The Lease Is Part of the Deal: Assignments, Landlord Consent, and Term

What a buyer and lender need

A lease term, including renewal options, that runs at least as long as the buyer's loan. SBA lenders generally require the lease term plus options to match the loan term, which is ten years for a business acquisition. A lease with three years left and no options does not support a ten-year loan, and the buyer either cannot borrow or has to borrow less.

An assignment clause the landlord will honor. Most commercial leases require landlord consent to assign, and most say consent will not be unreasonably withheld. Some say consent is at the landlord's sole discretion, which means the landlord can refuse for any reason or none. A few prohibit assignment entirely. The language decides how much leverage the landlord has.

Rent the business can afford. Occupancy cost as a percentage of revenue varies by industry, but a buyer's lender will look at rent against earnings and balk if the business is paying too much.

A landlord who will sign an estoppel certificate confirming the lease terms, that no default exists, and what the rent is. Lenders require this at closing.

The common problems

Not enough term. The most frequent issue. The owner has been renewing year to year, or is on a month-to-month holdover, or has a lease that expires before a buyer's loan would be paid off.

Consent at the landlord's discretion. The landlord can hold the sale hostage, and some do, asking for a higher rent, a fee, a larger deposit, or a new lease at market when the existing one is below market.

Personal guarantee. The owner personally guaranteed the lease, and the landlord will not release the guarantee when the business is sold, which means the seller remains liable for a lease on a business they no longer own.

Change of control. Some leases treat a sale of the business entity, even a stock sale where the tenant does not change, as an assignment requiring consent.

Below-market rent. The lease is a great deal for the tenant, which is good for earnings but means the landlord has every incentive to refuse assignment and re-lease at market. This one needs to be handled with care.

Use clause. The lease permits a specific use, and a buyer who plans to change or expand the business may need the landlord's consent for that too.

What to do, a year out

Read the lease. Term, options, assignment, guarantee, use, and any clause that mentions sale, transfer, or change of ownership. Have an attorney read it if any of those are unclear.

Extend the term before anyone knows you are selling. Approach the landlord about an extension or additional options as a tenant planning for the future, which is true. Landlords generally like long-term tenants and will often extend on reasonable terms when there is no deal on the table creating leverage. The same landlord, approached after the buyer is under contract, has all the leverage.

Negotiate the assignment language while you are extending. Ask for consent not to be unreasonably withheld, with a defined standard, such as a buyer with net worth or experience comparable to the current tenant. Ask for release of the personal guarantee on assignment to a qualified assignee. Ask for a defined response time so the landlord cannot simply go quiet.

If the rent is well below market, decide whether to raise it modestly in exchange for the extension and assignment rights. A lease at 80 percent of market with ten years of term and clean assignment language is worth more to the sale than a lease at 60 percent of market with two years and a landlord who will refuse.

Document the relationship. Payment history, no defaults, improvements the tenant has made. This is what gets shown to the landlord when consent is requested.

During the sale

The landlord is usually told after the letter of intent is signed and before diligence ends, because the buyer's lender needs the assignment or a new lease as a closing condition. The buyer submits a financial package to the landlord. The landlord reviews it and either consents, negotiates, or refuses.

If the landlord wants a new lease with the buyer instead of an assignment, that can be fine. It releases the seller's guarantee and gives the buyer terms they chose. It also gives the landlord the chance to reset rent, which affects the buyer's earnings and can lead to a request for a price reduction. Knowing the landlord's likely position before the LOI lets the seller price around it.

Timeline matters. Landlords with property managers and legal review can take weeks. Build that into the closing schedule and start the request as soon as the buyer is in diligence.

If the owner is also the landlord

Then the lease is written for the sale, and the owner controls the outcome. The lease should be at market, with a term of ten years plus options, triple net, assignable to a buyer of the business, and signed at closing. It becomes a selling point rather than a risk.

A worked example

A specialty retailer with $350,000 in SDE had a lease with 26 months left, no options, and an assignment clause requiring the landlord's consent at the landlord's sole discretion. Rent was about 20 percent below market.

The owner listed the business without addressing the lease. A qualified buyer signed an LOI at $950,000 with SBA financing. The lender required a ten year lease. The landlord, now aware of the sale, offered a new lease to the buyer at market rent, which reduced the business's SDE by about $40,000 and its value by about $110,000. The buyer asked for a price reduction. The seller refused. The deal died. The business went back on the market with a stale listing, and closed eight months later with a different buyer at $810,000, on the landlord's new lease terms.

The same owner, a year earlier, could have approached the landlord for a five year extension with a five year option and a reasonable consent standard, probably in exchange for a modest rent increase to 90 percent of market. That lease would have supported the first buyer's loan and the first buyer's price. The difference was about $140,000 and eight months.

What to ask the landlord for

An extension or additional options that bring the total term to at least ten years. Assignment consent not to be unreasonably withheld, conditioned on the assignee meeting defined financial criteria. Release of the personal guarantee on assignment to a qualified assignee, or at least a cap on the guarantee after assignment. A defined response period for consent requests, thirty days is common. Agreement to sign an estoppel certificate and a lender's access agreement when requested. A use clause broad enough for a buyer to grow the business.

Most landlords will agree to most of that for a good tenant when there is no deal on the table. Some will want something for it. A small rent increase, a longer commitment, or a deposit is usually a fair trade for terms that make the business sellable.

The estoppel and the lender agreement

At closing, the buyer's lender will ask the landlord to sign an estoppel certificate confirming the lease is in effect, the rent, the term, and that there is no default. Many lenders also ask for a landlord waiver or access agreement, which lets the lender remove collateral from the premises if the borrower defaults. Landlords who have not seen these before sometimes balk. Raising them with the landlord during the extension conversation, a year out, avoids a surprise in the last week before funding.

Why it matters this much

Every other problem in a sale can be priced. A short lease with an unwilling landlord cannot, because without the location there is no business to price.

This article shares our opinion and general information. It is not legal or tax advice. Always speak with a licensed attorney for legal advice, and a qualified tax professional for tax questions, before you act.