Related-party rent

Factual definition

Rent paid between related parties, such as a business and property owned by its owner or the owner’s family. The contractual rent may differ from market rent.

Hypothetical annual US$ millions: replacing below-market rent with a market-rent assumption adds 0.22 to expense and reduces normalized earnings before interest, taxes, depreciation and amortization (EBITDA) by 0.22. At an unchanged 8x enterprise-value-to-EBITDA multiple, indicated enterprise value falls by 1.76. That is a valuation sensitivity, not a guaranteed change in the sale price or the seller’s proceeds.

At the small end ($500,000-to-$5,000,000 businesses trading at 2-to-4× earnings) related-party rent is near-universal and almost never at market. It is usually innocent and always consequential: the owner set both sides of the lease, in whichever direction suited the taxes of the moment.

The consequence is directional arithmetic. Below-market rent inflates EBITDA and gets marked down, shrinking the price.

Above-market rent deflates EBITDA and gets marked up. At a 2-to-4× multiple, every dollar of re-marked rent moves the price two to four dollars.

Diligence every related-party lease to its market comparables, re-mark it, and then separate the two decisions the seller has fused: selling the business and keeping the building. If the property stays with the seller, the post-closing lease must be written at the market rate the diligence used, otherwise the buyer’s price was computed on rent the business will not actually pay.

This is the adjustment that is simultaneously small enough to seem technical and large enough, at the multiple, to change the price by more than any other single line. It is also the one where the seller’s ongoing role as landlord makes the renegotiation personal.

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