Leasing “Bootcamp” for Startups

You’ve finally made the decision to leave coffee shops behind and rent office space. You begin searching online, maybe even find a few places you like. You contact the listing broker and make an appointment to tour the space. It’s perfect for your business. The broker tells you the market is hot and you need to move fast (FYI, they always say that!). By the time you get home you find an email from the broker sitting in your inbox with a overwhelming 30 page lease attached. The broker says “don’t worry it’s a “standard” lease and fair to both parties, besides the only important part is the term and rent.” While this is your first foray into commercial real estate, you wonder why then do we need the other 29 pages? The answer is because commercial leases are binding legal documents that outline your responsibilities and protect your rights, and, most importantly, they can have a substantial impact your business going forward.

Whether you’re “office sharing” or entering into a more traditional leasing arrangement, there are five things to focus on:

  1. Letter of intent (“LOI”). This document is exchanged up front, and lays out the general terms to be incorporated into the lease. Many brokers will insist on skipping this step and go right to the lease, but if the landlord hasn’t agreed on the basic business terms you’re wasting time and money presenting him a formal lease. The LOI makes sure everyone is on the same page before drafting the lease, thus saving you unnecessary legal fees. The broker will usually prepare the LOI, but before you sign it make sure it says that it is a non‐binding expression of interest, and not a binding contract. Bottom line, make sure what is in there is what you want from a business perspective (i.e., rent, build‐out, security deposit, type of use, access, kitchen, pets, bicycles, ect.).
  2. Insurance and Indemnity. Allocation of the risk is an important concept in leases that determines which party bears the responsibility to respond to risk when something occurs in the leased space or building. Your ability as a small business to respond to the risk is satisfied by obtaining insurance coverage. Work with an insurance agent to review the insurance requirements in the lease, and, unless you have a prior relationship with the agent, make sure to obtain several quotes as prices many vary significantly. Included in leases are long provisions where the tenant indemnifies the landlord if certain events occur (i.e., tenant assumes the risk whether or not caused by tenant). As your company grows, indemnity provisions can be negotiated—but for a startup “it is what it is”—so insurance is critical.
  3. Assignment and Subletting. Your name is going on the lease, so you are ultimately responsible. If plan on sharing the space with others, make certain to discuss this in advance with the landlord, as many leases will contain a default provision if you try to assign or sublet the space without the landlord’s permission. For businesses that expect to grow through new or additional rounds of financing, this provision is particularly important because these could trigger a “change in control” of the ownership of your company which could lead to a default under the lease. Make sure to discuss this possibility as well.
  4. Personal Guaranties. Startup tenants may have a difficult time negotiating a lease that doesn’t include a personal guarantee; however, you may be able to negotiate to limit the scope or impact of such guarantee. There are several ways to accomplish this (see Negotiating Personal Guarantees in Commercial Leases), so it is important to discuss these options with your attorney.
  5. Tenant Improvements. It is extremely important to understand how the space will be built out, including electrical, HVAC and data/voice. While some tenants may want to control of this process, in the long run it’s better to have the landlord perform the work (at landlord’s cost). You have your own business to run, so let the landlord deal with construction delays and legal compliance issues. This after all is their expertise, not yours.

Rent in commercial leases usually has three components and you should get familiar with these as they go directly to the bottom line:

  • Base Rent. This is the base amount you are paying for occupying the space.
  • Additional Rent. The amount that is based on your percentage share of expenses incurred by landlord in owning and managing the building. These expenses can vary based upon what services are included as landlord’s operating expenses, so it is important to review this list.
  • Tenant Expenses. The lease may require tenant to pay service providers directly for certain services instead of reimbursing landlord as part of additional rent. For example, this can be janitorial services within the leased space, separately metered electrical, and taxes on your personal property.

Negotiating commercial leases involves a wide array of terms and options. If you need assistance in negotiating your commercial lease, please contact the attorneys at Morsel Law.