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.”
I have a business that is in a industrial area at which I have signed the lease to use my business on a property that is not owned by me. My question is, If the building and property are sold, How long do I have to be out of the property building? I have been on the property for 20 yrs in washington state. what rights do I have ?
Hey Carrie,
Great question for a real estate attorney, but my business broker’s answer is that the lease is your “hold” on the space.
Your leasehold protects you from loosing the space, even if it’s sold. The buyer would need to honor the lease or buy you out of it…
Typically property owners stop offering leases to third parties before they sell it for this reason. If they want you out they would have to negotiate to pay you to get out.
Read your lease and addendums for any exceptions here!
Hi Monica,
What you are describing is called a “First Right of Refusal”. That’s a great clause to include in the lease. It will help sell your business. Buyers are often concerned about the possibility of buying a business where the property could be sold to a new owner.
Greg Younts
I want to sell my carwash business.
Only.
I own the land.
I want to rent the building aka car wash. To new owner.
With a first right of refusal to buy the property at later date.
What’s this called?
Hey Monica,
That’s a business sale.
I would speak with a commercial real estate agent about what an appropriate rental rate would be for the property and adjust the cash flow accordingly. If you don’t charge yourself rent, deduct what the rent should be, if you over or under pay yourself, add or subtract the difference.
Offering a first right of refusal will be a request of any savvy business buyer who rents your space, so that will help.
Good luck with your sale!
Need a transfer of lease agreement form and a letter of intent to sell my business in lakeland florida
Hi Ed,
A transfer of lease agreement would be a document prepared by your landlord or possibly your (the seller’s) real estate attorney.
And a Letter of Intent is drawn up by the buyer, based on what they want to offer, and negotiated with the seller.
Both documents are very important when selling a business.
I am selling my business and the buyer is willing to take over the remaining lease and will sign a new lease after my lease is over since I still have five years options to extend my lease. But I have been waiting for two months without his response and consent. Is there any legal way I can do this?
Hey Kevin,
Congrats on selling your business.
If it’s the landlord you’re waiting on for a response, this is a common challenge. A lot of the work I do as an intermediary is messaging landlords to keep them on track. One national outfit I dealt with recently indicated they regularly have up to 2,000 assignments happening simultaneously at any given time, and so they get backed up.
Our solution is simply to call and email them every day if they are not local, and show up at their offices if they are. We also have our deal partners such as the transaction attorneys on the deal help us make the assignment a priority.
I’m sure there is a legal argument for them being responsive but that’s a question for an attorney and also not a quick solution!
Keep us posted on your results Kevin.
Seller of a restaurant in FL is asking 160k to buy him out & we take over the lease. What can the commercial agent ask for on closing costs? Technically we are not purchasing the property, we are buying the owner out & taking over a lease, so I’m a bit confused if there should be assignment fees or closing costs. Is it possible to break this down so we understand what to expect? Thank you!
Hey Jan,
You are correct, you are buying the assets of the business, including the opportunity to take over the leasehold.
Customary fees to are lease assignment/new lease fees and a security deposit to the landlord and legal fees to a transaction attorney.
If the seller has a listing agent, he or she may or may not co-broker with another broker (buyer broker). In that case, if you have a buyer broker, which is common in some markets but less common in more, your buyer broker would get his or her fee from the seller’s broker’s commission. This is the norm in residential real estate, but less common in business brokerage.
If they don’t co-broker and you have hired a buyer broker, that buyer broker would look to you for this fee, but this should all be disclosed in any listing agreement you sign before hiring him or her.
Lastly, you referenced a “commercial agent,” this is more likely a real estate broker, not a business broker, so ask this professional about their experience in transferring business assets that don’t have real estate for sale. As you’ve surmised it’s much different than selling real estate…
If they’ve never done this before, consider finding a business broker who has.
Hope this helps!
Thank you, Neal! Yes, he is indeed a broker, and it appears that the seller is responsible for the assigning fees, which is a relief. I have another question for you. My partner and I have established an LLC through an attorney to jointly open a restaurant. Regardless of our membership in the LLC, we want to ensure protection in case disputes arise between us. So, we have decided to create our own LLC’s and amend them to the partnership LLC – my question is, when filing for an EIN on the LLC for the secondary LLC to join the primary one, should I classify this as an LLC multi member or S-Corp? I am receiving very mixed answers.
Kindest Regards,
Jan
You’re welcome Jan,
I’m glad to hear you’re starting with the end in mind for your partnership. Your operating agreement with your partner should include specific language around what would happen in the case of a dispute.
Regarding the best legal structure, I’ll leave that answer to the attorneys to answer. I’d ask the one you are already working with or one of the great attorneys on this platform.
I’m selling my business and transferring my remaining lease term to the buyer. I just discovered the furnace and water heater should be replaced (which, according to my lease, is the tenants’ responsibility). What is my responsibility to the buyer? Am I required to disclose this information to the buyer?
Hey Pete,
I’d recommend reading the APA you have with your business buyer; likely it states that you’re transferring the assets of your business in good working condition.
That raises the question of if those items are assets of the business, or if they are fixtures belonging to the landlord.
These are complicated questions that, like many things in deals, are open to negotiation.
You could take the position that these are material facts that you are aware of and feel compelled to repair/replace, or you could consider the situation as “caveat emptor.”
Unfortunately I don’t know the specifics of your situation so I can’t give you more specific advise. Congrats on isolating a buyer to acquire your business!
My commercial space was sold with a mid month closing date. He wants me to pay for the full month. Is this right?
We have no formal lease agreement.
Hey Klee,
There’s not enough information to give you my full opinion, and I’m not an attorney, but:
If you sold a business with an assigned the lease, in a mid-month closing, normally you would pay for the portion of the month that is due, not the full month.
Does the person taking over the business lease for a retail space pay for the prior build out expenses as part of the lease buyouttake over? Is this normal cost involved?
Hey Lorna,
The seller of the business, who did the upfit to the landlord’s space, can ask for anything they’d like. But in my experience the answer to your question is no…
The business buyer won’t pay for what the business seller’s build out expenses.
Normally business buyers are buying a history of cash flow, and the build out should have resulted in this cash flow.
If the build out didn’t result in greater sales and pay for itself, it wasn’t a good investment for the business seller/original tenant or the business buyer/new tenant.
Hello. Seller of a small business has just renewed his lease agreement with landlord for 5 years. He doesn’t want to make an assignment for a buyer. Seller says that lease agreement is between landlord and the company and there is nothing to worry. Is there anything I should do?
Hey BJ,
I’m unclear of your role in this transaction but it seems odd that a seller wouldn’t want to assign his lease to a buyer.
Perhaps it’s a Stock Sale and the business buyer is stepping into the shoes of the seller and the company, in which this could make sense, but most of these deals are Asset Sales, and the Seller’s company effectively goes away, so the lease must be transferred to the Buyer’s new company.
In most Asset Sale transfers, the seller remains “on the hook” for the lease and the buyer probably won’t buy if he or she doesn’t have a guaranteed place to run the business.