Transferring the Lease When Selling or Buying a Business

Location, location, location.

This well-known mantra applies not only to home values but also holds significant weight in the world of businesses. Neglecting this critical aspect can jeopardize your sale.

The lease agreement plays a pivotal role in the sale process and can be one of the two major stumbling blocks when selling your business, the other being your financials.

That’s why it’s essential, both financially and in terms of a successful sale, to handle the assignment or transfer of your lease correctly. In this article, we provide a step-by-step guide on how to navigate this process, including when to approach your landlord and what to expect regarding your security deposit in the context of selling your business. We’ll also cover many aspects you may not have considered yet.

The ideal time to get started is right now…

When should I contact my landlord and let them know I am selling my business?

Early action is your best ally. Landlords greatly appreciate proactive business owners who provide advance notice of their intent to sell. Unfortunately, I’ve witnessed numerous sellers surprise their landlords with this news just a few days before closing, resulting in lease transfer refusals. Initiating contact with your landlord well in advance not only mitigates this risk but also reassures potential buyers that your landlord is on board and aligned with the transaction’s plan.

Doesn’t the landlord have to approve the transfer of the lease to the buyer?

Not necessarily. It’s essential to carefully review your lease agreement, as it typically addresses this matter explicitly. State laws in many jurisdictions also govern lease assignments, with a common provision being that landlords cannot “unreasonably withhold the assignment of the lease.”

The key question often revolves around defining what qualifies as “unreasonable” – a question that can sometimes feel as elusive as a $25,000 riddle (or more, depending on legal costs).

Landlords do have the option to contest lease transfers, and their reasons can vary. Therefore, it’s in your best interest to establish clear communication and alignment with your landlord before investing extensive time and effort in selling your business. Litigation rarely proves cost-effective in such scenarios; reaching a mutually beneficial agreement is typically the wiser path forward.

What is an “assignment” of the lease?

In an assignment scenario, the lease gets transferred to the buyer, while you continue as a guarantor. Whether this is favorable or not depends on your perspective:

• It’s a positive outcome if you’re financing a portion of the sale price, as it gives you the option to reclaim the business if the buyer defaults.
• However, it can be problematic because in the event of the buyer’s lease default, you’re likely to be held liable.

From the landlord’s standpoint, when you initially signed the lease, it likely had a specific term, typically spanning two to five years. When you sell the business, the landlord retains your name on the lease while adding the buyer’s name. In most cases, you’re retained as a “guarantor,” which essentially means you’re still responsible for the lease, albeit with limited rights.

Why does the landlord do this?

Why would they? Why should the landlord willingly heighten their exposure without gaining anything in exchange?

But what alternative do you really have? Your options are often limited, and from the landlord’s perspective, it’s a low-risk proposition. Hence, it’s a common expectation that they’ll request you to stay on as a guarantor.

What is a sublease?

In a sublease arrangement, there are essentially two distinct leases at play:

• Lease 1 — the lease between the landlord and you (the master lease).
• Lease 2 — the lease between you and the buyer (the sublease).

It’s worth noting that most lease agreements explicitly address this matter and often prohibit subleasing. To navigate this, carefully review your lease, paying particular attention to any clause titled “Assignment and Sub-Letting.”

The primary scenario where a sublease may come into play is when you’re financing a portion of the sale price. As you maintain your lease with the landlord, you retain full access privileges to the property. This can be advantageous, affording you greater control until the full payment is received.

What is the craziest story you have heard involving the transfer of a lease?

Believe it or not, in some lease agreements, there’s a clause stating that the landlord is entitled to half of the sale proceeds when the business changes hands. It might sound unbelievable, but I’ve encountered such cases. Ideally, the clause should specify that the landlord is entitled to half of the “leasehold value” or half of the proceeds attributed to the lease’s value. However, I’ve come across situations where landlords insisted on receiving half of the entire sale price of the business. In one instance, the business owner took the matter to court, but after spending a hefty $30,000 in attorney fees, eventually had to relent.

It’s crucial to thoroughly review your lease agreement or, better yet, have an experienced advisor examine it to ensure there are no major issues lurking within. Unfortunately, I’ve also witnessed cases where landlords unreasonably refused to assign a lease, often without a justifiable cause in my opinion.

Is there a fee to assign the lease?

Occasionally, a fee ranging from $500 to $1,000 may apply, although the exact amount can differ from state to state. This fee is typically deemed reasonable, considering that the process of assigning a lease can entail some effort on the landlord’s part, despite not yielding them any direct financial gain.

What can I do to ensure that the landlord will assign the lease?

Initiate contact with your landlord at the outset of the process, informing them of your intention to sell your business. Inquire about the landlord’s priorities for a new tenant, such as their experience, creditworthiness, and financial stability.

Once you’ve identified a potential buyer, proactively guide them to align with the landlord’s requirements. Assist the buyer in crafting a compelling resume, preparing a robust financial statement, addressing any credit issues, and presenting themselves to the landlord in the most favorable manner possible. This proactive approach enhances the likelihood of securing the landlord’s approval and smoothing the path to a successful lease transfer.

How is the security deposit handled?

Usually, the landlord retains your security deposit, while the buyer reimburses you for this amount. This streamlined process eliminates the need for the landlord to refund your deposit and then collect a separate deposit from the buyer, simplifying what would otherwise be two separate transactions.