Written by Craig Melby
Modern entrepreneurs have a new set of workspace challenges.
There is almost no industry today that is not ripe for major disruption and unexpected consequences. More than ever, part of a company’s risk assessment must include the liability they take on when they commit to a workspace, and how to keep things flexible enough to roll with the punches.
Unlike the more traditional, established businesses of yesterday with their slower growth rates and more predictable needs, today’s entrepreneurs are faced with accelerating technological changes and changes to the marketplace. They need physical space and lease terms which are flexible and also allow their companies to grow quickly, or relocate, fail, adjust their business model, acquire another company, or be acquired. The horizon for predicting future events has become very short indeed.
While this new phenomenon continues to become more obvious every day as yet another new start-up throws another formerly-successful business model into disarray, the traditional commercial real estate business and finance model has, in my opinion, simply not kept up, and many times has to be dragged kicking and screaming into today’s business world.
Fortunately, some forward-thinking businesses don’t just accept the status quo, and with enough thought, all parties can come to terms that reflect the reality of the contemporary business-space marketplace.
In an effort to help you do the same, let me share some of the primary ways to avoid being hamstrung by obsolete work-space lease terms.
If you need to pivot, or provide a new service and need to hire more people, your company’s growth should not be slowed because of the limited space you are in.
Many of today’s start-ups don’t know how much space they are going to need in a year, never mind the typical three or five years most landlords typically demand. In 2016 it’s typical for the lessee to push for shorter terms, with several lease-renewal options. That way, the tenant can better fit the growth needs of the company by moving more frequently if need be. Sure, most landlords are disappointed with shorter lease terms, and some circumstances make it difficult; but done right, it is still very doable. Business owners need to prize their flexibility as a significant asset, and seek facilities which they can use pretty much as-is, so the landlord doesn’t have to invest a lot of money into their company’s interior improvements.
Lease Termination Clause
Depending on how successful a company is in obtaining flexible lease length, startup entrepreneurs can build in an option to walk away from the space and go elsewhere if the situation requires. Typically called a “kick-out” clause by industry insiders, this clause is usually tied to specific time frames and penalties so it’s fair to both sides. Assuming a five-year lease term, a typical example would be to allow the termination anytime after the 30th month, and giving the landlord six month’s advance notice, along with reimbursing the landlord for unamortized expenses (including leasing and legal fees and tenant-improvement dollars contributed by the landlord).
Another way entrepreneurs build flexibility into their workspace lease is to obtain a right to increase the size of their space as their requirements evolve. This is fairly palatable with many landlords, for whom getting a bigger tenant with an extended term is always a good thing. It is fairly practicable, too, when the overall facility is large enough to absorb this type of requirement. Having many other tenants and spaces in a building provides a higher likelihood there will be space when needed. Typical expansion clause terms provide that the landlord receives a minimum six-month notice, and then the length of the new lease gets extended beyond the term remaining in the original lease. In some cases, the expansion clause is written with a specific space in mind (usually an adjacent one), plus a window of time during which the tenant can expand. The landlord then agrees not to rent that space to another tenant for any time period that goes beyond your right to expand into it. (This is not too difficult to do, especially if the landlord inserts a relocation/termination clause into the adjacent space’s lease.)
Do landlords like doing this? Of course not, but if given a choice between you renting from them or going elsewhere, they have to seriously consider it. This also depends on the strength and prestige of the tenant, and the other terms of the lease. Just remember: With all the massive industry disruption going on, the modern world is not business as usual. If you need to pivot, or provide a new service, and need to hire more people, your company’s growth should not be slowed because of the limited space you are in.
Limited Personal Guaranty
Founders shouldn’t be hamstrung by financial obligations that aren’t absolutely necessary and which could complicate future choices and options. By choosing space where the landlord doesn’t have to invest a lot of money fixing things up to your unique specifications, company owners should not have to personally guarantee leases. Or if they do personally guarantee a lease, the guaranty should expire at some point, or have a limit to the financial exposure. I see leases where the personal guaranty—if needed—expires after the second year of a five-year lease, or the maximum dollar amount of guaranty is fixed at the amount of the landlord’s cost of doing the deal (remodeling costs, legal and brokerage fees, etc.). Also common in the industry is an “evergreen lease guaranty,” where the guarantor is always obligated for 12 months of term, which is way better than the full remaining term.
Forward-thinking entrepreneurs always get renewal options. If their business is location-sensitive, it’s best to avoid circumstances that may force you to move and suffer the business disruption and loss of revenue.
Note that if things start to go sideways and you need to negotiate an unexpected termination of the lease, it helps in the negotiations if your exposure is limited from the outset.
Forward-thinking entrepreneurs always get renewal options. If their business is location-sensitive, it’s best to avoid circumstances that may force you to move and suffer the business disruption and loss of revenue. Without specific renewal options, even if landlord and tenant agree on the business remaining for more time, tenants are at a disadvantage when negotiating the new rate and terms. Typically, businesses can get a three-year option to renew when they sign a three-year lease, and five years on a five-year lease, but it’s also possible to get multiple renewal options, which are obviously better. Rental rate at time of renewal? Landlords prefer to make the renewal rate “at market,” a fixed percentage increase or the Consumer Price Index. We suggest entrepreneurs get a fixed rate, since the renewal can always be negotiated if the fixed rate option turns out to be higher than market, or accepted if it turns out to be below market rents.
Owners of fast-growing companies also need to pay attention to the assignment provision. This is usually buried in the “boiler plate” of leases and often overlooked, but it becomes more and more important with fast growing companies that have fast growing evaluations. Thinking of selling the company? Most standard assignment clauses prevent an assignment of the lease without landlord approval and negotiation; for an entrepreneur, this means that your company can’t be sold to another entity and subsequently assign the lease to the new owner without getting the landlord involved (and perhaps renegotiating everything). You obviously can’t cancel the lease and sell your company, but you also can’t “assign the lease” and sell the company either. I have seen lease assignment fees as high as $30,000—and perhaps even worse, another lease had language that gave the landlord the option to terminate the lease if the tenant even requested an assignment!
A Couple Other Elements To Which Entrepreneurs Should Pay Close Attention
Unlike the “old days” where large, corner offices were the badge of success and part of moving up the corporate ladder, today it’s flexibility and open floor plans that motivate the younger generation. Many companies place a high priority on amenities which attract and retain quality employees. Want to ride your bike or bring your dog to work? Got day care onsite or nearby? Employees will be loathe to move away from those conveniences. And remember: The cost of a little extra rent is peanuts compared to the costs of attracting, training, and keeping top talent.
Finally, be sure to negotiate the rental rate. Building in all the flexibility is key; but just as before, making sure you get all the rental discounts and landlord incentives to which you are entitled is still important. It’s nutty to work so hard for top-line gross sales, then give profits away needlessly because you are paying more than you have to.
Craig Melby has offices in both Brevard, NC, and Florida and is founder of LeaseSmart.com, a nationwide business real estate advisory company.