression on your potential buyer.  In this article, we are going to zoom forward just a bit to take you right to that closing table and that almighty check.  (We’ll bounce back to some other important considerations in later issues).

Every sale of an adult club is really a two-part deal: the real estate and the business.  Although there may only be one purchase price identified, somewhere in the background there very probably is (and should be!) a CPA on each side of the deal, each with possibly differing perspectives on how that sale is to be optimally arranged for the benefit of his or her own respective client. How much purchase price is allocated to the real estate and how much to the business has a dramatic impact on how much the seller gets to keep, and how the buyer’s purchase starts out being treated. 
Folks, it really, really crucial to get your accountant involved and prepped at the very early stages of a buy/sell for just one (of many) simple reasons: One way or another, once the sale is done, the IRS and/or your state revenue office will be seeing some paperwork come over to them. How that deal is arranged will have a lasting and probably locked-in impact on both the seller and buyer. This is not just a plain old buyer and seller deal, but a deal with accounting, reporting and lasting financial consequences. And I haven’t gotten into the attorneys yet!

The All-Cash deal

Sounds simple, doesn’t it? Cash (in whatever form it takes) at the closing table is still king. It works, and it works fine in usually the simplest deals. But when the sale price gets large enough, here is just one for instance for why that may not be the best way to go on just the real estate portion of the deal: If you are the seller, and you have owned the building for a fair number of years, when you sell it you just might get hit with some heavy capital gains taxes.  
But there is an alternative if you do not have to have the money immediately in hand: The 1031 Tax Free Exchange.The 1031 Exchange, sometimes called a “like-kind” swap or “starker exchange” for another piece of real estate, involves a third party intermediary or trustee, critical special language in the buy/sell documents, and a lot more preparation.  A 1031 swap is not simple and does have a lot critical factors in it that do require experienced professionals, including the broker(s), the lawyers and the accountants.  But the upside for the seller is to avoid (defer) tens, maybe into the hundreds of thousands of dollars in capital gains taxes.  Every situation is unique, and it really depends on how your ownership is set up.  I am not an accountant, so do go talk to yours if you own the real estate.
And just to spike the ball a bit, you can do a 1031 Exchange on the FF&A (fixtures, furnishing and equipment) of the business, but you are going to have to have all your ducks in a row with your accountant to make it worthwhile. The sale of the business, per se, is not allowed on a 1031 exchange.

The “Owner- Financed,”
(aka) “Private Mortgage” deal

The vast majority of the deals done in our industry in some way, shape or form have some manner of seller financing.  The seller is now not just the owner of the club wanting to sell, but is now, in effect, the loan officer for the deal.  (In case anyone out there is thinking about banks, or SBA Loans, your probability of getting a mainstream debt vehicle in any adult business or real estate is honestly next to zero.)  
With this type of deal, there are advantages for both parties. First, the buyer leverages his buying power: Instead of plunking down everything at the closing table, he or she puts down usually as low as 15-20%, but more likely from 25-45% or so.  The seller doesn’t get all his or her money up front, but suddenly has a cash flow consisting of the principal of the financed amount, plus the interest, and usually that interest rate is 2-4% (depending on the solidity of the buyer and other concern) above the going market rate for commercial notes. Since this is a “private” mortgage, nothing is required to be reported to the credit agencies. There are a lot of moving parts, considerations and negotiation points in a private mortgage deal, and I won’t go into all of them here; we will dig into a bunch of them in a subsequent article.

The IRS code 453 Structured Sale

This is a specific IRS “allowed” animal that very carefully “structures” the payout to the seller so that he or she does not cross over into higher tax brackets.  You will not be doing this one via do-it-yourself TurboTax! The entire purpose of this structured sale is to limit the tax liability the seller will owe on capital gains and the new 3.8% Medicare tax bite (aka Obamacare).  It is a private mortgage with guaranteed payouts,  but with very specifically arranged terms and timetables. Again, though I sound like a broken record, see your accountant.

The Earn-Out

By definition, an earn-out agreement is defined as “a contractual provision stating that the seller of a business is to obtain future compensation based on the business achieving certain future financial goals.” Whoa there! Come again?  When the seller and buyer have reached that dead- in-the-water point, where the deal may just die because the seller and buyer cannot bridge the gap between the offering price and the selling price, this might be a solution.
Though it starts out looking like a private mortgage, the buyer will agree to pay an agreed upon percentage more than “X’’ dollars of purchase price, based on gross sales or net earnings performance over an agreed upon time or benchmarks. The seller agrees to take less than his full asking price if it is apparent that the buyer cannot achieve defined and stated benchmarks  or those future earnings.  It is not perfect, but it does work. What it does take from both sides is pretty darned clean and transparent income and expense reports to—you guessed it—the accountants, on both sides.  It can be a very good win-win, and there have been a lot of these deals out there done primarily in the computer and Silicon Valley businesses.  
Have I personally negotiated such a deal for a client? No, not yet, but there is always the next one.  It does take a motivated buyer and seller who trust each other enough allow the seller to look over the shoulder, so to speak, of the buyer’s operation, and the buyer to do his level best to crank the operation up to a higher profit level. I’ve taken a hard look at a lot of these earn-outs, and they just may offer some serious advantages on one of our deals.
There are many, many variations on each consideration outlined above, and I have not even touched on stock versus asset considerations, but will do so in later writings. Feel free to flip me a comment or question, and I’ll try to point you in the right direction. But start with your accountant!
 The bottom line is, there is a lot of money now and in the future for both parties at stake on a club deal. Doing the best deal for both parties is going to take a lot more preparation, negotiation and assistance than just a handshake.     

Winston Hines, Broker in Charge of HWH Properties, is a licensed commercial Realtor and Business Broker, specializing in the purchase and sale of adult nightclubs throughout the U.S. for over 15 years. He can be contacted at either (864) 580-3826 or updaze@aol.

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