By Doug Alexander & Mark Shipman
Interestingly, many business owners don’t consider the importance of their lease or leases of business property when it comes to an eventual sale of the business. We see leases take many forms. They run the gamut from a simple handshake to confirm a verbal agreement to an extensive 50-page contract. At the time that any lease is entered, the business owner has to consider the length of the commitment. Most owners want to balance several key issues, including the following:
- What is the length of the financial commitment?
- How long do I want to be tied to this location?
- If my business grows, is there room for it to grow here, or will I need to move to expand?
These are only a few of the important questions that need to be asked, but they may be particularly relevant to a later sale. Typically, at the beginning of the lease, the issue at the forefront of the business owner’s mind is “How long will I be stuck paying rent?” For that reason, emphasis may be focused on entering into a short term lease. One key thing to remember is that the lease is a contract, a commitment of the tenant to pay the landlord for the right to use the space for a specific duration of time. Absent a default by the landlord, the tenant may not just abandon the lease without significant adverse financial consequences. Thus, an owner might think that the best bet is to get a month to month lease so that there is maximum flexibility in being able to leave on only 30 days’ notice. However, the problem with this approach is that the Landlord may also choose to end the lease on the same short notice, so the business is not protected. This is not something that the next owner of the business will want, and your sale may fall apart if a more suitable lease cannot be negotiated.
Another consideration is whether this location is just a temporary stopping point along the lifespan of the business, or a long term place to stay and build. Likewise, if you plan on staying put, you build. Likewise, if you plan on staying put, you have to consider the impact that growth of the business will have on that location. Will there be room to grow? Can you grow your business without a need to expand the space that you rent? Should you rent more than you need now to secure the ability to grow without having to move? All of these things must be considered carefully at the inception of the lease in order to adequately plan and negotiate workable terms. Furthermore, you need to consider what your successor will want down the road when he or she takes over. Your decisions may either add value to your business, or in the worst case make it unsellable.
As a result of these important questions, we often see business owners make several possible mistakes. Sometimes, these mistakes make little difference, but frequently they can and do result in unanticipated problems that prove costly. Consider the following:
The “Standard Form Lease.” How often does a landlord present a lease with the words, “This is just our standard form”, clearly implying that review is unnecessary and that changes are neither welcome nor possible. If you as the tenant succumb to this ploy and choose to forego review, at a later date you may find that several problems exist. For instance, the lease may not be assignable, and thus if you sell the business, you have no right to transfer the lease to the new owner. This puts the landlord in a position of strength at the time of your sale and may force you to make costly concessions to either the buyer or the landlord in order to get the deal done.
The “Long Term Lease.” Frequently we work on deals where the tenant is taking out a loan to purchase the business. The lender frequently wants some assurance that the new owner will be able to remain at the same location during the term of the loan so as to avoid the high cost of moving. This may push the tenant toward signing a long term lease, but the fact is that the lender may be equally satisfied with a shorter lease with several renewal options. Taking this approach can give the tenant more freedom and flexibility, while satisfying the needs of the lender at the same time. If you anticipate a sale, you want to be sure that your renewal options extend for a period long enough to satisfy potential purchasers.
The “One Party Lease.” Landlords want to know who they are dealing with and have some assurance that they will have a say in who their tenants will be. For this reason, they often include provisions which restrict assignment and subleasing. However, this needs to be negotiated. Assignment may even be defined to mean a change of ownership of the entity that is the tenant. Thus, in a sale of the company, even if it is a sale of stock in a corporation or an LLC interest, with such a provision included, the Landlord may create an impediment to the sale. If the sale is of assets rather than the company itself, then you will want the right to assign the lease to the purchaser. Be careful to negotiate reasonable provisions which will permit an assignment of the lease or a sublease so as to enable a future sale. Recently, we have seen cases pop up where tenants have not adequately thought through the question of what the lease should say when they had the chance. In one case, the tenant had a lease with two years left, and an option to extend for only two years more. When he decided to sell, the landlord would not agree to extend the lease because the landlord had expansion plans and needed the space. The tenant quickly found that the business was not marketable because no bank would finance the buyer unless the buyer could demonstrate a right to continue to occupy the space for the 10 year lease term. Ultimately, although we represented the landlord, we were able to suggest an alternative that resulted in a compromise which met the needs of the landlord as well as the bank which permitted the deal to close. Nevertheless, the tenant could have found himself up the proverbial creek without a paddle and forced to relocate the business at a very considerable cost before selling.
Of course this list is not exhaustive and there are many other questions that should be considered when leasing property. This includes negotiating for an option to purchase, rent escalation, payment of maintenance expenses, hazardous materials indemnification, restrictions on similar businesses locating in the same office complex, personal guarantees, etc. There is a reason that leases are often lengthy documents, they govern the relationship of the parties for a lengthy period of time, and they are worthy of careful review and consideration before signing on the dotted line. We can’t tell you how many times clients come ask us how they will get out of a lease that they blindly signed because it was just a “standard form” and thought that it would be easy to walk away later.
The lesson here is that when you consider entering into a lease, you need to be aware that it will have implications that extend far beyond the day you move in. It may serve you well, or it may prove to be an impediment to growth and even the sale of your business. In each case, the best choice is to meet with your financial and legal advisors and carefully consider all the consequences of the lease agreement before you jump in and commit. If you would like assistance in reviewing and analyzing these issues, please contact an attorney in our Business and Taxation or Real Estate and Land Use Group at 503-399-1070.