You have found a business that you would love to buy, but in order to operate it, you need to lease the premises. It’ll be essential to determine whether there is a written lease in place, and review that lease, particularly if it’s intended that the business will be operated from those premises after completion. The lease is also a critical element for establishing that you are buying a business as a ‘going concern’, so that GST (a type of service tax) is not payable on the transaction.
Undertaking due diligence on the lease is just as important as undertaking due diligence on the business. It will help understand the terms of the lease and eliminate risks.
So what do you need to look for when reviewing the lease?
Reviewing the lease
The main items that need to be reviewed under the lease are:
- Cost: How much is the lease and all costs associated with it? And when will those costs be charged and increased? The amount payable might include:
- Rent: Verify the amount of rent that is payable and how often will the rent bereviewed by the landlord and increased.
- Rent increases: Usually, the rent is increased on an annual basis either by a set percentage; or by comparing the market; or by the consumer price index. Depending upon how long the lease is and its terms, there might be a combination of ways that the rent is increased. For instance, there might be a three percent increase every year, then if you trigger the option to renew the lease for another period, the increase might be the higher of five percent or based on market review and calculated upon what similar properties are being rented at.
- Outgoings: Check whether you are obliged to pay the outgoings, or whether these are already included in the rent that is payable. The outgoings typically are the landlord’s expenses concerning the property and comprise of rates, insurance, fire safety inspection costs, cleaning and gardening, repairs and maintenance.
- Period: How long is the lease, and can it be extended or shortened?
- Term: Check the duration of the lease, and make sure that there is adequate time left on the lease to operate the business from that location. If you buy a business that only has a short period left on the lease, unless you can enter into a new lease with the landlord, you might not be able to operate the business, which might be detrimental to the business if the business is reliant on that particular location.
- Option: Determine whether you have an opportunity to extend the lease, and the time periods and methods in which to exercise that option.
- Obligations: What are the tenant’s obligations under the lease versus the landlord’s responsibilities?
- Air conditioning: Check the obligations concerning the air-conditioning. The tenant might be obliged to keep the air conditioning in good repair and might only be able to use the contractor that is specified by the landlord.
- Repairs and maintenance: Usually the outgoings include repairs and maintenance related to the property and does not usually extend to the tenant being required to fix structural items. However, the extent that you’ll be obligated to repair and maintain the property, particularly if there is existing damage should be checked.
- Signage: If you need signage, check whether there are any signage rights and whether a separate signage agreement is in place or required.
- Obligations specific to your business: You will also need to check whether there are any requirements that are specific to your particular business and that you can use the premises for the purpose intended by the business. For example, if you are buying a gym which is under a residential building, there will be opening times set by the body corporate. Special flooring might also be required so that the gym equipment doesn’t vibrate through the building and impact on other tenants. There may be council requirements regarding the noise (which might restrict the sound of music coming from the premises) or the ability for people to exercise on the footpath outside the building. So you need to think about whether there are any matters that are specific to the business that you are acquiring.
- Exit: How will you exit the lease, and what are your obligations when you leave
- Termination: Usually, the tenant can’t terminate the lease and instead takes on the lease for the required term. Sometimes there are termination provisions but only on specific events, such as if the premises is destroyed and can’t be fixed within a certain time period.
- ‘Make good’ obligations: If the lease is being assigned, the buyer will inherit the existing ‘make good’ obligations. However, you might not be aware of what the premises were like when the seller moved in. So apart from checking the obligations in the lease, ask the seller what improvements they made to the premises, and whether they took any photos at the start of the tenancy.
- Fit-out: The tenant might be responsible for the cost of the fit-out. If you’re buying an existing business, determining who paid for the fit-out is vital. If the fit-out has been paid by the tenant, the tenant might be obliged to remove the fit-out at the end of the lease, which if you take over the lease, becomes your obligation.
- Existing breaches or obligations: Check whether there are any existing breaches, work orders or disputes by the seller under the lease and whether the landlord has refused to grant an option or renew the lease. Make sure any existing breaches or obligations are settled before Completion, otherwise, they might become your obligation to rectify.
Assign or enter into a new lease:
Depending on the status of the lease, including whether there is a lease or if it has or nearly expired, you will need to decide if you’re going to take over the existing lease, or whether a new lease will be entered into between you and the landlord. If you’re not satisfied with the terms currently in place, you might want to seek an amendment, otherwise you will be bound by those terms. Sometimes however, you might not have a choice and be forced to enter into the existing lease.
If you’re taking over the existing lease, you will require the landlord’s prior consent. Before providing that consent, the landlord might require you to provide evidence of your experience, business references, take out insurances and provide a bank guarantee or agree to a personal guarantee. Remember, personal guarantees should be avoided if possible, given you will then be personally liable, and your personal assets (such as your house) might be at risk.
The timetable should allow for approval by the landlord and the bank (for the bank guarantee). These approvals, if they’re a condition in the sale agreement but are not obtained, have the potential to stop the sale of the business.
To ensure the buyer ends up with the benefit of a business with a premises, and not a business with no-where to operate from, the sale agreement should contain a condition that the completion of the sale of the business is subject to either obtaining a new lease, or the existing lease being assigned to the buyer
Key takeaways: Due Diligence – Lease
- To get the full benefit of the business and utilise the premises it is essential to understand the terms of the lease.
- Ensure you check:
- The cost of the lease including the rent, outgoings and any other obligations that will incur costs.
- Review how often, and how much the rent will increase.
- How long is the period of the lease and whether the lease can be renewed.
- Determine who owns the fit out – and if it belongs to the Seller whether it must be removed at your cost at the end of the lease.
- Determine if there are any other obligations, including whether you are obliged to look after the air conditioning, and the extent of any repairs and maintenance.
- Understand whether you can instal signage, and what prior consent is required.
- Be clear on how you can exit the lease, and what actions need to be satisfied before exiting the premises. Understand who is obligated to make good the premises at the end of the lease.
- Determine what consent and details you need for the lease to be assigned or whether a new lease can be entered into.
About the Author:
The following extract has been taken, in part, from the book, ‘Entrepreneur Know How – Mindset and Winning Steps for Buying a Business,’ written by Sharon Robson (Available through Amazon and select bookshops – see: https://entknowhow.com/the-bookstore
Sharon is the principal lawyer and founder of Antler Legal – a corporate commercial legal practice in Sydney, Australia.