Guest Column

Franchisees need to understand lease options

December 8, 2012
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As the economy continues to rebound in West Michigan, franchising is gaining steam once again – and that’s good news for commercial real estate.

A recent national article underscored several franchising trends. As younger entrepreneurs enter the market, they are looking for lower-cost ventures that are environmentally friendly, health conscious and engaged with the community. The article pointed to home-based senior services, no-frills gyms, healthy foods and pet pampering as franchise categories now on the rise — along with the perennial favorite, frozen yogurt shops.

Additionally, the author noted that franchisors are offering more financing assistance to their franchisees by getting involved in the lending process or creating their own lending programs. Many franchisees are bypassing banks entirely, reducing their business risk by opting instead for lower-cost franchise options.

But whether you’re opening a smoothie shop, fast-casual restaurant, jewelry store or dental practice, the success of a franchise depends in large part on the two L’s: location and lease. The old real estate adage of “location, location, location” is particularly true when it comes to franchises.

Once you have determined the optimal location, the next step is to work with the landlord to develop a lease that will ensure a successful start to the new business. Some of the major considerations include:

Understanding the role of the franchisor: Franchisors are extremely protective of their brands. They typically have highly detailed requirements that spell out dos and don’ts for everything from colors and signage to parking and roof slope. It’s important to understand how these franchise management requirements will affect your lease. For example, will the franchisor require the right to step into the shoes of the franchisee to cure defaults under the lease? Such franchisor requirements may cause the lease negotiation to be more difficult than normal.

Negotiating exclusive rights: Exclusivity — or the right to operate in a location without competition — is typically one of the top considerations for franchises. If you own a coffee shop, you don’t want another coffee shop opening up in the same shopping center. From the landlord’s perspective, though, the primary goal is have the center full of tenants. Depending on the size of the business, though, along with lease agreements already in place, you might not have enough leverage to gain total exclusivity. Some tenants negotiate other rights instead, such as the right to reduce rent if the main anchor store in the center closes its doors. (Speaking of closing the doors, keep in mind that most landlords will insist on provisions that do not allow their tenants to “go dark” even if they continue to pay rent.)

Determining your Top 10: Many retail and food franchises, particularly smaller operations, will opt to locate in a shopping center or mall with other tenants in order to drive traffic. A good starting point with lease negotiations is to highlight the top 10 most important issues to your business. Exclusivity is often at the top of the wish list, but may be unattainable for a variety of reasons. If that’s the case, identify additional issues that are important to your operation and focus on those, such as how the build-out and fixtures will be completed and who pays for it. Build-out and fixtures can be expensive, although some landlords will offer to pay part of the costs, particularly if they are anxious to have the space filled. To round out your top 10 list, don’t forget to consider fair market rent, personal guarantees, use restrictions, hours of operation, termination rights, parking, access, signage and related visibility issues.

Protecting your financial assets: Landlords and franchisee-tenants both need to protect their assets when dealing with lenders. The circumstances can sometimes put you at cross-purposes. Franchisees need to make sure they can stay in their space if the landlord defaults, while landlords need their tenants to provide comfort to the landlord's lender of a steady rent stream. A tenant should require that the landlord provide an SNDA — or subordination, non-disturbance and attornment agreement — while landlords (and sometimes tenants) often require the delivery of an estoppel certificate. The SNDA is a three-party agreement between a landlord, tenant and landlord’s lender that provides for the subordination of the lease to the lien of the landlord's lender, ensures the tenant will remain in the space uninterrupted in the event of a landlord default, and provides that the tenant will recognize the lender as its new landlord under certain circumstances. An estoppel certificate provides a prospective purchaser or lender with facts relating to the status of the lease, such as the amount of rent being paid, term of the lease and whether any defaults exist.

Rob M. Davies is a partner with Warner Norcross & Judd LLP. He concentrates his practice in real estate law. He can be reached at (616) 752-2133 or rdavies@wnj.com.

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