Neal had earned his MBA, holds CBI and ABI designations and serves on the boards of the Carolina Virginia Business Brokers Association (CVBBA) and the Better Business Bureau of Eastern NC.
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Commercial Lease Assignment 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.
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.”
Does landlord have the right to raise rent to market levels when tenant wants to sell his business as tenant has option to renew at low rent?! So at the sale, can landlord say this will be a new lease and new terms?
Great question Ava,
If it’s an assignment, the business buyer/new tenant is taking over the business seller/original tenant’s remaining term, so the answer would be no. If there are options remaining on the lease when the lease is assigned, those future options may be able to take advantage of the low rental payments you referenced, but the lease can also specify that if the lease is assigned, then those options can’t be executed by anyone besides the original tenant. As with all things in leases, you have to read the lease to find these answers.
If you’re asking if the landlord can refuse to assign and insist on a new lease, that’s a separate and possibly more complicated answer. As always, check with a real estate attorney for a definitive answer, but most leases include some language that states that the assignment “cannot be unreasonably withheld.”
Finally, if the tenant is in good standing, the lease should be an asset to the current tenant in that he or she has a documented right to the space; protecting him or from the lease being ended early.
I hope this is helpful for your situation Ava.
I’m selling my business and one landlord is refusing to assign the lease unless I pay him $10K. He’s saying that it cost him $10k for his attorney to review the new lease with new buyer. #unbelievable The other landlord wants to keep my $24K deposit. No reason. He just wants to keep it. These two landlords are now holding up the sale of my business. Both landlords have agreed to new leases with my buyer at a much higher rate and for a longer term lease. My attorney has tried to negotiate with with both landlords but they are not budging. We have pushed my closing date back four times over the past three months and I have paid my attorney $75k so far. Is there anything I can do?
Ouch Aretha,
I’m sorry to hear that the landlords are making your deal such a challenge.
The fact that you have an attorney involved is great, but I also see that you’ve compensated that professional a considerable amount already. That professional should be invaluable (or at least worth $75K+) in answering these questions with solutions.
Reading on your question, it’s hard to tell if you’re assigning leases or having your buyer get new leases for your business…
If you haven’t already, you could try to negotiate a fee to terminate the lease instead of assigning it, but when you mention one landlord is requesting to keep a $24K deposit, I’m imagining that’s a part of that option.
If these fees (cost to assign) are not already outlined in your lease, negotiation and litigation are the only solutions I’m aware of.
Perhaps others on this forum can offer more insights.
For the benefit of others, please keep us updated on your developments if possible.
Thank you. Our attorney reviewed both leases. Landlord #1 The lease doesn’t state landlord can keep the $24K deposit. We will continue arguing this point. Landlord #2 We believe his $10K is way too much to review a new lease so we’ve requested to see an invoice. Neither issue is outlined in our lease. We’ve pushed our closing back five times because of these issues. Both landlords negotiated higher rents and longer leases with the new company. Wish me luck. This has been extremely stressful.
If I sell my my small business to family memeber with 5 months left on the lease can I just pay until end of lease when they move at that time?
Hey Cvanduzer,
It’s been my experience that most landlords don’t care who pays the rent, as long as someone pays it. Yes!
2 of my businesses are in 1 building. 1 business is in Year 3 of 2nd 5 year lease (renewal), and the other is in Year 4. I am not considering selling either. However, as i was thinking about renewing the lease that’s in Year 4, i came upon this paragraph in the lease.
“In the case of an assignment and/or sale of the business by tenant, an amount equal to fifty (50%) percent of all amounts paid or payable to tenant by assignee and/or buyer directly or indirectly for the assignment of this Lease, shall be paid to Landlord. In calculating this amount, the assignment consideration shall include all rents, charges and other consideration paid or payable to tenant under the terms of any collateral agreements, and sums paid or payable by the assignee for the purchase or rental of all or part of tenant’s leasehold interest.”
Does this mean that if i sell this particular business, the landlord is entitled to 50% of the sale of this business?
Han,
I’m not a real estate attorney, and I would recommend you consult one, but that does sound like that to me. Personally I’ve never seen that language and it sounds unusual and onerous to me.
Thanks for the response. I did have a contract attorney review the lease prior to signing; he didn’t catch it. Thanks for your prompt reply.
My landlord made me sign a contract and is not letting me out of the lease even though another buyer is buying my business and wants to resign a new 5 or 10 year lease. They are stating that I’m liable regardless of subleasing. I’m trying to see if there’s any way i can get out of being the personal guarantor since I’m selling my business. I have 4 years left on a 5 year lease. Is there anything i can do? My business is not making enough money to pay rent and I’m coming out of pocket every month.
Hey Niko,
Sorry to hear about the bind that you’re in. If you’re referring to your landlord holding you to the personal guarantee that you signed when you authorized your lease, this is the default position that landlords take, in my experience.
This becomes a question for a real estate attorney regarding your rights and opportunities, but if you signed a binding personal guarantee your landlord may have all the power.
The good news is that the assigned tenant is in what I call “first position” to pay rent, so they have to stop paying before the landlord may come after you.
This encourages you to help your business buyer be successful, which is a big part of why landlords like to keep the assignee on the hook.
Hope this is informative.
I am selling a dental practice, with 38 months left on the lease. Landlord insists I stay on the lease for the full term. If my buyer dies or defaults on the rent, I will be liable. I am not staying in the practice.
Is there any kind of bond or insurance I can get to pay for the rent if the Buyer defaults?
Hey Karen,
Life insurance is a requirement for SBA loans and a seller could do the same to account for the death of a business buyer with a seller note.
Normally the collateral for default is a lien on the physical assets but perhaps a bond could work as well; I have not heard that solution before.