Publications

Being the new kid on the block is not easy. Start-up companies that are
beginning to grow rapidly face many challenges. Among them is the need
for space. Like the old line about going broke, it happens slowly, then
suddenly. So, what is an executive of a young growing company to do when
the parents want their garage back, or when the staff seems to be
perpetually playing musical chairs without the music?

It is time to find some real office space. With the imperative Find
Space Now (Now being the operative word), it can be tempting to just
sign what the landlord presents, fingers crossed and no questions asked.
Young start-ups and growing companies are different from mature,
established firms, however, and the needs they have and the issues they
face in leases are different too. With a little forethought and
negotiation, potential pitfalls and unpleasant surprises can be avoided.

In the current market for commercial office space,
many landlords balk at a prospective start-up tenant with a promising
future but no rent payment history. Landlords who usually expect a
security deposit of one months rent, or two at the maximum, have been
demanding up to a full years rent from some start-up tenants. This can
be a significant amount of money to tie up in an escrow agreement, but a
large security deposit may need to be offered if the landlord is
hesitant to accept the tenant or is demanding personal guarantees from
the tenants owners, officers and principals. If a landlord insists upon
a large security deposit, a tenant should be sure that it earns interest
(many commercial leases do not provide for this) and that the interest
earned is withdrawn and paid to the tenant on a regular basis. Tenant’s
should also request that a large security deposit be progressively
decreased as the tenant earns a history of timely rent payments.

The tenant should also consider giving a letter of credit, instead of
cash, as a security deposit. This can work well for both the tenant and
the landlord because it frees up large amounts of the tenants cash that
would otherwise be sitting in a bank account and it gives the landlord
easy access to the funds, which is particularly beneficial if the tenant
goes bankrupt.

Start-up company tenants may want to ask for a shorter lease
term with options to renew. While many landlords will ask for a higher
rent for a shorter term, the upside is greater flexibility for the
tenant if its business plan changes, for better or worse. Assuming
things are going to change for the better, a tenant may also want to
secure options to expand or rights of first offer/refusal on adjoining
space. If a landlord is unwilling to commit to a specific rent for such
additional space, but instead agrees to offer it at fair market rent, as
determined by landlord, the tenant should ask that the matter be
referred to arbitration if the landlord and tenant cannot agree on the
future rent (this is a good idea both for right of first offer space and
for space a tenant currently occupies when it comes time for renewal).
The time to get the right to terminate the lease if the landlord is
unable, in the future, to accommodate a growing tenants need for more
space is before the lease is signed.

The right to assign or sublet should also be reviewed. Many new companies

do not initially need all the space they are currently negotiating to secure

and intend to sublet a portion of their unused premises. However, most

landlords will not allow assignments or sublets without the landlord’s

prior consent. Be sure such consent cannot be unreasonably withheld, and ask
that consent not be needed if the subtenant is controlled by, controls,
or is under common control of the existing tenant. Some leases will
state that the sale or transfer of a controlling or significant portion
of a company’s ownership interests will be considered an assignment
triggering the need for landlord’s consent. Limit these terms so that the
landlord does not have an unexpected voice in the tenant’s financial
dealings.

If the landlord is providing building services under
the terms of the lease (heating, cooling, access), the lease often sets
specific hours for such services (typically 8 a.m. to 6 p.m.). A
start-up with plans to burn the midnight oil should inquire about the
costs and availability of after hours service. If cleaning services are
provided by the landlord, confirm when and how often so that vacuuming
does not unexpectedly coincide with what the staff considers prime
creative time. And, bear in mind that a landlord may charge an
additional rent if the cleaning staff is confronted with the remains of
a nightly pizza party.

One last issue is the commencement of the lease. Often
overlooked in the rush to get a lease signed, the tenant should be
certain of when it is actually getting possession of the premises. A
landlord may be delayed in delivering premises to a new tenant if the
old tenant is holding over. While it should be stated explicitly that a
new tenant is not obligated to pay rent until it has possession, it is
also prudent to set a drop dead date, whereby the new tenant has the
right, if it chooses, to terminate and cancel the lease if the landlord
has not tendered possession by a specific date. If time is of the
essence, and a landlord, for whatever reason, cannot deliver the
premises, a tenant must be free to seek and secure alternate space
without the obligations and enforceability of the old lease remaining
ambiguous and unresolved.