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.”
As a landlord, is it appropriate for me to ask for the business P&L from my tenant who has requested an assignment of the lease and is trying to sell the business? My attorney did not put this on the list of information required. Neither the potential buyer or her guarantors appear to be liquid enough to support the rent.
Hey Robert,
As a broker, we do see landlords ask for P&Ls on the businesses their tenants own.
As you surmised, they want to see if the business model in their space is viable if it’s going to transfer to the next buyer/tenant.
The net worth and experience related to the business buyer would matter more to me, and what I see is that most landlords are interested to see that the business buyer/prospective tenant could pay around 6 months of rent with the money they have available in a “go forward position” after they get into the business.
I hope this helps!
I am a landlord and my tenant who is selling the business is having the potential buyer communicate with me directly. This feels inappropriate. Is it?
Hey Robert. In my opinion it is not.
That buyer will need your approval as the landlord to become your next tenant if he does a deal with your current tenant, so this is inevitable.
As a broker, we do this work with business buyers with the landlord to ensure that the business buyer/prospective tenant can get approved for the space, as their is normally a contingency in the deal that the deal won’t go through without the lease.
If there is no broker in your tenant’s deal I’m not surprised that the buyer is going directly to you.
Hi, I have a small restaurant business getting ready to sell with 3 months left on the lease. I found a buyer who has a great credit history but the problem is the landlord is making our business sale difficult by increasing the rent to 45% more which deters our buyer. There’s 8 other empty spaces in the shopping center but he’s eyeing on our business and want to keep it for himself to sale. What should I do?
Sorry to hear you’re in this predicament Jane.
The challenge is having 3 months left on your lease, this has left you in a prone position that your landlord appears to be taking advantage of.
To take a balanced viewpoint, it’s possible that the market rate has increased and 45% is the new going rate in your market, but that does significantly hurt the value of your business.
It sounds like you’ve done a great job already by isolating a buyer/tenant with a great credit score. Helping the landlord realize that you’re presenting this new tenant and saving the landlord the cost of acquiring a new tenant (Landlords pay big fees to source tenants sometimes) is your best option.
A less fun option would be to adjust your sale price to make the increased rent more palatable for your business buyer.
I have a buyer who has their own existing business but want a bigger space so they like my shop and have agreed on a purchase price. We have bakery leased in NJ and am wondering if we should assign the lease to them under our bakery name and ask the landlord if he’s amenable to it or if we can just assign the lease and close our business. We are afraid the landlord will say no because rent prices are much higher than ours in the area. We have a good relationship but he’s smart. We have 5 months left on the lease with a 5 year option to renew. How should we go about this and do I need an attorney if we have a drafted contract for sale we both agreed to?
Ale- sorry for the delay. Did you decide what to do? Holly is right you can only assign your lease if the lease says you can (which is probably does if landlord consents). What is your plan for your own bakery? Do you want out? Feel free to set up a call with someone at our firm if you want to discuss further. I would recommend you have an attorney review any sale of business agreement.
Hi Ale,
If you want to assign your lease to the buyer, you should first take a look at whether there is an assignment clause or paragraph in your existing lease. If there is, the terms you’ve agreed to with your landlord about a potential assignment will be spelled out for you. If not, you’ll have to address the assignment separately with your landlord.
In either case, please consult with your attorney about the lease assignment and the sale of your business.
All the best…
i have 2 years lease and still valid.sign with pre vious share holder; and now they sell to new share holder, ane the new force me to sign new lease that same lease but in the lease that i have in clude property tax and building insurrane that i never pay because the previous shareholder take care and pay it . i only pay rent., and the lease ask me to pay . how can i should do? i have not enough mony to pay
Hey Don,
I don’t totally understand your situation, but it sounds like you are referring to TICAMs, which are a commonly misunderstood add on to base rent.
Your original lease may have had a base rent at a fixed rate, plus additional rents to include Taxes, Insurance & Common Area Maintenance (TICAM), if the lease was extended those cost would likely be extended as well.
My recommendation would be to review the lease and communicate with your landlord, and possibly a real estate attorney to discover your best options to move forward.
Greetings Vy,
That sounds odd that he’d take that long to write a lease, I’d ask why and if there’s a way to expedite this (probably money). I’d also ask about assuming the existing lease if there’s any remaining term, landlords normally like this option.
The risk to you would be for you to get into the space that the landlord could kick you out or make the terms onerous on you to stay.
Space is a vital component of a business like a salon, so you need to take the time and diligence to protect the space.
If it will cost you more than 10% of annual revenues for the space you’ll probably loose money with your business.
Hi,
I’m buying a salon business and the landlord said it would take him 3 months to draw a lease agreement. Should I buy the business now, or wait 3 months to sign the lease first then buy the business? I’m just confused with the proper timeline. Thanks