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.”
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- Tips for Expediting the Sale of Your Small Business - November 21, 2019
I sold my deli and new owner kept me on as a manager because the landlord would give him a lease with out me. The buyer was fully aware at the time of purchase. The new contract had seller and buyer on the year to year lease. I was recently fired for asking for unpaid wages & the lease was up the following month in which the landlord did not want to renew unless the orignal seller ( me) was on the lease again. But i was fired. The buyer then took an old lease forged dates/ rent amount and more with handwritten white out obvious not a real lease. The landlord contacted me to see if i would like the space because he gave a written notice to the current tentant. I accepted and was given a new 2 year lease at a higher rent amount of 600 more. At the time of his 2 week notice the current lease holder closed the shop stating maintence issues but yet told his lawyer he was sick. Now i have the space new name new menu new brand. My attorneys now are telling me to forfeit the space or pay the old tentant for loss of profits etc. What do i do?
Hey Yusuf,
There’s a lot to unpack here and I don’t know that I can add much value as I don’t totally understand the situation as it’s written. The fact that you’re attached to a transaction with forgery and what sounds like an individual who is not acting ethically is concerning.
Unfortunately this sounds like a legal issue more than a lease issue, and your attorneys, or an attorney on this platform should be guiding your decision. Outside of that, it sounds like you like the space and you have invested in it, but you don’t like the terms of your current lease; if appropriate I would also recommend explaining your situation to your landlord and imploring for their consideration to the special circumstances. I hope this helps.
Hey, I have a restaurant in which I own for over 7 years. I just signed an extension and I currently have 7 years left plus option. The landlord did not want to remove my personal guarantee or place a cap on it prior to extension. When I purchased the business, the previous owner was forced to sign a PG for 5 years (now released).
I’m planning on possibly selling the business in 3-4 years. I know this is a very difficult business to run with high rate of failure.
My question is if I sell in 3 years, I will have 4 years left. I doubt that the landlord will release me from the PG. If my buyer fails say within 3 years left with me on it, am I liable for all 3 years? Do they go after him personally first and then me? Will I be able to put a clause in the contract that if they come after me, I can go after his personal assets? It’s a large space and the rent is very high, so it would be a lot of money.
Greetings Mike,
You’ve asked a lot of great questions, and all of the answers are yes.
As far as who they come after first, the triggering event is what they call a “default” by your assignee; essentially when he or she stops paying they will be looking at you. The avenues for legal recourse they may chose will be based on their degree of letigiousness and how deep they believe your pockets to be.
Sounds like you already signed the extension so your option to negotiate will be reduced.