There comes a time when a business owner has to negotiate a lease, and there’s only one chance to get it right. We have all heard the horror stories, but most can be avoided with clear thinking and good legal and commercial advice.
Typically, in the course of your business activities you might have to:
– Negotiate a new lease
– Assign a lease to the buyer of the business
– Take on an assignment of a lease when purchasing a business
A lease gives you the right to carry on your business in a location, and a legal interest in the property for the term of the lease. It gives you the right to trade and, most importantly, security.
When buying, selling or renewing, the terms of your lease will determine your right and cost of access to these valuable customers. A secure lease, reasonable rent and outgoings will be generally regarded as a valuable business asset. A good lease creates a real value when selling a retail business, and conversely, a poor lease can devalue what is otherwise a sure thing.
Reading and Understanding the Lease
It is important that you read the lease documents carefully and ensure you understand what each clause meant to you and your businesses. Don’t leave it to someone else. Lease terms vary widely as they are regulated by state and local laws. Assume nothing, read everything.
Legal advice is crucial, but ensure your solicitor deals with retail and commercial leases on a regular basis. After all, you don’t ask your GP for advice on your toothache – you ask your dentist.
When reviewing leases, attention should be given to the areas that affect:
Profitability is a function of your skill as a business owner and marketer, and the accumulated customer base that drives your turnover. When it comes to buying or selling a business, continued access to these established customers is a critical factor in the valuation. It’s a large part of the difference between the cost of starting a business from scratch, and the buying price of an established business.
Security of Tenure is making sure that the business will remain profitable for many years. The objective is to have a long lease that will increase the net worth of the business from a resale perspective. Banks look favourably at longer leases. A short-term lease would only be considered if you weren’t sure that the business was going to survive, and you could exit the lease at the end of the first term and cut your losses.
Ongoing Liability is the continuing accountability of the previous business owner or tenant regarding the lease. It is common practice for leases to contain a covenant that maintains the original Lessee’s liability for performance after a business is sold for the duration of the initial lease term. Some state governments have enforced new legislation that helps a new tenant, so ask your solicitor to be sure. It is also prudent to establish (where possible) the history of the lessor’s performance as a landlord.
Clauses To Look Out For
Basis for Rent Adjustments
Rent is commonly increased in line with the CPI each year. Fixed percentage increases such as 5% to 7% are common in shopping centres. Increases compound each year, so keep that in mind.
In some leases there are percentage rental clauses. These clauses usually state the minimum weekly turnover. Above this value, the rent is calculated on a percentage of turnover rather than base rental. It is rare to see this enforced, as the threshold value is usually quite high.
It is common to have a rent review at the end of each term of the lease. For example, if you have a three-year lease with a three-year option, at the end of the first three years the rent can be adjusted to match the rate that is paid by the other retailers in the area. Make sure you know the market rates and are prepared to pay market rent if you have to.
Ensure you know what and how much you have to pay and what they cover. They may cover body corporate fees or building insurance, for example.
Ask whether your electricity consumption will be charged by the landlord or if you will have your own account directly with the supplier.
Repairs and Maintenance Contributions
Establish your obligations as a tenant, including a breakdown of the landlord’s equipment. For example, if the landlord owns the compressor that runs your cold room, it is reasonable that you are required to service it? Do you have to put a service agreement in place with a service company to maintain the landlord’s equipment? If something breaks – who pays?
Are there any required? Who pays for what?
Is there a refit clause in the lease? If so, when will it need to be done, who can complete such works and who will approve the works? Ask how much the average is spent in the centre on re-fit – you may be surprised.
Ask whether the lease contains a demolition clause. If a lease provides for demolition, the landlord generally must give a written notice to the tenant advising that the landlord has elected to terminate the lease. The period of the notice will differ between jurisdictions and according to the lease terms. If a lease contains a demolition clause, then you need to carefully consider the impact such a clause would have on you and your business if that right was exercised. Consider whether or not you are entitled to claim compensation from the landlord.
A relocation clause allows the landlord to relocate a tenant to different premises. Relocation clauses are sometimes common in retail shopping centre leases. If the landlord wishes to relocate the tenant, then the lease will provide for the landlord to give the tenant notice about the relocations. The minimum period of the notice will differ between jurisdictions. The lease will specify the actual period and compensation, if any. Relocation costs can be significant and include removal of fixtures and fittings, replacing fixtures and fittings, legal costs, etc.
Lessors Right to Terminate
The landlord rights to terminate are usually set out in some detail in your lease agreement. Common reasons are a breach by the tenant such as not paying rent, outgoings or trading unlawfully.
Lessees Right to Terminate
The tenant’s right to terminate is largely dependent on the terms of each individual lease but, generally speaking, the right of a tenant to terminate will be very limited. It may be limited to where the property can no longer be occupied because of fire or flood.
Enquiries with a town planner, local council or Safe Foods Authority should be made to ensure that your intended use of the property is and will be lawful.
Reviewing your lease is an unavoidable step that can make or break the future of a business. If you’re looking for more advice and information, get in touch with us here.