This article is part II in a series about leasing office space.
In part I, we discussed how a tenant’s representative can help–and hurt–your office space search.
In part II, we’ll discuss some provisions to consider negotiating before your startup company signs a commercial office space lease. The following list is in no particular order and you don’t have to negotiate every item.
Rent. Of course you’ll want to negotiate rent. Your tenant representative is better equipped than your lawyer to provide you with information about the market value of your commercial office space. Just remember that your tenant representative gets paid MORE if you pay MORE over the course of the lease (see “Term” below). Sometimes it’s better to negotiate harder on non-rent items because they can really limit your downside…which can be more beneficial than trying to squeeze out extra savings on rent. (See “Personal guarantee” below)
Term. Commercial landlords hope (and pray) you will sign a 5-year lease. It’s like going to a car dealership for a used sedan and coming out with a brand new H2. It’s just too much and you will be on the hook for more than you need, or worse, more than you can afford. Try negotiating that initial term down from 5 years to 3 years with a couple of 1-year options at your sole discretion. (Note: Your tenant representative will not be happy with this because his or her commission will likely be reduced if you sign up for a shorter guaranteed term.) Entrepreneurs often make the mistake of viewing their lease as a monthly rent obligation instead of a total rent obligation. For example, a $2,500 per month lease is really a $150,000 contract if your term is 5 years. The same monthly lease yields a $90,000 total obligation with a 3-year term. Go for the shorter term. It will provide your company flexibility and reduce its future lease obligations. A reduced initial term can also solve a huge problem caused by having to personally guarantee the lease.
Personal guarantee. When landlords pay for a large amount of tenant improvements, personal guarantees of the lease are commonly requested…and usually required. And sometimes landlords will require personal guarantees even if they provide minimal tenant improvements. But a landlord may be willing to let the personal guarantee burn off after a certain period (before the initial term ends).Unfortunately, most startup companies get suckered into the “standard” 5-year commercial lease and a 5-year personal guarantee. And since most startup companies do not make it past the 3-year mark, you can see why the personal guarantee is potentially a huge liability and thus a huge issue. For that reason, I recommend that your startup company NOT sign any lease where your personal guarantee extends beyond 2 or 3 years.
Renewal Options. The option to renew should be yours and yours alone….or else you really don’t have an option and your company will be forced to re-negotiate with your landlord. Remember that the landlord would rather have you continue to lease the office space instead of searching for a new tenant. Even so, landlords will often try to jack up the rent after the initial term. They hope that your company would rather pay much higher rent than move. Thus, set out the option period’s rent ahead of time, and at a reasonable figure, so your company can make plans to either vacate or remain at the premises when your initial term ends.
Early Termination/Buyout. Your business skyrockets. Your business tanks. In either event, your company now needs to get out of the office space lease. The quickest, cleanest, and best way to accomplish this is through the use of an early termination provision. Basically, your startup company would pay a predetermined lump sum to the landlord to walk away from the office space lease. If the lump sum isn’t completely astronomical, it can be a valuable provision for you…or at least limit your downside.
Late Charges. Just make sure you have a grace period for paying your rent late, as you’ll be busy and inevitably forget to pay the rent by the 1st of the month. Anything over 3 days is great and 5 days is optimal. Also make sure that the late fee isn’t so large that it ends up feeling like a penalty. Late charges should promote on-time rent payments rather than being a windfall for your landlord.
Holding Over. If you remain in the office space after your initial term without executing a new lease or option term, you are a “holdover tenant.” A typical holdover provision might call for “consequential damages” to be paid from the tenant to the landlord. Try to eliminate these damages or at least set a cap on them. (Even better, don’t be a holdover tenant.)
Security Deposit. A landlord has a legitimate interest in getting a security deposit since most startup companies have zero net worth. Often, startup companies are expected to pay large security deposits. A landlord may be willing to forego a security deposit (or at least reduce the amoutn of the security deposit) if the office space is in low demand. Try and negotiate that the security deposit will earn interest which belongs to your startup company or that the amount of the security deposit declines over the life of the lease. Otherwise, you are giving the landlord an interest-free loan.
Option for additional space. If your statup company needs more space and you want to stay in the building (or go to another property of the landlord), your landlord will likely be willing to let you out of your current lease without penalty. But just to be safe, consider inserting this provision into your office space lease. You want to avoid giving your landlord any leverage over your startup company, even in situations where the landlord will benefit from such a move. So get it in writing.
Relocation. Sometimes I’ll find a lease where the landlord wants the right to require the tenant to relocate to another office in the landlord’s building. Obviously, this has negative consequences for the tenant. If you are willing to keep this provision in the lease, make sure that you will be fully compensated for the economic damages you will suffer from the relocation (moving, advertising, printing, tenant-improvements, loss of business, etc.).
Common Area Maintenance (CAM). Typically found in retail leases but sometimes found in office space leases, CAM charges are paid by the tenant for the shared areas of the building or development. Your tenant representative should be able to give you a good idea if the quoted CAM charges are too high. I recommend getting these charges capped so that you aren’t surprised at a later date. Additionally, be sure that the landlord spells out exactly what expenses they are including in CAM charges. Sometimes landlords can be sneaky.
Permitted Uses. Avoid any language that restricts the permitted use of your commercial office space. Such a clause may restrict your future business activities in addition to limiting the amount of prospective assignees and subleasees.
Tenant Improvement Allowance. A tenant improvement allowance is a common concession by the landlord. Basically, the landlord will give the tenant a credit for $X, usually based on the office space’s square footage, to prepare the office space for the tenant’s use. Sometimes all the office space needs is new carpet and paint (which, by the way, you shouldn’t have to negotiate for). Be sure that your tenant improvement allowance will be enough to cover your expected buildout costs. Other issues that you should address are: (a) whether or not the Americans with Disabilities Act of 1990 (ADA) will impose construction requirements that you’ll have to fund, (b) whether you are entitled to a cash rebate for any buildout that falls short of the allowance, and (c) if the landlord will handle the build-out for you, that the landlord will use competitive bidding.
Insurance. Most leases require the tenant to maintain liabiity and casualty insurance. And I strongly recommend all tenants meet with a commercial insurance agent and discuss their insurance needs, whether or not the lease calls for insurance. Lease obligations cocnerning liability and casualty insurance should probably not be the subject of significant negotations. Just make sure, via your attorney and insurance agent, that the insurance and amounts are customary in such a setting and that any use of your insurance proceeds are contingent on the landlord’s use of his or her insurance proceeds to restore the building.
This list will continue in part III of How to Avoid Being Ripped Off When You Lease Office Space.