Six Considerations for Negotiating the Best Lease for Your Start-Up

November 23, 2015

Negotiating a lease agreement requires a prospective tenant to consider and address multiple factors. This is especially true for an early-stage business, which often faces many unknowns regarding the future of their business and where the lease itself can constitute a significant portion of their monthly expenditures. The following is a list of six things every tenant should consider when negotiating a lease agreement.

First, a prospective tenant needs to understand what is and is not included in the base rent amount and what additional expenses they will be responsible for under the lease. In real estate parlance, this can range from a gross lease where the tenant pays a fixed amount and landlord is responsible for paying all expenses that are normally associated with ownership (i.e., taxes, insurance, repairs) to a triple net lease where, in addition to the base rent, tenant is responsible for paying all operating expenses associated with the property. Since triple net leases are commonplace in the commercial leasing context, it may be important for a prospective tenant with a fixed budget to negotiate a period (i.e., 12 months) during which time they will not pay operating expenses increases or to agree to a  percentage cap (i.e., 3%) for yearly increase of operating expenses.

Second, the commencement of a lease can either be fixed to a date certain (i.e., January 1) or tied to the completion of some event. For instance, where a landlord has agreed to make certain improvements to the leased space, the lease commencement date should be defined as the date the landlord delivers the space to the tenant with the completed improvements. This protects against a tenant’s obligation to pay rent prior to landlord’s completion of their work. As part of their negotiations, tenants may also want to consider whether an agreement can be reached regarding an additional penalty if landlord fails to deliver the completed premises by a date certain.

Third, it is critical for a burgeoning business to consider the term of a lease, whether there are options to renew the lease or any termination rights.  Increased flexibility in leasing arrangements is a paramount consideration for startups since it is difficult to anticipate the future needs of the business. For instance, it may prove beneficial to negotiate a short initial lease term combined with multiple options to renew for subsequent terms. In negotiating options to renew, the focus should be on establishing the percentage increase in rent in advance and, if a fair market valuation will be used, to agree to the calculation for making that determination. In a similar vein, while landlords generally disfavor termination rights, it may be possible for a tenant to negotiate that right for an agreed-upon penalty payment.

Fourth, a prospective tenant should address the potential for future growth by attempting to structure a lease to provide for expansion rights into adjacent space if available. An expansion right can be made subordinate to the rights of existing tenants and should also address and determine the proper allocation of construction expenses that will be necessary to complete such expansion.

Fifth, the ability to assign a lease may be part of a critical exit strategy for a business, and prospective tenants should protect this right to the greatest extent possible. In the absence of a provision permitting assignment, a landlord could attempt to reject an attempt to assign the lease for any reason or no reason at all. If a landlord objects to the inclusion of an open-ended assignment provision, a tenant can alleviate these concerns by carving out only certain permitted assignments (i.e., transfer to affiliates, mergers or sale of all or substantially all assets), or through an agreement that any assignee will have at least the same creditworthiness as the existing tenant.

Sixth, it has become increasingly common for landlords to request a personal guaranty from the principals of the leasing entity. For obvious reasons, prospective tenants should attempt to limit their personal exposure, which could be done through agreeing on an expiration date based on certain milestones (i.e., history of timely payments or financial stability) or capping the guaranty to a certain dollar amount.

For more information about "Six Considerations for Negotiating the Best Lease for Your Start-Up," contact Clarke Sugar at csugar@axley.com or 608.260.2481.