Although you do your best as a small business owner to forecast revenue and expenses, sometimes there are extenuating circumstances that affect your business’s success or failure. Since leasing office space spans such a long gap of time (relative to the small business cycle), is legally binding and commits capital over a period of time, it is inherently risky. Using a worst case scenario (terminating your lease early) and best case scenario (needing larger space), below are some helpful tips can that assist in the reduction of the overall risk associated with signing a commercial lease.
There are 3 ways you can protect yourself
from a worst case scenario situation with your lease to include a Personal Guarantee, Assignment or Subletting, or Death and Disability clauses. By signing a personal guarantee, you as an individual (typically the business owner) becomes personally liable for the lease payments. For example, in the case of bankruptcy, if you sign a 5 year lease on a property and your business only survives for 3 years into your lease, you will have to make the last two 2 years of payments from your personal accounts. When signing a lease make sure you understand what you what you are personally liable for.
Landlords typically ask for personal guarantees on space when they have to spend a lot of money into customizing the space to suit your business or if you, the business owner, are a start-up company. Often times, a start-up company is viewed as a risk to the landlord so they may want to share the risk equally with the tenant. If this is the case, you can always negotiate. Perhaps your broker can negotiate that you only personally guarantee the amount of improvements that are specific to your business or have the dollar amount decrease as you get closer to the lease expiration date. If you happen to have a good broker, the landlord may agree to lift the personal guarantee if you show good payment history for a number of years (usually 2).
Having the right to assign the lease or sublet a portion or all of your office can alleviate many of the worst case scenarios that would result in your having to terminate your lease. If you are preparing to sell your business or feel that there is a chance you would need to relocate your office to another city or town, negotiating the right to assign the lease to another business willing to take it over or subletting some or all of the space can protect you in the future.
The death and disability clause is used in a lease to terminate the agreement should a specified individual (usually the business owner) pass away or become permanently disabled. For example, a law firm with only one lawyer and a receptionist might want to negotiate a death or disability clause into the lease so that if the lawyer passes away or cannot practice law due to an disability, the law firm (which now has no practicing attorneys) won’t be liable for the remainder of the payments.
How to prepare yourself for a best case scenario
There are also ways you can protect yourself in a best case scenario situation with your lease where you need to acquire a bigger space to accommodate the needs growth of your business. You may want to include a Relocation/Expansion and Right of First Refusal clause to your lease agreement. Negotiating a relocation clause in your lease typically gives you the right to move into any other office that the landlord has available for lease. Specifications vary so make sure you’re fully aware of the guidelines.
A right of first refusal in your lease means that you would like the landlord to ask you first if you would like to lease any adjacent spaces to your current office before they can lease it to another customer. “First rights” are beneficial because it could save you the cost of moving your entire office into a larger space. They are usually set up under a tight time frame, for example, you might only have 24 hours to tell your landlord if you’re going to take the space or not. Normally you will have to meet or beat the offer of the third party, so it might not be worthwhile to save the cost of the move if the terms and conditions of the deal don’t fit well into your business model. Even with a tight time frame in place, be sure to think our your next move clearly and seek the advice of those you trust with your business dealings.