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 hold a lease for a dental practice which I set up 5 years ago . The practice is small and the next door business was going on sale with a lease transfer.business is good and I needed to set up a second clinic to provide some services and free some space in my clinic
I agreed with the current owner that I will buy the business , keep It running with current employees and while transferring the use, I wouldn’t be wasting time but in fact making some tiny profit .
While negotiating the lease transfer I realised that the landlord is a terrible person with dodgy electricity settings and no rent free months for setting up the dental charisme builders décorateurs extra , i decided to back off the whole project as I wanted to set up for at least 15 years
5 years in current lease and 10 on a new lease
Just imagining how traumatic negotiating a new lease would be with this guy.
As the landlord and current lease holder were arguing who will pay a hefty piling up electricity bill of £4600 I decided to take over the shop , got my people in and ran the shop for 20 days during those days I paid for materials employees and running it
It generated double what the previous owner generated and it was going to the previous owner’s accounts as it takes time to transféré the card machine .
No that I backed up what are my options ?
I did give the current owner £5000 in advance to help him pay the rent as he was struggling
Please tell me where I stand I this ?
I am in talks with someone who want’s to purchase my business. The building I am in recently sold, so I have a new landlord who wants me to sign a new lease (I was on month to month) at the end of the year. The interested party would like me to negotiate a new lease before selling to them. While I understand this may be beneficial to the interested party, my fear is that the new landlord may not allow me to assign the lease to this individual and leave me stuck with a 5 year lease. Would it be better to negotiate a new lease, or to get the new landlord and the potential buyer together to negotiate a lease?
Greetings Dewey and congrats on finding a buyer for your business.
If you are going month to month with your space, you don’t have a lease to assign, and your business is vulnerable. Protecting your space is paramount to maintaining the value of your business. In a worst case scenario, your new landlord could circumvent you and go directly to your buyer with a lease opportunity. Your expired lease would contain the explicit instructions as to what rights you have or no longer have to your space.
For this reason I’d recommend going to your landlord and attempting to secure an assignable lease extension without a personal guarantee. This will be hard to accomplish, as landlords always want the PG. If you have a personal relationship with your landlord/landlord group I would be candid with them about your personal goals, sometimes they can be understanding about an owner’s needs to transition a business and the lease.
I would also do some diligence on your buyer, as the landlord will only be comfortable with him or her if he or she has experience in your industry and cash reserves after compensating you to pay rent for six months or more. Your landlord’s willingness to accept your buyer as their new tenant will be correlated to that buyer/tenant’s financial strength and experience as an operator.
Lastly, keep in mind that if you have found a great tenant for them, you could be saving them time and money, as landlords expect to pay commissions and sometimes go without tenancy when tenant terms end, so you may have some leverage here. Additionally, most landlords prefer to assign leases instead of writing new ones to save on legal fees. This information should help you understand the landlord’s motivating factors in your deal.
I hope this helps and feel free to direct message me if I can be of further assistance.
The business owner of a store in a commercial Mall promised me to sale the business at nominal price as they wanted to retire. He never mentioned what nominal price would be. Initially he said that lease is expiring by Dec. 2020. I kept in touch regarding buying this business. he would always re-affirm that as soon as the lease renewal approaches , he would talk to management to lease this business to me. Last week when I approached him for the same purpose he shocked me by saying that one of the employee in his business is offering a price which was three times my expectation. In other words, I could not buy that business, if I had to match his employee’s offer.
I have been owner of a similar business in Toronto in Scarborough Town Centre, where I ran that business successfully for five year and had to sell the business because of my divorce issues.
Could you advise me that would it be wise, if I communicate with the Mall Management directly as let them make this decision on merit based on previous experience etc. , this way probably I would be able to bypass the current business owner.
Azhar:
There are many ways to answer this question, but in the basic sense, I understand that you are upset that the owner of the business won’t sell you a business at a price you are willing to pay.
No, you cannot negotiate with the landlord. That would be like trying to buy a car from the car dealer and you don’t like the asking price. So, instead, you want to ask the owner’s neighbor for a better price. But the owner’s neighbor doesn’t own the car to sell it to you. Likewise, the landlord does not own the business, so negotiations with anyone other than the actual owner of the property makes absolutely no sense whatsoever.
Now, if the seller of this business is telling the truth about his employee offering triple the price, then one of two things will be true: Either he will sell the business to this high bidder and new buyer will then lose money and go out of business, OR he will succeed in this business and your estimate of fair value was not correct.
On the other hand, the seller could be bluffing, trying to get you to overypay him.
Of course, the simple truth is, if the price is higher than you are willing to pay, feel good about walking away from the deal. There’s nothing worse than overpaying because your emotions override your logical thinking and you have buyer’s remorse 6 months or a year later, or worse, the business goes under completely.
WALK away from a bad deal and feel good about it. A sale only happens when the buyer AND seller are happy with the deal.
So i’m looking at a lease for a retail location and the “assignment fee” is 50% (!!!!) of the sale.
It’s a relatively high profile shopping center, but I will definitely negotiate this. Thanks for the info 🙂
James,
Thanks for your question. Yes, that is outside of normal for the range I have seen. Pre-negotiating that before you sign will pay dividends if/when you need to assign, and improve your options for exit.
Andrew,
Apologies for the delayed response, your landlord appears to be onerous on terms and conditions for the transition of your lease. It sounds like a bank is involved as well, which complicates things. Hopefully you have an attorney helping you put this deal together, I would advise you to involve an attorney in your negotiations; it can help in complicated situations like you are in.
Jolie,
The landlord’s position is the default, holding onto the original tenant’s personal guarantee. That was a promise to fulfill the rent obligations outside of your corporation when you signed your original lease. You used the correct term; negotiation. Anything can be agreed too. To answer your question, outside of stressing the financial strength, qualifications, & experience of the replacement tenant you are offering to replace you, it will probably come down to money. You could offer to pay to get out of that obligation, for example. It sounds like your landlord has asked for personal property as collateral, this could be negotiated as well. Offer something that already has a lien so his is a second. Keep in mind that landlords don’t want to go and chase back up payment options, so your PG is more of a safety net for him/her. This is a hassle for you and your landlord, and the exercise is purely to manage risk. The more confident your landlord is in your replacement tenant, the less he/she will look to you as a backup.
I hope this is helpful!
I am the owner of the building, my tenant own the news papers business and sold the business to the new owner I am the lanlord and owner of the building never know. After I heard rumo from neighbor I go to the business to ask to meet the new owner but I have no luck, I have to stop by at the office and leave my message to the reception and reach out to him by phone many times but no luck.
After more than 3 months 6/10/20 first time I did see him and step up to him ask him for sign the lease and the lease will iincrease due to my intend to repaint and do some upgrade to the place and welcome him at a new tenant in person. As much I just say he have to sign the lease and rent will increase, he told me he will move out by 8/1/2020. I send him letter with certifite mail and service by in person to leave my building in 20 days, also I ask him to fill out application credit from him and his partner, also asking for the keys and not trespassing my place which is he did and moving stuff belong to my builidng with out asking me. Please advise how can I handle this matter.
Greetings Kim,
This is an unusual situation indeed!
My opinion as a business broker is that as the land owner you have rights to the use of your property, and the relationship between you and your tenants should be defined by a valid lease agreement to the specific parties (person and businesses) utilizing your space.
I’m not an attorney, and I would recommend you talk to a real estate attorney regarding this, but it does sound like the new owner of the business in your space is not cooperating; they may also be a liability to you. As you’ve already made numerous attempts to communicate with them directly to no avail, I highly recommend you enlist a qualified attorney to contact them on your behalf.
Can a landlord raise the rent at fair market value at the time when the tenant
wants to assign the the lease to new buyer.
Greetings Pritpal,
This is more of a legal question so I would advise you to consult a real estate attorney, but as a business broker I would say that if the lease is being assigned, the landlord, or lessor, is merely transferring the existing rights and terms in the original lease from one tenant to another, including the rental rate.
If the tenant agreed to an amendment or requested changes to the terms, such as an extension, that may be a valid opportunity to address the rental rate. I hope this helps!
I am looking to sell my business for 4.5 times EBITDA, value $2.5 million.
After several back and forth negotiations, the buyer has offered $2.425, which is much less than the valuation, but also wants to include the lease security deposit of $12,300 as part of the $2.425 offer. Any thoughts you could provide would be appreciated.
Hi Michele,
As a business broker, a few questions come to mind. Is the buyer challenging your valuation with specific reasons as to why they think the business is not worth $2.5 MM? How did you determine the value of your business? Was the value determined by you, a business appraiser or some other third party?
The best way to counter a sale price objection(s) is to address their specific objections and make sure they understand how the $2.5 million value was determined. If you can show the value was determined based on industry data and a valuation performed by a third party expert such as a business appraiser, this could help you get your $2.5 MM sale price.
I hope this helps.
Hey Michele,
Congrats on reaching an offer exchange stage in the negotiation of the sale of your business.
Assuming it’s an asset sale, that security deposit is an asset of your business, and it shouldn’t be considered a buyer credit in a traditional closing. It sounds like that’s what your purchaser is advocating for. Effectively your buyer is you offering $2.4127, not $2.425. Items such as lease deposits, pro-rations for rent paid, pre-paid advertising, and more all should be accounted for on a closing statement, and the purchase price should remain what you agreed upon.
My suggestion would be to ensure that the buyer has clarity on the reconciliation of the lease and other adjustments that will need to be made at closing, and ask the closing attorney to help with this discussion.
My lease has almost expired. But I sold my business my questions is what kind of letter do I write to the landlord? he said extension lease but what about renewal lease? which one is better. I live in California. Thank you!
Hi Margaret,
If you’ve sold your business already, it’s important that you review the lease language to determine if the lease may be assigned to a new owner.
If you sold the assets (and not the business entity), you may be in violation of your lease agreement.
If you sold the business entity, you still may have needed to obtain the landlord’s permission to assign the lease.
It’s not my intention to alarm you… just want to point you in the right direction. Take a look at what the lease says about “Lease Assignment”.
If you need legal assistance, you may request that here.
All the best…
Hello I am in the process of purchasing a business the landlord denied my application with no reason. The current owner of the business just made an offer to the landlord to be my guarantor. I was an employee for this business and I really want to run the business. I am scared the landlord might deny me again. Can the business be sold without notifying the landlord. I have the money I don’t know what is making him deny me. I had a bankruptcy back in 2012. Can this be the reason why?
I only provided Buyer’s Personal Information. It ask for social security but no where in the form does it state my credit will be viewed. I appreciate your response.
Hi Araceli,
Hmm… You may want to ask the broker representing the business sale about the personal information form you provided to the landlord.
I’d want to know what was the information used for.
All the best…
Hi Araceli,
I am sorry you are having such difficulty with the landlord!
The Landlord you are dealing with may have included certain legal text or clauses in his/her commercial lease agreement with the seller which may prevent the lease from being assumed or assigned by others.
The only way to know if this is the case is to look at the lease agreement.
It could be the Landlord obtained a personal credit report on you if you gave him the information and permission to do so.
Hope this turns out well for you and the seller!