Understanding Your Franchise Lease Costs

A special place in Franchisee Hell is reserved for you if you are not completely aware of the details and intricacies of the lease you will assume if you acquire an existing business or build a new location. If you just close your eyes and make a wish that everything will turn out nice-nice, you are likely feel an icy blade stabbing you in the back in the future. When it’s time to sign a commercial lease or lease assumption, you must thoroughly understand every single clause.

Here are some of the key terms you need to thoroughly understand before you sign a lease or lease assumption:

• Name of tenant. Is it you, personally, or your business entity? Is it the Franchisor, with you, the franchisee, being a sub-lessee?
• Permitted use. Be careful that the permitted use is specific. I know about a store whose landlord forced the franchisee to spend $80,000 on a specialized scrubber/venting system because another tenant didn’t like the smell of freshly baked bread in the morning. This problem could have been solved if the lease stated that the tenant was going to be baking fresh bread every day, and that this would create the smells of fresh bread.
• Exclusive use. If you are in a shopping center or another multi-tenant location, can the landlord rent to a competitor of yours? Is that OK with you?
• Number of square feet. How much do you really have? Understand the difference between usable and rentable square feet.
• The term of the lease. How many months from the Commencement Date does the lease run?
• Early termination. Under what circumstances could either the tenant or the landlord terminate the lease?
• Fixturing period. How much time is the landlord giving you to build out or remodel? Is this period free of all rent, or will you have to pay CAM charges and utilities?
• CAM (additional rent) charges. CAM stands for Common Area Maintenance. Be sure you understand the components (property tax, insurance, utilities, janitorial, management, etc.) and what your pro-rata share is.
• Commencement date.What is the date that the lease officially begins? Is it at all tied to being open for business, or is it when you sign the lease, or somewhere in between?
• Tenant improvement allowance. How much is the landlord giving you in tenant improvement allowances? When is it paid, do you get reimbursed, or does the Landlord directly pay the contractors? (TIP: Landlords will frequently grant a tenant improvement allowance upon lease renewal. The trick is: you have to ask!)
• Security deposit.How much is it? Can you amortize this down over time, and conditional on good performance?
• Personal guarantee. Is a guarantee required? Is it personal, or given by the business? How much is it for? Can this be reduced or negotiated away over time?
• Base minimum rent. It is important that you understand how this is calculated. Many landlords today are trying to get away from having the rent based on number of square feet. Be very careful.
• Percentage rent. Many landlords, especially in shopping centers, will attempt to get extra rent based on your sales volume. This will involve monthly reporting of your sales results, sending in copies of your sales tax returns, and is nearly always accompanied by the landlord dictating the minimum days and hours you must be open.
• Rent escalation. This is always negotiable, and ranges from no increases during the term of the lease, to periodic fixed percentage increases, to increases based on one of the CPI indexes.
• Options to extend the lease. If you intend to occupy your location for an extended period, or if you plan to sell the business at some point, you may want options to extend the lease. Sometimes, the landlord may be willing to fix the pricing for those options if you fight for it, and sometimes the landlord will insist on “market rate” at the time you renew. Either way can work to the tenant’s advantage. Sometimes the uncertainty created by a “market rate” clause enables a more in-depth negotiation at lease renewal time.
• Business hours. A landlord often times couples prescribed business hours with percentage of rent in order to make sure the location is grossing as much as possible. Be extremely cautious: there can often be serious financial penalties for not being open during the prescribed hours, even if those hours are unprofitable to the store.
• Parking. Do you have assigned or designated parking for your location? Be sure to assess the availability of parking for both your customers and employees.
• Signage. Many tenants are shocked to learn that the landlord may insist on extra charges to locate signage, especially on a pylon or monument sign. Be sure to cover this in your negotiations.
• Relocation/expansion rights. For locations in a shopping center of any size, the landlord often reserves the right to move the tenant’s location "at will" to somewhere else in the shopping center, sometimes even making the tenant bear some or all of the cost of the move. This can be devastating to the business.

Secret: Have a commercial real estate broker who specializes in commercial leases help you negotiate the lease. Offer to pay this person up front, so they don't have a huge incentive to make you sign a lease in order to get a commission.