Some parts of finding a new office space are easy, like making sure it’s attractive to ideal employees and flexible for growth. Then come the negotiations and minutiae of making a deal that can take the wind out of your sail and cause you to rethink the whole idea. It doesn’t have to be that way. If you take some time to understand what you should expect from a landlord and also what a landlord will expect from you, the process can run smoothly.
One of the major deal points in any negotiation is the securitization of the lease, or what the landlord will maintain in case a tenant does not hold up their end of the deal. This is especially important when the landlord is spending tens of thousands, if not hundreds of thousands, of dollars to build your company the space of its dreams. The challenging bit for many startups is that they do not have the financial history to make landlords comfortable with spending that kind of money. As a result, landlords expect some amount to be put up by the tenant as security. This can come in several different forms, including a security deposit, a letter of credit, and a personal guaranty.
Here are the pros and cons of each form of security to help you decide (along with your real estate broker) the best avenue for you and your company.
This is the most common form of securitization in a lease. A typical security deposit is equal to one month of rent and is paid upfront when a tenant signs the lease. The landlord holds the security deposit throughout the lease term and returns it back to the tenant at the end, provided the tenant adheres to all of its obligations in the lease. The size of the security deposit may increase depending on the amount of money a landlord spends on tenant improvements. In some cases, a landlord will ask for up to 6 to 12 months of rent as security deposit. This is challenging for any company, especially a startup, who is strapped for cash to begin with. In the event you are willing and able to put up a larger security deposit, it should always be negotiated that some of the security deposit is refunded on a regular basis, provided you’re in good standing with rent payments and other obligations. In no case should you let a landlord hold several months of rent for the entirety of the lease term.
Letter of credit
Some companies have a strong relationship with their bank and have built up an availability of credit, often times used to help a growing company. In the event a tenant has available credit from the bank, they can put up a letter of credit in lieu of a large security deposit. While this negates the issue of paying cash up front, it can still have a significant impact on a company’s access to capital. Similar to a security deposit, it should be negotiated when the amount held in a letter of credit is reduced over time and ultimately would go away as you stay current on rent and build trust from the landlord.
Though this is an uncommon solution, it’s still an option for many startups. Essentially, the owner of a company puts up their personal assets as collateral should something happen with the lease. This is viewed as an extreme solution that should not be taken lightly by you or your real estate broker. In the event you find the absolute perfect office for your company, cash is tight and available credit is limited, this may be the proper route. (In my nine years of representing tenants in these types of negotiations, I have only had one client sign a personal guaranty. He did so with the confidence that his company would succeed and that he was not stretching himself thin. It worked out in the end for him and it never became an issue, but it was well thought-out and low-risk when it was all said and done.)
It’s important to have an upfront conversation with your real estate broker as to what you are comfortable with when securitization arises during negotiations. Knowing your startup’s most viable options will allow a good real estate broker to find proper opportunities with the right landlords.