Commercial Lease Assignment When Selling Your Business: Problems
As part of selling your business, the lease can be one of the most overlooked barriers to completing the deal. The buyer and seller may have a “meeting of the minds” when it comes to the lease, but if it isn’t assigned they have nothing to buy or sell. Let’s explore a few of the common issues that come up related to a lease in the sale of a small business. As part of selling your business, the lease can be one of the most overlooked barriers to completing the deal.
Inadequate Time Remaining on the Lease
Ideally a tenant should sell a small business with more than three years left on the lease. The takeaway here is the longer the better. It’s not uncommon for me to meet a seller who is going “month-to-month” on a lease and proud of it. In their mind they’ve reduced their commitment to the business, but in the buyer’s mind one of the largest expenses of the business is unsecured and at risk of inflation. The buyer’s ideal scenario is a monthly rent price that is known and set into infinity, and for this reason many buyers ask if there is an option to buy the real estate. When sellers go month to month, the lease negotiation with the landlord is shifted further towards the advantage of the landlord/property management firm.Landlord Approval is often a Condition to Close in Asset Purchase Agreements
When a business is sold the buyer must be approved by the landlord to be granted an assignment or a new lease. The seller normally only cares if the buyer has the funds to pay for the business, but the landlord doesn’t want the buyer “squeaking in” with nothing left in the bank account, or even worse bringing debt into business. Landlords want to see reserves for a buyer to be able to pay the rent for up to six months, and they will ask for a “PFS” or personal financial statement to judge the rent worthiness of a tenant. Much like an SBA loan, they may also want to see some experience from the tenant that’s relevant to the business they are buying. While the landlord can’t tell an owner how to run a business if they pay the rent and follow the rules of the lease, they can make it difficult to get in.Assignment Fees From a Landlord may be Excessive
It’s not uncommon for a landlord or property management group to ask to see the contract for the sale of the business before considering a new tenant. They do this because they want to know how much the seller will make when they sell the business, and they may want a piece of the action. This is called an assignment fee. For the right to transfer a lease, or what is often justified as “attorney’s fees,” an assignment fee is demanded to release the current tenant from their obligations. The fee is normally between $2K-$5K, but in one case I’ve seen a landlord ask for 10% of the contract price, which was $33,000. Assignment fees are negotiable, and a good broker and/or business attorney can assist a seller in negotiating this amount. It also highlights the value of having a good relationship with the landlord.Security Deposits on Commercial Lease Assignment may be Necessary
While the assignment is typically the responsibility of the seller, the landlord can and will also ask for a security deposit from the buyer. A reasonable security deposit is one month’s rent, but this too is subject to negotiation. I’ve seen up to six months requested, and again it’s highly negotiable. Both the term and how long it’s held can be negotiated. While the seller of the business may think this isn’t his or her problem, it can be a problem if the security deposit makes the acquisition prohibitive for the buyer. Landlords may ask for longer term security deposits as a deterrent to acquiring the space if they’re not trusting of buyers. Having a strong personal financial statement and experience to run the business is the best defense against an unreasonable security deposit.Assignment Conditions may Surprise Everyone
Just when you think it couldn’t get any worse, there’s more. Landlord’s often don’t like letting the original tenant off the hook. If a seller gets his or her lease assigned, the landlord will most likely insist that the seller stays on the lease as back up in case the buyer doesn’t pay the rent. Why have one “throat to choke” when you can have two? The best defense here for a seller is to negotiate the removal of a personal guarantee when renewing a lease years before selling the business. If the business is strong and long lived, and the landlord likes you, renewing for a long term but removing your personal obligations will best position you to exit your business without the associated liabilities attached.Conclusions
Some things like the “month to month” phenomenon of sellers are counter-intuitive. A final example are below market rents. While below market rents can be great for a seller for cash flow, it’s all the more reason to expect a landlord to “correct” the rent when a new tenant arrives. Market rates are what you want to be paying to avoid any unpleasant surprises when it’s time to sell the business. When it comes to leases, the landlord has most of the cards. Even when neighboring spaces are unrented, landlords see a small business sale as their opportunity to make some money and adjust market prices to current levels. Here again we see the difference in the renter versus owner perspective; the renter thinks “they need my business because these other units are unrented, so I’m going to get a great price” while the landlord thinks “this tenant needs to pay market rate or higher because these other units are unrented.”
Neal Isaacs
Owner, Broker at VR Business Brokers of the Triangle
Neal is a former shark diver turned Intermediary. He owns VR Business Brokers of the Triangle, the local representation of the International VR Business Brokers | Mergers & Acquisitions. His focus is seller representation of privately held businesses with annual sales of more than $1M in the Triangle market.
Neal’s strengths include matching buyers and sellers, pricing businesses, and negotiating deals.
He is an MBA, CBI, ABI and serves on the boards of the Carolina Virginia Business Brokers Association (CVBBA) and the Better Business Bureau of Eastern NC. He’s lived in Garner for 15+ years and is an active member of the Garner Chamber of Commerce. He enjoys cycling and spending time with his wife Vivian.
Neal’s strengths include matching buyers and sellers, pricing businesses, and negotiating deals.
He is an MBA, CBI, ABI and serves on the boards of the Carolina Virginia Business Brokers Association (CVBBA) and the Better Business Bureau of Eastern NC. He’s lived in Garner for 15+ years and is an active member of the Garner Chamber of Commerce. He enjoys cycling and spending time with his wife Vivian.
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Hello,
I am under a lease agreement which runs out in march. I’ve proposed a new lease (I want to sell my business within 6month to a year). Should I get a new lease before selling or should I tell the land lord my plans of selling and ask for a new lease to be written out to the potential buyer? Any advice would be greatly appreciated.
Laura-
This could work both ways: (i) a potential buyer could want you to have a long-term lease in place if it wants to keep the business operating out of the same space after Closing; OR (ii) a potential buyer could have plans to move/merge the business after Closing in which case it would likely deduct the cost of getting out of a long-term lease from the purchase price. Perhaps you have a feel as to which would apply in the event that you sale your business? If you are unsure, then perhaps a shorter-term extension might be best. Happy to discuss.
Sincerely,
Mark Fazio
Hello Laura,
You should get a new lease with an assignment clause. This protects you if you don’t sell in the near future. It also allows you to transfer the lease to someone who buys your business. It actually will increase the appeal of your business when a buyer knows a lease is already in place and does not need to be negotiated. The caution is to not have an unreasonable condition for assignment, like a penalty or a requirement that you guarantee payment after transfer.
Look for the language “Cannot be unreasonably withheld” in the assignment clause. This means that if you bring a good candidate the landlord should be able to reject them. Most buyers want a long term lease and many won’t consider a business with less than a year remaining.
Like Thomas, I have an unreasonable landlord.
I’m 65 years old and he knows I am going to sell sooner than later. His latest lease agreement proposes my rent to increase by almost 40% and that’s above market.
I need the location because my employees all live in this neighborhood and if I move now, it will disrupt my business.
Any suggestions?
Also, I’ve always had a three year lease. If I ask for five or six years, do you think that will work against me when trying to get the rent payment down? Thx!
Hey Al,
Sorry to hear that you have an unreasonable landlord, and I do understand that your location is tied to the value of your business. It’s good that you know the market rate, as it should give you some leverage when negotiating. Even though you know that you don’t want to move, your landlord will also know that you have that option at a lower rental rate, and he or she wants you as a tenant as much as you want the space.
A couple more things:
It sounds like you are negotiating directly, but you may want to speak to some commercial real estate agents in your market to see if one will represent you in your lease negotiation. Many get paid from the landlord if they are successful in bridging the gap on price and terms between a tenant and a landlord.
Asking for five or six years should help your case, not hurt it. Landlords want long term tenants so you are reducing the owners risk of future vacancy by committing to more time. They should give you more favorable terms if you are negotiating for a longer lease term.
If you haven’t already, consider negotiating to remove the personal guarantee from agreement and sign only with a corporate guarantee. Landlords want to keep everyone on the hook so it’s hard to do this, but if you can achieve it you will have less commitments to your business after you sell it.
Hope this helps!
Selling tenant has a lease with landlord and purchasing tenant purchases property and remains in the space without a lease assignment. Does the selling tenant lease remain in effect as is? If not, what are the lease terms and conditions for the purchasing tenant?
That’s a great question for a real estate attorney with specialized knowledge of local laws Mr. Spann!
As a business broker and the author of this article my response would be that the current leases of the property need to be addressed in the sale of any commercial real estate to avoid this problem. I would also review the terms of the lease that the “Selling tenant” (I believe you mean an owner of a business with a valid lease to a property he/she does not own) to see what protections are in writing.
Lastly, I see a lot of tenants who can not get a long term lease because the owner of the property is looking at selling it so they want to avoid this problem.
I am planning to sell my business next year and have a landlord that has always been difficult to work with. No matter what, he tries to get me to pay him more.
Where do I look in my lease about the assignment language? ARe there specific words I should look for that will tell me if I am going to have troubles? I am renewing my lease in December and thought I may have a way to fix this before I sell.
Thank you for your help!
Greetings Thomas. Most leases have a section titled “Assignment/Subletting” or “Right to Assign.” The key words to look for are “Cannot be unreasonably withheld,” and most newer leases do have this language. It simply means that if you bring a viable tenant your landlord should not be able to refuse to assign the lease. If you are renewing in December see if you can get out of renewing your personal guarantee and keep your corporation as the only party that’s legally responsible. Work closely with your real estate attorney to protect your interests and understand your obligations for your lease. Best of luck in your negotiations!