Leases: Don’t Get Caught Out

Some Key Lease Terms To Consider

When buying a business with a lease in place, some of the key terms to consider are:

Can the premises be used for the business? All leases have a defined use. Depending on where the business is situated, and the number of shops in the centre, this can be defined as wide as “retail” or as narrow as “sale of food as per the attached menu” with the menu attached. What is important is that the definition of the use allows the buyer to undertake all their desired activity. Also, a lessor and seller will not usually guarantee that the particular business can be run from the premises. Whilst the business may have traded from the particular premises previously, the buyer should check with a town planner that the use is lawful. Otherwise, the buyer could find themselves bound to a lease in which they cannot operate their business.

Is the length of the lease sufficient? Leases contain a fixed term. This is the period in which the lessee can operate the business. Some leases also contain option periods. These are further periods available to the lessee if they wish to exercise the option. If the particular location of the business is important to its success, the longer the lease term and any options the better. If the length is insufficient, the buyer may attempt to negotiate a new lease or an extension of the lease term as a condition of purchasing the business.

Are payments required under the lease sustainable? Whilst the rental that the buyer is required to pay immediately upon becoming the owner of the business might be reasonable, it is important for a buyer to satisfy themselves with the manner in which the rental will be reviewed under the lease (usually every year) and what other payments are required under the lease. Rental is often reviewed on the annual anniversary of the lease commencement date. The rental is often increased by a fixed percentage, CPI or a “market” review. Other payments required under a lease also include a contribution to outgoings and promotion levies. All these need to be considered. Also, the buyer will normally be required to pay a security bond or bank guarantee prior to taking possession of the business normally equivalent to 3 months rental. This can put a serious dent into capital if unexpected.

Are fit-out/refurbishment requirements in line with your business plan? When the premises were leased to the founder of the business, it was probably an empty shell. The founder would have been required to fit-out the premises. Most leases require the premises to be “refurbished” at some point during the term. What is required varies from lease to lease but it often requires at least the re-treating and painting of all surfaces and changing the floor coverings. Some leases also require a new fit-out. If this is the case, this needs to be factored into the projections of the business sale. It could be an expensive exercise.

Given the significant impact of the lease on the success of the business, it is important that these items are satisfactory before proceeding with the purchase of a business.