Not every employee can work from home, not every business can be run out of a garage, not every transaction can be completed online, and not every meeting can or should be held on Zoom. While the pandemic unquestionably caused a dramatic shift in how and where people do their jobs and companies do business, plenty of commercial enterprises still need a place to call home. For smaller or early-stage companies that need to set up shop or expand into a larger space, acquiring commercial property is usually a cost-prohibitive and overly risky proposition, which is why they are much more likely to lease their new space rather than purchase it.
A small commercial lease may not involve as much capital investment or long-term commitment as ownership, but that doesn't mean it warrants less thoughtfulness, consideration, and due diligence. Indeed, taking a cavalier approach, giving short shrift to provisions that might appear to be "boilerplate", or failing to consult with counsel before signing a commercial lease can have disastrous and long-term consequences for prospective tenants. Leasing even a modest space can impose significant commitments. Done right, a commercial lease can establish the foundation for sustained success. Done wrong, it can become an albatross that puts a business's ongoing viability at risk.
Here are several items for entrepreneurs to consider while looking for commercial space for their small businesses and seeking counsel to assist them.
Working With a Broker
While an experienced commercial real estate lawyer can offer guidance throughout a proposed lease's legal and financial implications, a seasoned broker will have expertise and insights regarding market conditions and values that can help in making an informed decision about rents, improvement allowances, and other issues.
Signing a Personal Guarantee
Especially for start-ups or new businesses lacking a strong credit history and steady revenues, commercial landlords will likely ask the owners to sign personal guarantees of their company's lease obligations. There are also some options to consider other than a full guaranty for the entire term of the lease. Business-owners should determine at the outset whether this is a deal breaker so they are either ready to move forward or move on when presented with a term sheet or proposed lease containing such a demand.
Improvement Costs and Allowances
As an incentive for prospective tenants, a landlord may offer an allowance to facilitate the tenant's buildout of the leased premises, which may or may not cover the full cost of needed or desired improvements. A business owner will want to have an educated sense of buildout costs, ideally after receiving quotes from contractors, so that they can evaluate the attractiveness of any proposed allowances.
Rent Commencement Date
The day rent and other lease obligations start and the day a business is ready to open are unlikely to be the same. In overseeing any improvements, the initial rent payment will typically be due on a fixed date, regardless of how far along or behind the buildout may be. If, however, the landlord oversees the improvements, the rent commencement date will likely be pegged to the date the landlord substantially completes those improvements. Tenants need to consider whether they want the responsibilities involved in supervising a buildout and whether they need to be in their space by a specific date. Additionally, leases should address issues related to rate abatement and other remedies if improvements do not proceed as promised.
Exit Issues – Assignment and Subletting
At some juncture, a business owner may wish to assign or sublet some or all of their leased space to a third party. Commercial leases almost always require the landlord to give prior approval beforehand. Ensure the landlord cannot unreasonably withhold its consent to a sublease and note that the lessee will still likely be fully liable for all rents even if they assign the lease or sublet the property to another party.
The lease can state the tenant is responsible for all operating expenses (net lease) or that those costs are on the landlord (gross lease). For office and industrial leases, the most common arrangement is for the landlord and the tenant to share operating expenses, with the tenant paying for its proportionate share of the increase in operating expenses over the same costs in a base year (a modified gross lease). Under a triple net lease, a retail tenant pays its proportionate share of all expenses of the property, including real estate taxes, building insurance, and maintenance in addition to the cost of rent and utilities. The lease should specifically define "operating expenses," how they are calculated, and whether there is any cap on the tenant's obligations.
Notice and Opportunity to Cure
No one wants a technicality or an unexpected delay in making a rent payment to be an excuse for terminating a lease. Business owners should seek to include provisions allowing for notice of default and an "opportunity to cure" before the landlord may begin exercising remedies.
These are just a handful of the issues that prospective commercial tenants must consider and address as they evaluate potential spaces. Consulting with experienced counsel as part of the process is the best way to ensure this consequential decision aligns with business objectives and insulates the business from as much risk as possible.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.