July 15, 2025 - The current interest rate environment and stricter lending by banks has forced companies and their leaders to look elsewhere in search of liquidity and cash flow. One often overlooked strategic tool business leaders may be able to use is a sale and lease back transaction (SLB). In the right situation, this can be a powerful tool to unlock liquidity. An SLB involves a company selling an asset, typically real estate or equipment, and simultaneously leasing it back from the buyer, thereby converting an illiquid asset or assets into cash while having the ability to continue using them.

An SLB allows a company to generate immediate cash flow for the business from the sale proceeds without disrupting the operations of the company. That cash flow can then be re-allocated from the previously illiquid asset to be used for critical needs including research and development, expansion, and debt service. The liquidity injection can be extremely valuable to companies, particularly in uncertain economic times, during periods of restructuring, or when capital needs are high due to growth opportunities.

Prime Candidates for SLBs

While an SLB can be a powerful liquidity tool, not every company or asset may be suited for an SLB. Here is a list of some criteria that may mean a company or asset is particularly well-suited for an SLB.

1. Asset-Heavy Businesses: Companies with significant real estate or equipment holdings, such as manufacturers.
2. Stable Operators: Businesses with predictable cash flows and long-term operations needs for the asset.
3. Creditworthy Lessees: Companies with strong credit profiles may be more attractive to investors and can negotiate better lease terms.
4. Private Equity-Owned Companies: Private equity firms often use SLBs to extract value from portfolio companies without increasing leverage.
5. Companies Undergoing Restructuring: SLBs can provide non-dilutive capital to support capital needs for turnarounds and restructuring.

Transaction Structuring

The structuring of SLBs is a critical component to ensuring that the company entering into the SLB transaction gets the accounting treatment the company expects so that it has a predictable impact on the financial statements, financial reporting moving forward, and maintenance of KPI’s and bank agreement covenants. SLB transaction accounting is governed by Accounting Standards Codification (ASC) Topic 842, Leases, specifically ASC 842-40.

The first criteria that an SLB must meet is the sales criteria under ASC 606, Revenue from Contracts with Customers. This provisions of ASC 606 includes requirements including: (1) the agreement to sell the asset has legally enforceable rights, is approval by both parties, and has identifiable rights and payments terms; and (2) the buyer-lessor must obtain control of the asset, which may be evidenced by its ability to direct the use of the asset and obtaining substantially all of its remaining benefits. Transactions will automatically fail the second of these two criteria, the transfer of control, if the lease is classified under ASC 842 as a finance lease or sales-type. If the lease is a finance lease or sales-type, the buyer-lessor is not deemed to have obtained control and the accounting treatment for this so-called “failed sale and lease back” transaction, is different than one which receives normal sale and lease back treatment under ASC 842.

Therefore, it is critically important to structure the lease correctly and know before finalizing the transaction how the lease will be classified under ASC 842 to achieve predictable post-transaction accounting and impact to the financial statements.

If a lease meets any of the following criteria, it will be classified as a finance lease for the seller-lessee (a sales-type for the buyer-lessor), and therefore not eligible for SLB accounting treatment:

1. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
2. The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
3. The lease term is for the major part of the remaining economic life of the underlying asset. However, if the commencement date falls at or near the end of the economic life of the underlying asset, this criterion shall not be used for the purpose of classifying the lease.
4. The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments equals or exceeds substantially all of the fair value of the underlying asset.
5. The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

The fourth criteria requires the most attention, because #1-3 are relatively straightforward and can easily be avoided by not putting features like this in the lease and #5 is not a very common situation for most companies. Companies entering into SLBs should look at the fair value of the asset being sold, the term of the lease, the discount rate to be used to discount the lease liability (the rate implicit in the lease, the company’s incremental borrowing rate, or the risk-free rate is also an option for private companies), and the payments under the lease to ensure that the SLB transaction is going to the accounting treatment the company is looking to achieve before the transaction is finalized. If, after combining all those factors, the net present value is substantially equal to or exceeds the fair value of the asset being sold, it will be a finance lease for the seller-lessor. The lease being a finance lease instead of an operating lease may have unintended consequences for the balance sheet and covenant calculations as there is an interest component present with financing leases that is not with operating leases.

If the asset transfer is considered a sale under ASC 842-40 because it meets certain provisions under ASC 606 (as discussed above), when the proceeds provided by the buyer-lessor are paid to the seller-lessee, the asset sold is removed from the books of the seller-lessee. A gain is then recognized and a right-of-use asset and lease liability are created for the operating lease that is now in place as part of the SLB transaction.

If the asset transferred is not considered a sale and the transaction falls into “failed sale and lease back” accounting, then the proceeds provided by the buyer-lessor are recognized as a liability on the balance sheet of the seller-lessee. The asset which was “sold” remains on the balance sheet of the seller-lessor, and the liability is discounted at a rate in accordance with other accounting topics. However, the interest rate should be adjusted to ensure that the rate being applied does not result in a built-in loss at the conclusion of the lease when control transfers to the buyer-lessor. This accounting treatment is inherently more difficult because it requires companies to estimate the future carrying value of the asset many years in the future and evaluate it periodically to see if the discount rate on the financial liability needs to be adjusted.

How Citrin Cooperman Can Help

SLBs are a powerful liquidity tool for many companies. The transaction should be evaluated thoroughly prior to execution to ensure that it is structured properly. A proper structure ensures that your company receives the desired financial reporting treatment so that management, stakeholders, and lenders are not surprised by the impact of the transaction on the company’s financial statements, KPIs, and covenants. If you are considering if an SLB is right for your business, contact William Morrill at wmorrill@citrincooperman.com or your Citrin Cooperman Manufacturing and Distribution Industry Practice professional today for assistance.