Get the Lease of Your Dreams
On a busy city street, the little restaurant gleams like a jewel. It fits your site-selection specs to a teaspoon. You can live with the concept and expense profile and the seller’s motives make sense, so you’re putting together an offer to buy the business. It’s all you can do to keep from licking your chops.
As a group, restaurants like the one-of-a-kind full-service independent sit-down business you’ve got in your sights may not get the attention that their fast-casual or QSR counterparts do. But together, they make up a $160 billion segment of the overall industry, and they’re turning over fast right now. The most successful among them are household names–like New York’s Nobu and D.C.’s the Old Ebbitt Grill–sometimes attached to even bigger household names–like Robert DeNiro and the presidents of the United States, respectively–or to huge fortunes.
Bottom line, though: What other business with such potential can you get into with so little? Only yesterday, you asked your best friend this question, part of your “I’ve-done-my-homework” speech, well known to be triggered by the raising of an eyebrow.
“While I was dreaming of how I would someday get that Gouda and that warm salted potato into the mouths of future guests, I should have been researching the restaurant’s certificate of occupancy.”–Gabrielle Hamilton, Blood, Bones & Butter
One in four independent restaurants will close or change hands in the first year of operation, according to the Cornell Hotel and Restaurant Administration Quarterly. In the second year, it’s almost half and in the third, roughly 60 percent. As an investor, you’re familiar with the leading reasons why: not enough capital or experience, too much competition in the landscape.
Therefore, yes, you’re approaching negotiations with enough depth in your pockets, your bench, and your competitive insight to make a serious go of it. Indeed you do burn with the passion that will get you through the inevitable difficult times. Of course you’ve got an exit plan.
Whether you’re hiring a manager to run this business, folding it into one you already operate, or, like most, planning to run it yourself, you’re buying–well, betting on, anyway–two main things: the management’s ability to generate an income stream and your ultimate ability to sell the business for a capital gain. Before you make your offer, you’ll need to search out and identify anything that could weaken that income stream or the resale value of the business. That’s risk, and you will never eliminate all of it.
Not the Lease of Your Worries
Restaurants are not investments for dummies. “They are notorious for having legal problems that crop up weeks or months after the sale closes,” advises John Corcoran, a lawyer and popular consultant to entrepreneurs. Indeed, as the sportswriter-turned-restaurateur Bruce Buschel comments in his well-known New York Times chronicle of business failure, little about the restaurant market is what it seems to be.
“Crowded places are not necessarily flourishing,” Buschel writes. “Bankrupt places were not necessarily poorly run. Variables are wild: rents, location, capitalization, management, reviews, public relations, social media, timing and luck, if you believe in that sort of thing.”
We believe in luck, but we don’t go anywhere without a flashlight. In this series of posts for would-be buyers, we’ll shine ours into some of the dimmer corners, hideyholes, and nasty pain points of small independent restaurant businesses and the deals where they change hands. We hope to give you the chutzpah to stare all those drain flies, rumors, and landlord clawbacks in the face and systematically bludgeon, scrape, and hose them out of your agreements.
In one sense, there’s no trick to making this work, unless it’s knowing that you must grasp and deal with the risks and rewards for the other party–not just for yourself. To bring down the risk level, you don’t actually have to outwit the seller, manipulate the powers that be, or tell a lie. Think of the so-called “art of the deal” as simply understanding as much as possible about the business and the terms of the agreement to buy, run, and sell it. That, and being honest with yourself about their effects on you.
“If you can meet with Triumph and Disaster, and treat those two imposters the same.”–Rudyard Kipling, “If”
The owner and landlord can be partners in crime, the brokers can be jackals, and the lawyers can be mercenaries but when you go to shake hands at closing, the only devil in the room will be the things you can’t control.
So…. Does that include the lease?
Your Assignment: Should You Choose to Accept It?
The lease for the property your restaurant occupies is, as they say, everything.
“A tenant-friendly lease can add to the restaurant owner’s cash flow and enhance the value of the business, making it easier to borrow against and more profitable to sell. A poorly negotiated lease can be a liability which the business never overcomes.”–Restaurateur “Randy A.,” quoted on My First Restaurant
And, everything about it is negotiable. You may be surprised to learn just how much control you can exercise over its terms. Those terms are theoretically infinite (and may actually coming close to that number), so for now, we are going to focus on just one. It’s important.
Make sure the lease is transferable.
There are all kinds of ways a lease might not be transferable–not only to you, the buyer, but from you to another buyer. It could be a month or two from expiration. It could limit the ultimate pool of qualified buyers for your business. It could require that all signage be in the name of the original tenant, or include a lien on the seller’s property, restrictions on the use of the space, no parking–the list is endless. Not being able to transfer the lease will almost inevitably be a problem, and will certainly be your problem when you go to sell the business. It’s yours to solve, and, as many restaurant brokers counsel, the time to do so is before you sign the lease agreement.
As counterintuitive as this may seem at first, it’s not the seller’s responsibility to ensure the lease allows for assignment to a buyer of the business. And if a seller has failed to secure the assignment of the lease, the landlord can’t give a buyer the benefit of it. Nor is the landlord required to put an assignment, or transfer, clause in the lease. Believe it or not, there could be language in the lease that lets the landlord restrict your rights, even end your lease, if you so much as ask to reassign it.
Let’s say the sale goes through and it’s discovered afterwards that the lease didn’t legally transfer. What happens then? The new owner might have to renegotiate a new lease on much worse terms, like triple the rent or some other deal breaker. Worse still, they might have to leave the property, and there goes the business.
This is why buyers negotiate for a provision in the contract that makes closing contingent on their getting the lease assigned to them, or getting a new lease in place that they find acceptable, with the landlord’s written approval. It’s why they make sure it spells out just how the lease will transfer to another party and whether, having assigned the lease, they remain liable for the rent.
Tenants would ideally assign the lease without needing the landlord’s consent, and be totally free of additional liability having assigned it. People in jail want out, too; many brokers and attorneys suggest negotiating instead for a lesser set of options, like defined reasonableness on the part of the landlord in deciding for or against assignment, for example.
Peace and Serenity, Dang It!
Leasing professionals and restaurateurs agree it’s wise to
– Allow time to review and negotiate your lease–including time built in to ensure you can review the terms of your lease later.
– Enlist professional help from a restaurant buyer’s broker and a commercial real-estate attorney specializing in restaurants.
– Be prepared to walk away. After all, these days, more new restaurant opportunities are popping up than ever. The next post in our series will hold some examples of those up to the harsh light of valuation.