Transferring the Lease When Selling Your Business

Transferability of Leasehold Rights

A leasehold right is the right of a commercial tenant to occupy and use leased property. A business owner’s leasehold right is memorialized in a commercial lease. The lease is a critical component of the value of many businesses, especially in retail-related industries. When it comes time to sell, the lease must be transferred to the buyer so that the buyer has similar or better lease terms as the seller. Otherwise, the value of the business must be adjusted (downward) to reflect the increased leasing costs (i.e., rent) that a buyer would face after purchasing the business.

Contingency to Close

The transferability of a commercial lease is a crucial component of many business sales, and is often a contingency of the deal closing. In a purchase agreement governing the sale of a business, the buyer and seller must agree on the ‘contingencies to close.’ The contingencies must be accomplished prior to the closing date, or the deal will not close. Invariably, two contingencies are the buyer’s completion of formal due diligence (to its satisfaction), as well as the assumption of the lease (or allowing the buyer to sign a new lease). As a contingency to close, the process of assuming the lease should be started 30 days or so prior to closing. This gives enough time for the buyer to assume – and if necessary negotiate – the lease directly with the landlord.

When to Contact Landlord?

A common question that many business owners have during the business sales process is when they should inform the landlord that they are selling their business. Generally speaking, business owners should only contact their landlord about the pending sale after the business is formally ‘under contract’ with a buyer and in the formal due diligence phase. Formal due diligence occurs only after there is a signed Letter of Intent (LOI) or purchase agreement accompanied by a refundable deposit placed in escrow from the buyer. Until these steps happen, the seller can not assume that the buyer is truly serious about buying their business. The seller should not otherwise waste their valuable time and resources in getting their landlord involved until the business is ‘under contract.’

Contacting Landlord About Potential Sale

  • Once a deal is officially ‘under contract’ whereby the buyer has the exclusive right to buy the business for a period of time, the seller may contact their landlord about the potential sale.
  • The seller should inform the landlord that they are selling their business, identify the buyer by name, and ask the landlord about the procedure by which the buyer may assume their lease.
  • If the landlord or their agent expresses concern about losing the seller as a tenant, the seller should give reassurances that the buyer is qualified and competent to run the business, and will make an excellent long-term tenant.
  • In most instances, the landlord will have a procedure in place in which they give new tenants qualification forms to complete while also requesting financials and other personal information.
  • The landlord will surely conduct a background check on the new tenant/buyer, and may ask for a personal meeting.
  • The typical approval process may take up to 30 days, and sometimes more depending on the landlord.
  • Many business owners are fearful that the confidentiality of the sale will be breached when the landlord is told about a pending sale.
  • The landlord must be reminded that it is in everyone’s best interests to keep the sale confidential and to not disturb or disrupt the business while the sale is pending.

Lease Transferability Provision in Commercial Leases

Prior to selling one’s business, a careful examination of the the lease transferability provision should be conducted. Most commercial leases stipulate that the landlord may not unreasonably withhold their consent of the lease being transferred to another commercial entity. But the landlord often retains their right to withhold consent of a lease transfer if the transfer results in an entirely different use of the premises. Sometimes the lease transferability provision may be interpreted differently, so it is important to clearly communicate with the landlord and try to negotiate any differences as soon as possible.

Lease Transfer Fees

Many commercial landlords impose ‘transfer fees’ in their leases. Such fees (in theory) cover the costs of the landlord’s background checks and administrative costs necessary in transferring a commercial lease. The ‘transfer fees’ may be excessive in some cases, and is usually borne by the seller (since they are the party who signed the original lease with the ‘transfer fees’). In addition to any ‘transfer fees’ borne by the seller, the landlord may require a higher security deposit from the buyer. The seller’s security deposit should be returned, unless the seller’s corporate entity remains on the lease.

Personal Guaranty of Commercial Lease

Many landlords require a commercial tenant to personally guaranty the performance of the lease over a set period of time. In case of default, the landlords can then personally hold the tenant individually liable for non-payment of rent. When a lease is transferred, the landlord may require the new tenant to personally guaranty the lease. Whether and to what extent a personal guaranty is required should be negotiated between the tenant and the landlord. The more established the business the better chance that the landlord will waive a personally guaranty. The higher risk of default, then the higher chance that the landlord will require a personal guaranty.

Seller Remains Personal Guarantor

A commercial lease often stipulates that the current tenant will need to remain on the lease as a personal guarantor even after the transfer of the lease to a new tenant. The business owner should review their lease and accompanying documents related to the personal guaranty in order to be aware of such a provision. It is possible for the business owner to negotiate with the landlord and extricate themselves from having to remain as the personal guarantor after the transfer. If the seller must remain (for a period of time) as the personal guarantor after the sale, then the seller should meet with and question the buyer. The seller must be comfortable that the buyer has the knowledge and experience to pay the rent on time and fulfill the requirements of the lease.

The transfer of leasehold rights from the seller to the buyer in a business transaction is often an essential component of the deal. The seller will want to maintain the confidentiality of the sale during the lease transfer process, while carefully reviewing their possible costs and risks under the transfer provisions of their lease.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.