By Richard D. Harroch and Mark C. Rosen
Office space is one of the largest expenses a growing company incurs. Negotiating the best lease possible can save your company enough cash to hire a few more employees or to launch a marketing campaign. Because no lease is standard, we offer some suggestions below to help you become a little more lease-savvy and negotiate a favorable office lease for your company.
Keep in mind that your ability to negotiate an office lease is dependent on how much leverage you have. Do your homework. Are other companies vying for the same space? Has the space been vacant for a long time? Factors such as these may make the difference between you calling the shots, or a landlord insisting on onerous terms throughout the lease process.
1. Length of lease term
Landlords are typically willing to make concessions for longer-term leases. However, your company’s needs may change and you may find yourself locked into a lease that is too small, too big, or with rent that is above-market if demand for space subsequently declines. Try to negotiate a shorter-term lease with renewal options—a two-year lease with a two-year renewal option, for instance, rather than a four-year lease.
2. Tenant improvements
Your new space may need some improvements or alterations. Who pays for these improvements (a new paint job, new carpets, reconfiguring the space) depends on how tight the commercial office space market is in your city.
Most form leases provide that the tenant can’t make any alterations or improvements without the landlord’s consent. Ask for a clause that says you can make alterations or improvements with the landlord’s consent and that the consent won’t be unreasonably withheld, delayed, or conditioned. Often, you are able to negotiate a “tenant improvement allowance,” which is an agreed sum of money that the landlord will provide for the improvements and alterations you want.
3. Rent and rent escalations
Some landlords will give free rent for the first month or two of a lease. Fixed rent over longer-term leases is relatively rare. Sometimes, landlords insist on annual increases based on the percentage increases in the Consumer Price Index (CPI). If your landlord insists on rent escalations, try to arrange for a CPI rent increase that does not kick in for at least the first two years of the term. Then, try to get a cap on the amount of each year’s increase.
If you have to live with a rent escalation clause, try to negotiate a predetermined fixed increase; for example, a rent of $5,000 a month the first year that would only increase to $5,200 a month the second year and $5,400 a month the third year.
4. Repairs, improvements, and replacements
Be aware of a clause that says that at the end of the lease you must restore the premises to its original condition. Try to negotiate a clause that states the following: “The premises will be returned to the Landlord at the end of the tenancy in the same condition as at the beginning of the tenancy, excluding (1) ordinary wear and tear, (2) damage by fire and unavoidable casualty not the fault of the Tenant and (3) alterations previously approved by the Landlord.”
5. Assignment and subletting
Startup companies should negotiate enough flexibility in the assignment and subletting clause to allow for mergers, reorganizations, and share ownership changes. Watch out for a clause that says a change in more than 50% of the company’s stock ownership will be deemed an assignment that is prohibited without the landlord’s prior approval. As the company grows and new people invest in it, this clause can be inadvertently triggered.
6. Try to avoid these one-sided lease provisions
Landlords use form lease agreements that can be very one-sided. Be on the lookout and negotiate on these types of provisions that are heavily landlord-favorable:
- The landlord is given the right to pass on to the tenant, without limit, increased operating costs such as property taxes, building repairs, or insurance premiums.
- The landlord tries to lease the premises “as is” or tries to disclaim responsibility for compliance with environmental laws (e.g., asbestos issues) or the Americans with Disabilities Act.
- The landlord tries to require the tenant pay any tax increases resulting from a sale of the property.
- The landlord tries to reserve the right to terminate the lease at the landlord’s convenience.
- The landlord tries to prohibit the possibility of subletting or assignment.
- The landlord insists on personal guarantee of the key shareholders of the company.
7. Consider available subleases
Sometimes good deals for office space are available as subleases from companies who don’t need as much space as they once did. You will be subject to the terms of the master lease with the landlord, so you need to carefully review that lease. You will also want to limit your responsibility for increased operating costs that get passed through to the sublessor from the landlord.
Some of the benefits of commercial space subleases include:
- Space that is often turn-key ready with built-in improvements
- Cheaper and easier to get
- Shorter length of term (most direct leases with landlords are three to five years)
- Better terms than direct leases with landlords
- Possible access to common areas, reception areas, and conference rooms
8. Comparison shopping on lease rates
When you are shopping around for office space, make sure you are comparing apples to apples. In real estate leasing lingo, “usable” square footage is not the same as “rentable” square footage. For any given space, the useable square footage is always a lower number than the rentable square footage because the useable square footage does not include common areas such as public corridors, elevators, lobbies and bathrooms from the overall calculation of the total space. So, make sure to use the same method of space measurement when comparing lease rates in different spaces.
9. Consider using a tenant broker
You want to have alternative space choices to consider. Ultimately, if a prospective landlord is difficult to deal with during lease negotiations and makes unreasonable requests, you might want to consider leasing office space elsewhere.
A good tenant broker is essential here and will represent your company’s best interests. He or she will educate you on the current market; locate spaces that meet your stated parameters; arrange tours and accompany you to view these available spaces; and then prepare offer letters to, and negotiate, with landlords for all spaces that work best for your company.
That same broker will work in tandem with you and your attorney throughout the lease negotiations. Should there be a need for architects, space planners, general contractors, furniture, cabling and equipment vendors, your broker can help you create the team that works on behalf of your company.
10. Prepare a Letter of Intent to the Landlord
A good way to start the negotiations for an office lease is to prepare a Letter of Intent (“LOI”) or “term sheet” to present to the landlord. This can set forth the essential proposed terms: lease rate, term of lease, renewal options, etc. Here is a sample form of such a letter of intent for an office lease that you can tailor to your particular situation. See also additional provisions at the Forms & Agreements Center at AllBusiness.com.
Copyright © by Richard D. Harroch. All Rights Reserved.
Richard D. Harroch is a Managing Director and Global Head of M&A at VantagePoint Capital Partners, a large venture capital fund in the San Francisco area. His focus is on investing in Internet and digital media companies, and he was the founder of several Internet companies. His articles have appeared online in Forbes, Fortune, MSN, Yahoo, Fox Business, and AllBusiness.com. Richard is the author of several books on startups and entrepreneurship as well as the co-author of Poker for Dummies and a Wall Street Journal-bestselling book on small business. He was also a corporate partner at the law firm of Orrick, Herrington & Sutcliffe, with experience in startups, mergers and acquisitions, strategic alliances, and venture capital. Richard can be reached through LinkedIn.
Mark C. Rosen is the founder and CEO of Rosen Realty Group, one of the first commercial real estate brokerage firms in San Francisco specializing in commercial tenant representation. Since 1984, RRG has negotiated over 1,000 office leases for its clients, many of which are startup companies focused on software, engineering, internet, mobile applications, SaaS, pharma, biotech, venture capital, as well as law firms. RRG represents Mozilla Firefox in its office leasing requirements throughout the San Francisco Bay Area, the United States, Europe, and Asia.
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