Restaurant Subleasing Is a Risky Business
Creativity can be the deciding factor in whether a restaurant sells quickly or simply withers away as revenue dries up after months of being on the auction block. The creativity involved in structuring any deal is imperative if name change papers will ever be filed.
A restaurant owner anxious to change professions recently asked if a one year sublease, with an option-to-buy agreement, would be a good way to sell her restaurant. Out of all the creative ways to structure a deal, the sublease with an option to buy is probably the worst-for the owner. It is definitely the one with the most risks and downside. If you happen to be the lessee it is a great way to acquire a property, kick the tires, take it for a test drive and decide whether to consummate a long term commitment. But usually this leaves the owner holding a bag full of bills while watching someone hold the keys and cash.
The problems that arise with a sublease/option agreement are monumental. The new operator would presumably maintain the name, style and menu of the restaurant. In doing so goodwill could be destroyed, customer base dissolved, and cash flow could essentially evaporate overnight if the standards and abilities of the new operator were not stellar.
By the end of the first year lease term, there could be nothing left to return to for the original operator other than a pile of unpaid bills, numerous small claims court appearance date and an empty dining room nightly. That is the ultimate downside.
I am not inferring that every sublease/option deal goes south. However, unless the owner requires a substantial security deposit/down payment within the guidelines of the contract, there is little incentive for the lessee to stay and build the business after the first year if business isn't growing as quickly as projected.
And, if a potential lessee has enough cash for a substantial down payment, both parties would be in a better situation to enter into an owner finance sale agreement. In this type of contract the owner can include stipulations regarding non-payment and other default situations.
We have all done things in the restaurant business that we are not proud of. Whether it be stiffing a vendor, mistreating an employee, or taking advantage of an owner attempting to sell their restaurant. Thanks to the sublease with an option concept I have stolen restaurants. Three to be exact.
Some years ago, I had my eye on a small 50 seat restaurant in Wayzata, Minnesota,the shining city on Lake Minnetonka, 15 minutes from Minneapolis. I had been watching the space for over a year. I knew the owner as he had approached me once about possibly purchasing the restaurant he was operating. I knew the space needed a new concept, menu and style. The original owner of the restaurant had sold the business, taking back a note for $60,000.00. The operator who had signed the note was in financial trouble as business had decreased and he was desperate to get out from the note and the day to day stress of a failing enterprise. After weeks of inquiring to his whereabouts his chef finally confessed he was locked away at his cabin in Northern Minnesota. The chef also told me his phone had been disconnected due to non payment which would prohibit me from contacting him.
Persistent to acquire the restaurant, I paid the phone bill, arranged to have the service reconnected and called him. A week later, after numerous calamities I handed him a relatively small amount of cash and signed an agreement to operate the restaurant for a year, pay his note during that time, and agreed if I liked the restaurant I would buy it outright a year later.
The fact we never contacted the original owner who held the note and that could become a problem never occurred to me. We did the deal without any legal representation. I was anxious to get in – he was extremely anxious to get out. When the owner walked by the window of her restaurant the morning after I had basically demolished the inside preparing for a rapid remodel, she became surprising hostile and immediately demanded payment of the $65,000.00 note.
Unbeknownst to everyone, including my partner, Kranston, there was a lien on the restaurant for non payment of a carpet installation bill. I learned of the lien when I called the installer to ask about tile. This put the operator and the original owner in violation of their lease with the landlord, who happened to be one of my best catering customers through another restaurant.
As soon as the original owner called the note, I negotiated a long term lease on the space with my catering customer. Initially, I had intentions of paying the original owner her note, and the operator his monthly fee. However, I quickly learned the operator leased me the space illegally - he had a clause in his agreement stating he couldn't sublease - and the owner was excessively arrogant. I hate that.
Soon into discussion with the original owner, she began to fling derogatory racial slurs in an attempt to define my tactics during our negotiations. Once she insulted my financial backer, I played the court card and told her she owed me rent for storing her worthless equipment in my space. I informed her it had to be out in seven days or I would take possession of the equipment. Of course she couldn't move the equipment unless I would agree to remove the massive front window of the restaurant in order to get everything off the premises. I certainly wasn't going to allow that.
In the end of the negotiations, which really was our beginning, we acquired the restaurant - including the equipment along with one case of canned Jalapeno Peppers along with a case of Waffle mix - for $20,000.00. We turned that restaurant into an $850,000.00 a year property and eventually sold the business for $250,000.00. The original owner got paid for her equipment but not the good will she had built up over five years as the operator who sold it to me had destroyed that.
