Negotiating Your First Office Lease

It’s easy to fall in love with a business location. These expert tips help you approach the situation with sound knowledge and a clear head.

One of the first big-dollar contracts entrepreneurs sign as business owners is a lease for office, warehouse or retail space. So, Business on Main asked Bill Green, real estate partner with Perkins Coie, for guidance on how to avoid beginner’s mistakes and negotiate first real estate leases with confidence.

Business on Main: What should entrepreneurs do before they fall in love with a location?

Bill Green: Ideally, it’s helpful to get some legal advice before signing a letter of intent [LOI] with a landlord. Even though LOIs are nonbinding, it’s harder [without one] to renegotiate key positions regarding the security deposit amount and how it’s put up, lease renewal issues, rights to lease additional space, operating expense increases, et cetera.

What can go wrong when business owners go at it alone without a lawyer’s guidance?

Many business owners don’t have a huge budget for legal expenses, which is understandable. They may assume that a LOI — and even the final lease — is just boilerplate, even though you can negotiate a better deal. I try to explain to clients that they’ll have to live with a lease for five to 10 years. It’s worth spending some time up front to get it right and think through the issues that can cause problems later.

What are some issues that can catch business owners by surprise?

Given today’s economic climate, business owners should be aware of issues related to the landlord’s financial condition. You want some protections built into your lease that prevent you from being kicked out of the property in the event the landlord defaults on bank loans or the building is sold to a new owner.

Operating expenses can be another significant issue. You want to negotiate some caps on annual increases, especially those expenses that are within the landlord’s control. Before signing a lease, it’s worthwhile to get some good data on operating expenses for the prior three or four years. You should also ask for the right to audit the landlord’s books to confirm operating expenses. This is typically not included in a landlord’s standard form lease.

Since the commercial real estate market is soft, do business owners have more leverage today to negotiate away personal guarantees as part of lease terms?

Not necessarily. While landlords are anxious to lease empty space, there’s equal or greater concern for the tenant’s financial stability. Landlords are asking for the same financial documentation they did before the recession, but now they’re really looking at it! Plus, we’re seeing greater emphasis on security deposits.

Can owners of startups and early-stage companies that aren’t yet profitable negotiate around a personal guarantee?

In these situations, owners should assume there’ll be a cost to the company somewhere else in the final lease agreement to balance the absence of a personal guarantee. You can be creative in proposing alternative structures to the guarantee, too. For example, business owners can negotiate to steadily reduce their personal exposure over the course of the lease. Owners can also negotiate to reduce or eliminate the personal guarantee as the company achieves certain financial performance milestones.

How litigious are business owners these days on personal guarantees?

I haven’t seen a lot of litigation because most lease disputes are settled before going to court. However, landlords certainly have an advantage in settlement negotiations when the tenant’s personal assets are on the hook.

A company’s facility requirements can change, and subletting is often a quick solution. What are the fine points of subletting clauses?

You definitely want the right to sublet. An ideal position is to be able to do some minor subletting without landlord consent. Otherwise, you want a lease agreement that prevents the landlord from unreasonably withholding consent or delaying the response to sublet requests. Business owners should also look closely at draft lease provisions in which the landlord has the right to terminate the lease if you are looking to sublet.

Other issues that arise over sublet rights are economic. Who owns the right to sublet profits — the tenant or the landlord? It’s best to negotiate these details up front rather than at the time you want to sublet.

What should entrepreneurs focus on during a first walk-through of the property?

If there’s a tenant, think through what happens if the tenant doesn’t move out on time — same thing with promised facility improvements. You want to negotiate some financial consideration for delays in occupancy that can be costly to your business. You also want to get an inspection from someone who is qualified.

Out of curiosity, how did you choose real estate as the focus of your legal career?

At the start of my legal career, I had the opportunity to work on the sale of a hotel to Donald Trump. I really enjoyed it — and 24 years later, I’m still enjoying it.