Sinkholes you don’t want to fall down: Lease Tips For Startups

BeyondHQ
BeyondHQ
Feb 13, 2019 · 6 min read

Congratulations! Your company is growing and now you’re ready to either get your own office space, expand headcount, or add another location. How you scale will make or break your momentum, and can even determine the future success of your company.

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A bad lease agreement can quickly lead you down the wrong path. There are many elements to consider when looking for the right lease, including rent and amenities, where employees live and their commute patterns, capacity, length, office views — the space will be like a home away from home to your employees, after all — and the list goes on. Getting to the right lease agreement for your company will require you to carefully negotiate with your landlord. With so many factors in play, and many other priorities for your business to balance, you don’t want to get derailed by bad lease terms.

Here are some tips and tricks to consider as you negotiate. Obligatory note that this is not legal advice :) This list is far from comprehensive, but it should arm you with a few of the basics for you to get started with a broker. It comes from the mind of our head of ops, Devorah Rosner, who has spent the past two decades helping scale companies from tens of employees to thousands. We’d of course be happy to help you think through these and other decisions. Please reach out to us.

Length of lease

Whether your company launched 6 months ago or 2 years ago, how are you supposed to know how big you’ll be years from now? You’ll need to evaluate the length of lease and make sure you can afford to pay rent for the life of the lease. Tier 1 markets may demand as much as an 8–10 year commitment, so consider finding a shorter sublease, a less expensive neighborhood or even a Tier 2 or 3 market.

Type of lease

Is the lease modified gross, full service, or triple net? Be sure you know up front because not all leases are created equal. Triple net lease additional costs can add up to 30% more than rent alone. If your lease is triple net, determine specifically which items are included, which you are directly responsible for, what systems maintenance you’ll be responsible for and the current condition of the above so you can estimate, anticipate, and budget for future capital costs. Try to negotiate items out that are not pertinent to your space and business.

Costs

There are many costs to consider, but the obvious two are rent and tenant improvement allowance.

  1. Rent: Work with your broker to ensure that the landlord’s asking price is comparable to other properties in the area of similar type. Don’t be afraid to counter with a lowball offer. This is the start of the negotiation, so unless you’re in a crazy seller’s market there should be opportunity to come to a middle ground that feels like a win-win decision.
  2. Tenant Improvement (TI) Allowance: These funds are used to make improvements to a space in order to fit your business needs. The landlord may offer some TI funds up front to upgrade the space. How much they give you in TI is directly correlated to their asking rent. Higher allowance up front typically means that your recurring rent will be higher; lower TI means lower rent. You’ll amortize the rent spend over the life of the lease, while the balance of your TI spend will likely be capitalized. If cash is king right now, consider taking the up front handout in exchange for higher rent, which you can more easily cover as your revenue grows.

Annual Cost Escalations

Your lease will build in annual escalation of rent and operating expenses (OpEx), usually as a percentage of increase (e.g. 3% YoY). Budget these in so you’re not caught unprepared. Even if you’ve negotiated a favorable starting rent, rate of annual escalations are negotiable too, so plan your trade offs accordingly.

Plan for base year

The landlord typically pays your share of the building’s OpEx (tax, insurance, utilities, janitorial, common area maintenance, etc.), incurred during your first calendar year — or base year. After that, you pay your pro rata share. Before you accept the proposed base year, consider asking for previous years’ OpEx costs and ask questions about upcoming improvements or maintenance. For example, the landlord may have deferred upgrading the building HVAC (which is long overdue and extremely expensive). If they do the upgrade after your base year, your recurring OpEx costs will unexpectedly skyrocket. Your 3% annual increase will also now be based off of that new number. If this isn’t already in your budget, it could harm your bottom line.

Also, if the building is only partially occupied during your base year, push for a “gross-up” clause. There’s a lot more to know about your base year, so read this article to get up to speed.

Clauses

The landlord likely won’t offer favorable clauses, so it’s up to you to propose clauses that are best for your business. Prepare to make trade-offs in order to get what you want. There are dozens of possible clauses, so here are a key few that are often overlooked and can sink your business if not favorably negotiated.

  • Restoration — If you make improvements to the space, will you have to restore it to its initial condition when your lease expires? This is a pricey endeavor when you’re walking out the door, so get clarity up front.
  • Sublease — Do you have the right to sublease some or all of your space? If not, you’re on the financial hook if you need to shutter a location or downsize before the lease is up. If subleasing is permitted, make sure you’re aware of the landlord’s profit share terms.
  • Right of First Offer (ROFO) — When you outgrow your current space and want first dibs on an adjacent space or others that become available during your lease, ROFO and ROFR are important items to consider.
    If you have ROFO, the landlord will notify you of an upcoming vacancy and invite you to the table before the property goes to market. This is most advantageous in hot markets where bidding wars can drive up rent.
  • Right of First Refusal (ROFR) — ROFR means that you only have to decide to take more space if someone else makes an offer. You have first right to match that offer to the take space out from under the prospective tenant, or decline. Landlords don’t like this clause, but you need it. Be sure to ask for continuous ROFR.
  • Renewal rights — If you’re happy, the space is perfect, and at the end of the lease you want to renew, make sure you build in the right to do that. Negotiate the rent escalation structure up front to keep escalation at a reasonable rate.
  • Termination rights — Have an exit strategy in case the space ends up being suboptimal. Unless you negotiate a break clause, or the landlord has recapture rights, you could be on the hook for your full lease term even if your business goes under or you move to bigger digs and can’t find a subtenant. This is another clause that is mostly helpful in hot markets.

Remember, getting great lease terms is a negotiation. There is a balance of give and take for the parties involved. Ask for more than you need and be prepared to offer up the less critical pieces as bargaining chips. Your real estate broker should be bullish on your behalf, so don’t be afraid to encourage them to be aggressive. This can be a daunting process, but when done with care, it will set your company up for even greater future success.

There are many other things to know about opening a remote office. At BeyondHQ, we are building the operating system for scaling distributed teams. Email us, tweet us, catch us on LinkedIn, or on our website. We look forward to helping you scale!

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