Ally Colvin | Restaurant Nuts | May, 7 2018
One of the most important contracts you will sign during your restaurant’s lifetime is your lease. Although the widespread joke is that, even after a tough negotiation, the lease “lives in a drawer” for the next 10, 15, or 20 years, the reality is that a well-negotiated lease can save a restaurateur from substantial headaches down the line. And the right clauses can go as far as to save a restaurant owner from losing his or her shirt.
This list is in no way exhaustive but we will focus on four important concerns that a savvy business person should raise at the early stages of negotiation before signing a restaurant lease.
(1) Be sure to draw out the more major business/monetary terms first, before beginning to negotiate the lease, in a “letter of intent.”
When parties agree upon initial terms of a commercial lease, the best course of action is to sign a “letter of intent,” or “LOI.” An LOI is a short document that details the major business points of a deal before a full contract is prepared. LOI’s are sometimes also referred to as a “memorandum of understanding” (or “MOU”) or a “term sheet.”
LOI’s are often non-binding and are used to make sure that all of the parties involved have reached a basic understanding of the transaction. Despite the fact that an LOI may be non-binding, the terms listed in the LOI are usually not subject to further negotiations, so it is important to make sure they are fully agreed upon. To renegotiate these terms further down the line is called “re-trading,” which in the industry is akin to “four letter word.”
The reason an LOI is important is because, in theory, once the parties get past these terms and are in agreement, then the rest should be a matter of lawyers duking it out over the legal terms in the lease. Without having these terms agreed to in advance, the parties run the risk that they may get deep into negotiation and incur legal fees without knowing if the “deal-breakers” are firmly in the rearview mirror. It is in both parties’ best interest to agree to these salient deal terms beforebeginning to negotiate the lease.
(2) Have a good handle on all of the business/monetary terms.
As discussed above, it is important to lay out the business/monetary terms in advance of going to contract so that both parties have comfort in the fact that the major terms are agreed to. A more nuanced part of this idea is that you should be sure to have a comprehensive understanding of all of the business terms that appear in the lease. Here are a few monetary terms that are easy to overlook.
How much will you pay in “additional rent”? Besides paying fixed rent each month, you will undoubtedly incur other charges under the lease, called “additional rent.” Some items that fall under this umbrella are utilities (electricity, gas, water and/or sewer charges), operating expenses, and real estate taxes (depending on the state in which your restaurant is located, you may be responsible for a portion of the building’s real estate taxes). It is important to review past bills for the building to make sure you understand what these charges may look like in the future.
Will your security deposit increase each year? Sometimes, it will be buried in your lease that your security deposit increases every year in accordance with how much the rent increases each year. For example, if your rent is $5,000.00 per month, you gave a security of three (3) month’s rent upon signing the lease ($15,000.00), and your rent increases 3% per year, then it could very well be written in your lease that, come year #2, you’ll owe your landlord another $450, which is the escalated amount of $15,000 x the 3% increase. That type of increase will continue throughout the life of the lease.
Does your lease’s rental rate go to “fair market value” during the option period? All too often, a lease is written in a way where, if you have a 5-year “option to renew” at the end of your lease, the rental rate resets to “fair market value.” This means that if rental rates in the neighborhood have increased, even exponentially, your rent will increase along with the market rate.