October 4, 2016
With franchises that require a brick and mortar location, it’s essential to ensure that the lease works in favor of the franchisee. Over my years practicing real estate law, I’ve seen many leases that leave operators exposed to being forced to move, having the lease terminated, or unable to sell their franchisee unit when looking to retire or cashout.
From a business perspective, this is not only costly but can severely damage the business.
To help protect against these scenarios, here are several things to consider when reviewing the lease for your franchise unit.
Many franchise agreements are 10 years. Franchisees rarely want to sign a lease for the full length of their franchise term. It’s safe to exercise some caution in committing to a location long term. However, the best practice is for the lease term to match the franchise term. So in the example above the lease should also be 10 years. You should also try to negotiate two five year options to renew. This gives you the flexibility to either exercise your option for an additional five year term or gives the buyer of your franchise the ability to stay in the location. Bottom line, if the buyer of your business is uncertain about their ability to stay in the location long term it will have a material effect on the value of your business and marketability.
While the franchise agreement is typically for a decade, many operators build up the business and sell prior to fulfilling the entire term. This is a strategic business move, and having an exit strategy should be part of the equation when signing the lease.
A good lease adds value to the business when it comes time to sell.
Regardless of if the franchisee plans to sell the business in the next ten years, planning for potential exits is a foundation of smart business planning. It also creates more options down the road. It’s favorable to watching the franchise unit you build and invested heavily into crumble because no buyer sees value without being able to guarantee the location.
Options limited to the existing tenant isn’t the only deal killer in signing a lease. I advise franchisees against agreeing to relocation clauses. This means that the landlord can choose to move you to another part of the complex. While typical agreements stipulate that the landlord will cover relative costs, they never factor in the labor costs of your employees, loss of business during the move or potential business losses following the move.
Other unattractive clauses include percentage rent. This stipulates that once gross revenue exceeds a certain point, the landlord receives a percentage. I feel that this penalizes you for being a good tenant who invested in and executed a good business model. The counter agreement will be that your success is tied to the location.
When advising an operator on singing a lease, I always work to limit their personal liability as much as possible. The first step is signing the lease as a LLC or corporation.
I combine this with lease options. That means that while the principal has to guarantee the lease terms, should the operator choose to sell at year three, they are not the principals on the lease for the full ten years. Instead, the new owner of the franchise assumes the principal position when they renew the lease option at year five.
Additionally, I work to cap the exposure at a year. Should the franchisee need to relocate or the business goes under, in a good market the landlord can typically find a replacement in 6-12 months. Capping the exposure at a year limits the rent the franchisee is on the hook for personally.
It’s important for franchisees to work with a seasoned lawyer to review their lease when committing to a brick and mortar location. Franchisees have invested heavily into this business model, and the terms around the physical location of their business can factor heavily into the long-term success. Few businesses can survive building up a location for five years only to have their landlord terminate the lease due to an overlooked clause.
Protect your interests by working with an experienced franchise lawyer. Not only do I have extensive experience in franchise law, I started my law practice with real estate law. I’ve brought this unique blend of expertise to help growth the franchise I am co-owner of. This includes reviewing franchisee leases to ensure that their desired location works to the betterment of their unit.