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’M 81 YEARS OLD COME 8 2 40 ……..I HAVE COMMERICAL PROPERTY I WANT TO SELL ……….BUT THE PERSON WANTING THE PROPERTY JUST TOLD ME HIS LAWYER IS WORKING ON THE PAPERS AND HE SAID HE WILL BE LEASING THE PROPERTY AND PAYING X AMT PER MONTH……………AM I PROTECTED , THAT HE HAS TO KEEP PAYING OR CAN HE BE FREE FROM THE LEASE AND STOP PAYING AND ME HAVE TO FIND A BUYER ? I WANT THIS OFF OF ME AND ON THE BUYER …..
Myra,
If I’m understanding your question, it sounds like you want to sell your commercial property but you’re getting an offer to lease, and your question is about liability and certainty of cash flow.
If my understanding is correctly, my comment is that a lease is not the same as a sale, and you would still be liable and at risk of lack of cash flow as long as you continue to own the property. If selling is your primary goal, I wouldn’t recommend signing the lease, unless you believe there may be an investor who would be interested in buying the property with the lease in place. Investors would be interested in whether the rents agreed to in the lease are at or above market rate, as well as other important terms.
Consult a real estate attorney for a more detailed legal answer; this is my opinion as an intermediary who helps owners with their options for exit.
Can a market owner demand a percentage of your business sale? No lease involved.
Valerie:
I will gladly give you a great answer for 2% of your gross sales.
Basically, a landlord can ask anything he wants. If you don’t want to pay, move your booth. Yes, it IS A lease, even if it is an oral agreement.
Well stated Randall!
I was trying to buy my business partner 50% off, gave him 80%of the money he asked me for and told him that I will give him the rest of the money in several payments, after I gave him the money 2 days later the landlord told him that she’s not renewing the lease and now he doesn’t want to give me my money back. can I take him to court since he’s selling me a business without a lease???
Greetings German,
Sorry to hear about your predicament.
I’m not an attorney so I can’t give you legal advice, but part of owning a business is ensuring that you have a legal access to the property it depends on. For this reason most deals are continent on a valid leasehold. It sounds like you might have gotten stuck in the middle, owning a business that you may not have access to the space to operate. I would advise you to review the lease, review your partnership agreement, have an honest conversation with the landlord about your intentions to run the business in the space, and consider hiring an attorney to advise you on your legal options. Best luck to you.
Had our business for 15 year. Ill health forced sale. Landlord very understanding. Sold to a cash buyer in 2 days 9th March 2021. Landlord stopped talking to us and buying a sandwich twice a week. Landlord and his solicitor have stalled the sale ever since for whatever reason. Buyer going to take over lease but 2 weeks ago landlord offered a new lease with a longer term. Now into June and still not completed. The costs are running high and we have to pay his and our own solicitor fees. I really want to complain but don’t know who to! His solicitor has just asked the buyer’s solicitor the sale price is. Can our landlord ask for a percentage of the sale price?
Assuming that a solicitor is what we call an attorney in the States, this sounds like an all to common situation; a deal stalled by a landlord.
It’s common for landlords and their advisors work at a slower pace than tenants prefer… As far as what to do, you should review the lease for language that protects you, including any language about the assignment fee, and the words “cannot be unreasonably withheld” in regards to an assignment.
Work with your own solicitor/legal representation to understand what your options are. To answer your question directly, yes the landlord can ask for details of your transaction. If he or she is in a position to interfere with your sale, sometimes they do ask for a part of the compensation, especially if this fee hasn’t been defined in the lease.
Sorry to hear you’re in a bind Susan. The good news is the landlord does want a tenant in your space, so you should reach a resolution eventually.
If you sell your business, and the new owner signs a new lease with the landlord, does the landlord have the right to transfer your security deposit to the new tenant?
Hey Victor,
As a tenant, the security deposit is an asset of yours being held by the landlord.
The specifics around the handling of the security deposit should be detailed in the lease, but in most cases you should get it back if you finish your lease and return the property in the agreed upon condition.
In the event that you assign your lease, the new tenant will need to put down his or her own deposit, in which case the landlord may have them pay you directly instead of collecting it from them and redistributing it to you.
I hope this answers your question.
Can the sale of 100% of Tenant’s stock be considered an assignment of the lease?
Hey Dan,
That’s a great question for a real estate attorney.
I’m not an attorney, but as a business broker my perspective is that it is not, as the same firm who has signed the lease is still performing in a 100% stock transaction.
My commercial lease tenant was just acquired by another company. Do I need to complete an assignment of lease? Any else to consider or complete? If my tenant is still operating (not sure of this yet) under the name on the lease, would an assignment of lease be necessary?
Hello Sydni,
I’m not an attorney, but as a business broker my perspective is that if it was an asset sale, meaning a new firm has bought the assets/goodwill, then yes. If they did a stock sale and a different firm took over the shares of the former company, then it’s essentially the same company and they are bound by the same lease. Chances are it’s an asset sale and they will need an assignment.
I own commercial property.
One tenant sold his business. Buyer will take the same space.
Do I return the seller his security deposit back or does he request it from new buyer
Linda: If the business is the named lessee, then the business did not move out or change. Therefore, there is no security deposit returned because the lease is still in force. The buyer and seller should work out between themselves how to settle the deposit, because on the books of the business, this is simply an asset just like any other tangible asset.
Great question Linda,
Normally the closing attorneys document the details, but I work with most of my buyers and sellers to agree on handling of the security deposit.
Most of my business buyers will pay the business seller’s to “buy” their security deposit, then the landlord will acknowledge that the security deposit has been transferred.
This is the simplest process instead of New Tenant > Landlord > Original Tenant.
This also assumes you are satisfied with the condition of the property to return the security deposit to the original tenant.
Hope this helps!
My landlord is asking the buyer of my business for a personal gaurantee or $100,000 deposit… this well exceeds the deposit I put down. The new buyer wants to put it in a llc. but the landlord wants it in his name only. These terms are clearly improving the landlords position. This has turn the buyer off and dosent want anything to do with this landlord.
Hey Jeff,
Sorry to hear your landlord is making your transaction more challenging.
Asking for a personal guarantee is “the norm” in my experience, the $100K deposit ask sounds like they are just giving the prospective tenant an alternative.
Also, putting the lease into an LLC is also “the norm,” but the personal guarantee should offer your landlord the protection they are seeking, in most cases. I’d be curious if the landlord feels as if they prospective tenant lacks the experience or balance sheet strength to take over the lease, you may want to probe both your buyer and landlord to explore this. When conditions come up they are often a solution to a challenge that you need to overcome; maybe there’s another way.
Lastly, if the landlord isn’t comfortable with your buyer/prospective tenant then they will most likely be looking at you as the “back up.” Be sure you understand what will happen with your own personal guarantee should this buyer/prospective tenant take your place.
Hope this helps.
We are about to sign a lease for a restaurant space, but found a clause in the fine print that the landlord is to have 50% of the premium sales price if and when the tenant sells the business. It already seems unfair that the landlord wants any portion of the business owner’s transaction of his own business, let alone 50% of the premium. What should I do?
I agree with Holly and Randall’s response Daniel.
I’ll also add that just because a lease doesn’t include a clause that enables a landlord to take a portion of the business owner’s sale price doesn’t mean they may not ask for one.
I had this happen and the landlord asked for 20% of the sale price to assign where the lease was silent. The outgoing tenant negotiated the fee down, and the incoming tenant negotiated a defined, reasonable fee to avoid it happening to them when they exited.
Hi Daniel,
I’ve had clients run into this situation when negotiating a lease.
I told them to RUN AWAY. There are other places to lease with a landlord who wants to be in the real estate rental business and not in your business. Why would you reward your landlord for selling your successful business?
I couldn’t agree more with Randall, seek legal advice regarding any lease you sign!
Good luck Daniel!
Daniel:
Before signing ANY lease, consult your attorney! Thinking you are saving $1000 by not using an attorney is a poor business decision.
You can negotiate ANY terms the landlord offers. You can establish your business across the street and the landlord gets nothing!