This article was written by Dick Ginnaty, CPA
For a lot of businesses the biggest dollar commitment made at the start of the business (and periodically thereafter) is the lease that is signed. A $1,500 per month lease for five years means you are making a $90,000 commitment usually guaranteed personally by the owners of the business. In my experience, the lease commitments are one of the biggest reasons for bankruptcy, and it may be avoidable if the lease clause and considerations described below get negotiated and included in the lease.
It is very, very difficult to feel absolutely secure when committing to a long term lease in the startup of a business. Too many things can happen that may make the leasing decision the wrong one. Owners can get sick and can’t continue with the business. The partnership breaks up. The nature of the business changes. The location’s traffic isn’t right. Spouses change jobs and locales. Divorce happens. Anyone of these events can make the lease a financial albatross.
What’s the solution? First, only commit to the least timeframe possible (get a two year lease with a three year option vs. a five year lease). Remember options don’t cost you but give you the right to continue in the space. Second, document the promises or assumptions made by the management company (i.e. the big anchor store will stay, or will move in, no competing store will be allowed to lease space in the building or center etc.). Third, negotiate a cap on all aspects of the rent (base rent, annual increases, common area charges, property tax increases etc) and finally, try to negotiate the inclusion of an escape clause.
An escape clause is a clause that says the lease will terminate early if certain pre-defined events happen. One event that can and does happen is death of the owner. Negotiate that the lease will end a set number of months after the event. There is nothing more tragic than the remaining family facing a long term lease obligation after the breadwinner is gone.
Be realistic in the negotiations. The landlord needs time to re-lease the space and it needs to be ready for renting before they can market the space. Having said that, it is hard to imagine that six months of rent (perhaps paid when the escape clause is exercised and the space is vacant and returned to leasable condition) would not be reasonable. To incentivize the landlord (or management company) to consider your requested clause, I would wait until all else is negotiated and agreed upon, to ask for the escape clause, and I would offer them a few cents more per month (or a reduction in the tenant improvement allowance) for the flexibility. The more events that would trigger the escape clause (i.e. the greater the flexibility on your part), the greater the incentives that will probably be required.
Always remember to calculate what you are offering. A reduction of the tenant allowance of $3,000 over a five year lease amounts to a 5 cent increase per month to the landlord on a 1,000 square foot lease.
Good luck and here’s hoping it “all adds up” for you.
(If there is any area in accounting or tax that you think needs to be addressed in this newsletter please e-mail Dick at Ginnatycpa@aol.com and if it is of general interest, he will address it in future articles).