Legal And Financial Issues

I received an excellent question recently regarding business leases. While this component to buying a business can entail a wide array of issues, I want to cover off the most common questions that come up.

 

Taking Over a Lease Versus Signing a New One:

On this topic, I am neutral.

The key with any lease when buying a business is to have one in place that reflects what you, the buyer, needs for the specific business.

For example, if you are buying a retail store that relies heavily on the location to drive customers, and is not a destination location, then clearly you will want the longest lease possible in place to ensure your future success.

However, what if, the business is located in a plaza where an anchor tenant drives the traffic? In this case, you’d want the ability to either renegotiate or break the lease should that key tenant leave. Sticking with the retail example, if the current lease has less than five years you would surely want to either have an option added or a new lease negotiated with the landlord.

On the other end of the spectrum, if the business does not rely on its location to drive revenue, and you are confident that you can easily find other space and it will be cost-effective to do so (especially in today’s market) then, outside of the nuisance of moving, as long as there’s a year or so remaining on the lease an assignment is fine.

When looking at a lease, you will want to check the section regarding assignment or transfers. Generally, the language to look for in the existing lease is that although there may be some conditions, any transfer/assignment will “not be unreasonably withheld” by the landlord.

Triple Net Lease:

A triple net lease is exclusive of insurance, taxes and maintenance. A base rate is applied and then the annual costs for these three components (or an estimate thereof) is added to the base and reconciled annually in most cases. In a NNN lease, the landlord will provide you with an estimate of these costs so you are not going into this blindly.

Conversely, a gross lease will include all these components in your monthly rent at a fixed rate (there can still be a year-end adjustment for common areas or extraordinary items).

If The Business Goes Under – What Happens?

This depends entirely upon the terms of the lease and whether or not you have signed to personally guaranteed the lease. It is not uncommon for this to be a condition for a small business lease, and some landlords may even implement this as a condition to an assignment. We are seeing more of this in more volatile businesses such as restaurants and in many cases, the landlords requires the prior owner to remain as a guarantor as well.

If you are required to provide a personal guarantee, you should negotiate a condition that releases you after a certain period of on-time rental payments. For example, after you own the business for 12 months or so, as long as all of your monthly rent payments were made on time the guarantee is eliminated.

On this note, I urge any new business owner to make it a habit to always pay their rent on time and not even a day late. In fact, get it to the landlord a day or two early. You will always stick out as being a good tenant with the landlord and, rest assured, they know how each tenant pays. By establishing a reputation of being on time, all the time, if for any reason the business runs into any difficulty in the future the landlord will be far more inclined to work with you because of the credibility that you have established. The same strategy holds true with all of your suppliers. Establish yourself as a good paying account and they will be more willing to assist you if you ever need some extended time to pay them.

Proper Amount for Security Deposit:

There are no hard rules, and each lease is different; however, you can count on it being the equivalent of anywhere from one to three months of rent.

As usual, I welcome any comments. It will be especially helpful if any buyers or brokers can tell us about some challenges they may have encountered regarding leases and what strategies they utilized.

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