Real Estate

Eyes On The Prize Five Important Questions To Ask Before A Small Business Signs A Lease

A small business considering leasing commercial space AND a landlord in pursuit of filling vacant space have some interesting, and surprisingly similar issues to consider in hammering out a deal. In most cases, experienced landlords know that certain rights will be requested, and knowledgeable small business tenants will know how to ask these questions. Before diving into the minutiae of default provisions, environmental issues, indemnity rights and other essential terms, the parties should consider some basic, but essential issues. This article will examine five such “game changers”, although by no means is this an exhaustive list.

Whole or Partial Exclusives –

Small businesses need the protection and security that enables them to sell their products and provide services without running afoul of exclusives that bigger tenants in the center, business park or office space may have relating to their business operations. In addition, small businesses also need affirmative exclusive rights in their leases to prevent the landlord from leasing to a competing business in the future. An example is where a bakery shop wants to lease a space where the grocer anchor tenant may already have an exclusive on selling “bread and baked goods”. Since most smaller tenants do not have the negotiating leverage to demand complete exclusives, alternatives could include carve outs for specialty goods and services (e.g. birthday cakes)and/or caps on sales of certain items (e.g. bagel sales cannot exceed 20% of total gross sales).

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Flexibility to Assign or Transfer the Lease –

Small business will need the ability to easily assign or transfer/sublease in the event of ownership or business operation changes. This is especially true with franchised companies who may start off as a corporate store and then want to assign or transfer the lease to a local franchisee. Landlords often resist these requests because of the uncertainty that could result from an unknown assignee taking control of the shop. Perhaps the best way to deal with this concern is to provide the landlord with additional security in the event of an assignment, such as the tenant remaining liable for a certain amount of time after the assignment is complete or a corporate or personal guaranty that was not part of the original lease terms.

Restrictions on Relocation within the Center –

One of the biggest problems for small operators in multi-tenant properties is where the lease allows the landlord to relocate them to anywhere on the property. This situation creates moving costs, lost profits and potentially extended reductions in sales as a result of being placed in a less visible or accessible part of the development. Small businesses need to ask for tight restrictions on relocation and build in protections in the lease that require the landlord to provide adequate notice, as well as reimbursement for moving, new upfit and business interruption. Tenants should also ask that they not be moved to areas of low visibility or access within the property (such as the end cap, next to a competitor or behind the major storefronts).

Limitations and Alternatives to Personal Guaranties –

Landlords will almost always require that small businesses provide a person guaranty of the Lease. In order to protect themselves, tenants should ask their landlord for a “sunset” provision on the scope of the guaranty that either limits the duration or the amount of liability. This way, the tenant has a chance to show its landlord the business can grow and remain viable, while limiting the overall exposure of its principals. Other forms of security can also be offered to landlords in lieu of personal guaranties such as security interests in business assets or other real property, letters of credit or corporate parent guaranties. The goal here is to strike a balance between providing adequate assurance of performance to the landlord and constraining the liability of the persons operating the tenant business.

Define Option Rental Rates Up Front! –

Many times small businesses receive a lease from their landlord that grants option rights to extend the term of the lease “at rates to be determined by the parties at a later date” or “at the prevailing market rate at the time of the exercise of the option to extend the lease.” The first of these is an agreement to agree, which may be unenforceable in many states. The second is an invitation to a future disagreement. Both of these clauses will often cause discord between the parties when trying to determine “market rent” years into the future. By requesting that the option rental rates be specifically defined or tied to a known formula at the time the lease is executed, tenants can remove this uncertainty and the attendant costs and consternation involved with determining the rental amount at a later date.