Related-party transactions, explained simply
Where the owner leases the premises to the company through a separate property entity, the rent may reflect convenience rather than market value. After the sale the arrangement will normally be repriced, and EBITDA is adjusted to reflect the real cost.
Related-party items can also create obligations that surface only after closing, such as loans to or from the owner or guarantees.
Rent paid to the owner against market rent
IllustrativeAlder Creek Manufacturing, $ thousands per year
The $150,000 shortfall reduces EBITDA by $0.15 million, equivalent to $1.2 million of value at 8.0x.
Common related-party transactions
| Transaction | What diligence checks |
|---|---|
| Rent paid to the owner’s property company | Is it at market rent, and will the lease continue? |
| Family members on payroll | Are they working, and at market pay? |
| Sales to or purchases from owner-controlled businesses | Are prices at market rates? |
| Loans to or from the owner | Must they be repaid at closing? |
| Shared services with another owner business | Will they continue, and at what cost? |
Worked example
Alder Creek pays $100,000 a year of rent to a property company owned by the seller. A market rent for the building is $250,000, and after the sale the seller will charge market rent. Diligence reduces EBITDA by $0.15 million, which is $1.2 million of value at 8.0x.
Alder Creek Manufacturing, Inc. is a fictional company. All figures are illustrative.
Why it matters in a deal
Related-party terms can quietly raise or lower profit, and can leave costs or obligations that appear only after closing.
Red flags
- Related-party arrangements with no written contract
- Sales to related companies at above-market prices that inflate revenue
- Owner loans not recorded in the books