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3 Lease Provisions You Should Take the Time to Read

Your team spent months looking at office spaces…you found the perfect space. You spent weeks sending term sheets back and forth…you’re comfortable with the economic terms. Your broker called…the landlord delivered the lease agreement. The broker tells you the lease is “fairly straightforward.” But is it?

One of the largest sources of cash burn for early-stage companies is office space. Entrepreneurs enter into leases with a full plate of uncertainty with respect to strategy, growth and future needs. Sure there’s a business plan, but you know what entrepreneurs do to business plans? They change them. In reviewing leases over the years, I’ve identified a number of business points that disguise themselves as legal points. These are hot button issues for early-stage companies.

1. The Assignment and Sublease Provision.

• What you want: You want to be able to sell the company without the landlord holding up the deal. Ideally, the language would let you assign the lease without the landlord’s consent in connection with a sale, either through a merger or sale of the company’s stock or assets. If the landlord will not accept that, a middle ground is to have the landlord agree not to unreasonably withhold consent and to provide consent within a certain, short period of time. You want to be able to move on if the company’s needs change and you need to retract or expand your office space. The economics of subleasing are painful enough. The landlord should agree not to unreasonably withhold consent to a sublease, and the list of restrictions related to subtenants should be as limited as possible.
   
• Why it matters: Flexibility. Typically, early-stage companies are moving toward an exit and growth is unpredictable. It’s important to negotiate on the front end so that the company has freedom to operate when it matters most.

2. Right of First Refusal/Right of First Offer.

• What you want: A right of first refusal for any space in the building that could make sense for your company in the next three years. Clients, brokers and attorneys all scratch their heads when it comes to the difference between a right of first refusal and a right of first offer. A right of first offer requires that the landlord tell the tenant that certain space is available and provide the tenant with the first crack at making an offer for the space. This requires the tenant to show its hand from the start. A right of first refusal requires a third party to strike first. If space is or becomes available and the landlord receives an offer from a third party, the landlord must give the tenant the right to lease the space on the terms in the third party’s offer.
   
• Why it matters: With an early stage company, change is constant. Often the easiest way to accommodate that growth is to expand into neighboring space right where you are. A right of first refusal provides you with the first right to do just that on terms set forth by an independent third party.

3. Landlord’s Lien/Security Interest.

• What you want: No security interest at all. Approximately 30% of the lease agreements I review come over with a landlord’s lien/security interest provision that creates a lien in favor of the landlord on all or most of the assets of the tenant. It should go without saying that I recommend that you have an attorney review your lease. But, if you choose not to, after reviewing the economic terms, do not sign the lease without checking thoroughly to make sure that the landlord has not included a lien provision. I recently reviewed a lease that included a lien on “inventory, equipment, contract rights, accounts receivable and the proceeds thereof.” Do you know what that means? In addition to the other terms, “contractual rights” means the landlord was taking a lien on the intellectual property of the company.
• Why it matters: Say your company wants to get a loan. You’ll need a lien waiver from the landlord. Already have a loan? I bet it prohibits letting a third party take a lien on your assets. Say your company wants to take in investment dollars. You’ll need to disclose the lien created in the lease. Time is limited. Remove this provision at the lease-negotiation stage and you will not have to worry about it again. The good news is that most landlords will remove this provision entirely without much of an issue.

Author: Emily M. King