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.”
My landlord went to my buyer and told him that the office space is illegal and will be demolished as well as an electric upgrade will be mandatory of upwards of 20k plus when I leave and lease assumption is approved. I have been in location for 22 years and office was part of space I rented I was never was told of either issues. The landlord can demand more money if space is on open market. My buyers are now wanting to back out since they don’t want to be in the middle. The landlord also disclosed personal information about me and I asked him not to prior to having conversation with buyer. Did he interfere with lease assumption legally? My lease states I have the right to assign lease it was the Same business coming in same equipment even some employees no changes
Hey Scott. Your situation of a landlord threatening the consumption of a deal between a buyer & seller is not unusual, unfortunately. As a business broker, I can’t advise you on if what he is doing is legal or in performance of your lease, but a real estate attorney could. It does sound frustrating!
Does the landlord have to approve the buyer for a business if the seller is in default and still has back rent to pay? This backrent is for California commercial tenancy.
Hey Terry,
I’m not an attorney but the leases I’ve read for assignment terms normally start out with language regarding the that the current tenant needs to be in good standing in order to have the opportunity to assign.
Gary
Hi, my family LLC owns the property and buildings currently occupied by a manufacturing company. We have just entered the second five year term of our lease agreement with another five year option when we get there. Our tenant is being sold to a larger firm who has asked to “clean up” the language in our current agreement. The question is does the sale of the tenant open the door for renegotiation of the agreement or does the current agreement stay in effect? It seems odd that they mention cleaning it up if there isn’t an underlying motive.
Hey Gary,
As a business broker, normally I’m representing the business buyer/new tenant trying to assume the space, and encouraging them to accept the current terms as it’s not a new lease, it’s an assignment…
It’s my broker’s opinion, and I’m not an attorney, that the landlord doesn’t have to change a thing on the lease to assign it, but often it’s extended or amended for things like the use of space or signage…
Rarely are the key terms like rental rates amended.
Yes I’d be suspect of a “clean up.”
Hi, we are in the beginnings of selling our fast food restaurant business when we approached the landlord and discovered our lease was actually on a month-to-month and are in the process of working on a lease with the landlord. They know we are intending on selling unfortunately and have quite a bit of leverage. They included a Right of Termination provision upon request of assignment on the lease. I don’t know how likely they would use it, nor if we could get it removed. What would the landlord’s angle be for having that provision? Is there an alternative to that in regards to assignment that we can possibly offer up that might be acceptable to them?
That’s a tough one Sarah on both accounts; for the right of termination option and the lack of a runway for your prospective business buyer.
I have not seen said provision before but I’m never surprised by a lease anymore! Normally finding a great replacement tenant is your best solution for a successful assignment but the reality is that your landlord could just write a new lease to him or her as there would be nothing stopping them from that.
I recommend consulting a real estate attorney with experience in these cases.
Our hands are tied as Landlord when a tenant sells his business and assigns lease to his buyer. Is there a way we can negotiate rent?
Hey Flo and Agnes,
I normally and helping the business owner navigate the lease assignment process so I’d encourage others to jump in on this answer.
My answer as a business broker…
The lease is the definitive document that establishes the leasehold, so the ability to change the rent would need to be found in that document in order to do that. If you can’t find that language, you’ve made a commitment to offer that lease for the term of the agreement.
What I’ve seen other landlords do when they don’t want to assign is raise the amount of the security deposit to discourage the prospective new tenant from stepping into the current tenant’s lease.
If your lease stipulates that the assignment “cannot be unreasonably withheld,” then it’s up to you and your real estate attorney to determine what is reasonable.
Hope that helps.
Can LLC be transferred to new owner without landlord’s consent. I have a lease paper that only shows my LLC name. So it seems that I can transfer to new owner without let my landlord know.
Hi Miya le,
Typically a lease agreement will include a section or clause that addresses situations such as an ownership change.
If your LLC was the party that signed the lease, you still may need to obtain the permission if the equity changes hands (or even if the majority of its assets are sold).
You should carefully review your lease agreement and discuss it with your attorney.
All the best…
Hello, can I buy a business without transfer lease ?
I plan buying my friend’s business. Her lease still has 5 years left, but landlord will raise rent to market level with new lease and new term if transfer
Hey Le le.
My broker’s opinion is that technically, you could purchase that from your friend, but it wouldn’t be wise. The landlord could evict you at any time without a valid lease, making your business investment worthless.
Typically, leases are assigned in order to preserve the terms of the current leaseholder’s agreement, but there are some leases that specify that the terms change if they are assigned.
If you’re friends OK with it, I’d suggest talking to the landlord to see if they will assign it with the same or similar terms. Most landlords just want a solid tenant who will pay the rent.
Good luck!
Hi Le le,
If you proceed and buy your friend’s business, without the landlord’s permission or signing a new lease, it’s very likely your friend will be violating her lease.
Typically, there are clauses in leases that prevent tenants from transferring ownership of either the business or the majority of its assets to another party.
All the best…