Transferring With A Lease When Buying A Business

There are many moving parts to the business buying process. Along with the search, analysis, valuation and investigation, consideration has to be made to properly reviewing any contracts in place when buying a business. This can include agreements with suppliers, customers, specific licenses to operate the business, insurance policies, and of course the lease for the premises.

Most of these agreements will only become available for the buyer to review during a formalized due diligence period. However, some can in fact present a giant roadblock and impede the deal from getting done. A buyer has to be sensitive to the seller’s concern of confidentiality about the sale, and their possible apprehension to investigate whether these agreements will transfer over to the buyer. This is especially true when it comes to the lease.

Lately, we have seen a number of cases where the landlord is requiring the buyer to pre-pay a year or more of rent prior to allowing the assignment or transfer of any leases. In the past, this was more common in the restaurant sector due to the high number of failures, yet it may be impacting other business types as well.

To the outsider, it would seem that any landlord would be more than willing to transfer the lease and especially in the present environment with commercial properties experiencing such unusually high vacancy rates but that is not necessarily the case right now.

Generally, a landlord has two simple objectives: keep the premises occupied and have a tenant that pays the rent when it is due. So why, in these more challenging times, would they be more rigid? It is precisely because they have high vacancies and they do not want to invite any more given the current business (the seller) is bound by an already existing lease.

For the buyer, before they get into any detailed negotiations on the business, it is imperative to review the lease to determine the parameters under which it may be assigned. There is typically a clause under the heading of lease transfer or assignment in a standard lease where the details will be outlined. What a buyer wants to look for is language that basically states that the lease can be assigned/transferred (usually with written permission from the landlord), and that the assignment “shall not be unreasonably withheld”. This means the landlord has to have a compelling reason not to do so.

While it sounds good in theory, it is not always the case. And it is generally not worth the cost or time to try to battle it out with the landlord if there conditions to assign it are unreasonable. A well-prepared seller should discuss the potential sale with their landlord early on to at least measure their willingness to accommodate a lease transfer, or, to learn what criteria the landlord requires to do so. This is certainly one component you will want to discuss early on with the seller when buying a business. It is critically important for a buyer to do so for any business that relies on the actual location to drive its revenues and profits.

If the location is less important to the business, then the buyer may have some latitude to potentially relocate the business in the future although that is rarely the number one choice. However, if there is a long-term lease in place, surely the seller will not simply turn the business over to a buyer without removing themselves from the lease obligation. A landlord may even ask the current owner to remain on the lease as a guarantor, and in this case, the buyer has to be willing to indemnify the seller, if they (the seller) are even willing to do so.

Landlords can be a bizarre bunch. Some are quite flexible and will be a pleasure to deal with in this aspect of the process. Others can be really hard-nosed and actually derail the deal. Either way, a buyer’s priority has to be to understand precisely what the parameters are in order to take over the lease, and to do so early on in the process. Even though a buyer will include the lease transfer as a condition to nearly every deal, you certainly do not want to get far down the line in a deal only to learn that the landlord will be an obstacle.

As such, table this issue early on with the seller. Find out if they have spoken with the landlord. If not, get them to do so. Despite a seller’s concern that they may not want the landlord to know the business is for sale, it is something that a buyer needs to understand early on, and so it may require this component to be one of the first conditions that has to be met in any purchase agreement. Plus, a seller can always approach a landlord in a benign way stating “I am thinking about possibly selling the business. What do I need to tell the buyer regarding the transfer of the lease?”

The lesson here is that despite language in a lease that would seem to indicate that it will be transferred, and regardless of what the seller may tell you, you need to know the precise status early on, and in writing from the seller soon after you have an accepted offer in place with the seller.

On a separate note, later this week, on Wednesday the 24th, I will be conducting the third part of the webinar series that Guidant Financial has sponsored. This week we will be covering business valuations. The participation to date has been overwhelming and the feedback simply wonderful. If you would like to join this free event, you can get more details by clicking here.

Have a great week.

Comments

[Bill Harrill]

We had a case where a landlord (an international shopping center owner/manager) demanded $100,000 from a UPS Store in one of their centers and $30,000 from a sports bar to do the lease assignment. Their reasoning was that there was nothing in the lease that prohibited them from this and that the location of the shopping center was a primary reason that the business was sold so they should participate in the profits of the transaction. (of course they did not participate in the losses of the 2 businesses that have closed in the center recently) This could be setting a dangerous precedent.

[Clinton]

Excellent post, Richard. Landlords who have a good tenant who pays regularly aren't often keen to give that up in exchange for a contract with a new party whom they have no history with. Sometimes it's possible to sweeten the deal for the landlord. In one case I found the landlord agreed because of the permanent property developments the buyer wanted to make. There are occasions though when the landlord, though he has credit checked and otherwise approved a buyer as the new leasee, holds out for a higher rent "to compensate for the extra risk he's taking on".

[W3 Business Advisors]

Valid points here, transfer of a lease can be a deal breaker for a buyer knowing the status of the lease early on is key.