Real Estate Soundbite: A Quick Guide to Real Estate Law for Start-ups and SMEs
In the current economic climate which is riddled with uncertainty, the innovative spirit of UK entrepreneurs is flourishing. However, when embarking on their entrepreneurial journey, most founders' priorities are developing innovative technology, securing funds and making sure that their business survives. Equally important to consider are a variety of legal issues, especially when the company wants to take on new premises.
The most common way for small businesses to acquire premises in the UK is by leasing. In this Real Estate Soundbite we explore some of the most overlooked yet vital points for entrepreneurs to remember when seeking a lease of commercial premises.
When looking for premises for their company, entrepreneurs are often faced with rejection or strenuous terms due to their lack of profits or cash flow. Indeed, most Landlords are wary of companies that are not profitable, as they pose the risk of non-payment and even costly litigation in relation to non-payment.
To protect against these risks, Landlords usually require Tenants to provide a rent deposit. This reduces the start-up's ability to run its business successfully, as valuable funds are locked in, rather than being used to scale up the business. That said, many businesses will be prepared to pay a deposit in order to secure their new premises.
Rent deposits also pose legal issues which founders need to be aware of. For example, they should insist that the Landlord holds the deposit moneys on trust for the Tenant in a separate bank account. This aims to avoid litigation or loss of the deposit in case the Landlord becomes insolvent. Alternatively, the Tenant may request the Landlord grants them a fixed charge over their beneficial interest in the deposit balance, as security for the Tenant's compliance with the obligations in the Lease.
Founders may also wish to insist on the bank account in which the deposit is held to be interest bearing, and that this interest be paid to them by the Landlord at regular intervals, particularly if the deposit amount is substantial.
Once they have convinced the Landlord that they are suitable Tenants, founders need to consider the terms of the Lease. The main concern for start-ups and SMEs is business uncertainty. In other words, they do not know if their business will still exist in 6 months, let alone in 10 years. Nor do they know whether they'll have 10 or 200 employees by the time the lease ends. For these reasons, flexibility in the Lease contract is vital to the development and survival of these companies.
Prospective Tenants may wish to request a break clause in the Lease, allowing them to end the Lease early if their circumstances change. They should also ensure that the Lease includes an alienation clause in the contract to allow them to transfer their Lease to a third party who will replace them as tenants for the remainder of the term of the Lease, or to underlet the premises to a rent-paying subtenant. Generally, Landlords would be open to an alienation clause as long as they have a degree of control over who the lease is assigned to. It is typical that alienation or underletting will be conditional upon their consent. In such cases, founders should ensure that the Lease provides that the Landlord's consent may not be unreasonably withheld and ideally that there is no Authorised Guarantee Agreement in place making them liable for any future breaches of the Lease by the assignee or subtenant.
Finally, it may be possible for the founders to negotiate a customised contract which allows for a rent phase-in (this is the approach taken by WeWork and Central Working, the largest shared workspaces providers in Europe and the US). The rent phase-in allows companies to pay rent according to the number of desks used or the square footage of the area needed. This allows the founders to grow their business into the space and to free up capital during the growth phase of the business. It does, of course, depend on the size of and space available within the premises that the business is leasing.
Reparations and Insurance
When entering into a commercial Lease, Tenants should be aware of the extent of their property as well as of their repairing and insurance obligations. A Full Repairing and Insuring Lease ("FRI") is a common form of lease. This requires Tenants to keep the whole premises which have been leased (which may include structural parts) well-repaired; generally to the condition that the premises were in at the start of the lease. As the Tenant is responsible for the state of the premises, the Tenant will be responsible for repairs, even if they were not responsible for the damage. It is also important to check whether the landlord will be responsible for insuring the premises.
To protect their position, tenants may request that a Schedule of Condition be attached to their Lease. This is a set of photographs and specifications which sets out clearly the state the premises were in at the start of the Lease, so reduces the likelihood of dispute later on.
Additionally, tenants should seek to avoid liability for "inherent defects", which existed in the property before the tenant took occupation.