Whoa, there! Pens down, everyone. Good location, good space, good traffic, affordable base rent, what could be wrong? Nothing. Except everything, if you haven’t negotiated these seven issues.
Business owners generally calculate how much rent they can afford as a percentage of annual sales. The number should generally be less than 10 percent of projected gross revenues. That is only the beginning of the calculation, however. Two issues deserve particular attention.
- Rent averaging can be a real benefit to tenants because it minimizes expenses during the startup period. If, for example, the lease called for a 9 year base term at $15 per square foot, a landlord might be open to structuring this at $10 per square foot for the first three years, $15 per square foot for years 4-6, and then $20 per square foot for the last three years.
- A landlord may ask for additional rent (termed “percentage rent”) to be paid if sales are greater than an agreed upon amount (called the "break point"). Negotiating the break point is obviously pretty important, and calls for the attention of your attorney.
Common Area Maintenance Fees
In addition to rent, commercial tenants pay a share of common charges–landscaping, parking lot maintenance, cleaning and so on. CAM charges can skyrocket, unless you negotiate these three things:
- A fixed CAM rate, to protect your business if other tenants leave,
- A cap on CAM increases and
- No responsibility for CAM administrative charges, which some landlords use as a cover for rent increases.
Obviously your business wants to strike a balance between flexibility, which suggests a shorter term, and security, which suggests a longer term. The usual thinking is that small businesses should aim for a one or two year lease with the option to renew. The landlord would probably prefer a longer term. This is an opening to talk about renewal terms and subleasing, among other things.
Make sure that your obligation to pay rent under the lease does not begin until after a “build-out” period, during which you have the opportunity to make any changes to the space prior to opening for business.
Maintenance and Repair
Do not accept an “as is” space without inspecting it, and be aware that commercial leases, unlike residential ones, often shift the burden of maintenance and repair to the tenant. At the very least, work with your attorney to negotiate dollar limits to your responsibility for certain big-ticket items like plumbing and air conditioning.
Three provisions in your lease may protect your business from financial risk.
- Sublease. Even if the term of your lease is longer than optimal, a provision that will permit you to sublease adds flexibility in the event you outgrow your space, or if revenues are less than expected.
- Co-Tenancy. The space may be valuable to you because of the traffic generated by an anchor store. What if it leaves? With a co-tenancy clause, you may be able to break your lease without penalty if the landlord does not replace the anchor within a certain period of time.
- Exclusivity. This protects the value of your investment by preventing the landlord from leasing to a direct competitor within the same development.
If business revenues are not sufficient, the landlord will want you to continue to pay the rent out of your personal funds and resources. In the best of all possible worlds, you wouldn’t have to offer a personal guarantee. For new tenants, it’s hard to avoid, but you might be able to limit it to your first few years in business.
If you default on your lease, the landlord will toss you out. No one wants to plan for a business disaster, but it’s better to negotiate about it before any problems arise. You may be able to get a grace period during which you can cure the default or you may be able to limit your liability, so that you end up being financially responsible for less than the remaining term.
Your commercial lease may end up defining one of your longer term relationships, so it's important to get it right. Reading and understanding it is step one. Under no circumstances should you do this alone. Involve your business attorney from the beginning and you're likelier to be happy with the results.