Buying leasehold businesses.
As is often the case, what’s true for the residential market, is true for the commercial sector. It only follows that entrepreneurs who are priced out of buying freehold businesses will therefore look to leasehold businesses. At Hilton Smythe, we ask the question whether this is merely the second-best option or has a range of merits of its own?
NB – For the sake of brevity, we direct you to our existing post defining the difference between freehold and leasehold businesses.
Why lease hold may be wise
As mentioned in our 2022 Q1 facts and figures update, our recent sales figures have revealed a proclivity towards the purchase of business only and leasehold businesses among today’s buyers. Of course, with the rise of eCommerce and rising property prices, this is hardly surprising.
While it may seem that a freehold business is preferable due to the absolute ownership it affords the owner, there are other considerations to be had. For example, since less capital is needed up front to secure a leasehold tenancy, this option is particularly suitable to smaller businesses; or those which wish to keep their options open with regards to investing in other aspects of the company.
Alternatively, if you find you need to move location (either to expand operations or because you can no longer afford the property), a leasehold offers far greater flexibility to do so. With a freehold, you will be tied down until you can either sell the property (often a lengthy process) or, if circumstances allow it, find a tenant.
Although not applicable in every case, it’s common practice for the landlord to pay some or all of the costs of insuring the property and undertaking maintenance and repair costs, affording the buyer greater flexibility.
Is it better to look for a leasehold property?
As alluded to above, buying the freehold of your own commercial property represents a significant investment, one that is not viable for many buyers. Therefore, by purchasing a relatively short lease, or a lease that presents the option to exit early, affordability can be met with flexibility (should your circumstances change).
Therefore, it’s often the easiest option (and the one the lowest initial costs) to rent a business with premises that are available on a short-term licence.
This manner of arrangement allows you to take on a business without also taking on a substantial longer-term commitment.
Selling a business with existing lease terms
Whether you’re a prospective buyer or seller, it’s imperative to consider the length of term remaining on an existing along with its current terms. For example, the rent, any break clauses or repair and maintenance obligations.
If it transpires that remaining term is for a sufficient length of time, and the buyer is happy with the remaining lease terms, then the sale will typically proceed by way of an Assignment of the existing lease.
Understanding assignments
An assignment is a process whereby the existing tenant (referred to as ‘the Assignor’) transfers their existing lease to the incoming tenant (known as ‘the Assignee’). This is formalised with the landlord’s official consent. As part of this process, the landlord (or their representative) will perform due diligence on the assignee to ensure that they will be reliable tenant. This process will likely involve an analysis of previous trading accounts, a bank reference, trading reference and credit checks.
Here, the landlord will require independent legal representation process and the terms of the lease would usually require the Assignor to meet the landlord’s legal costs in respect of their application for consent.
In some cases, the landlord will require additional collateral from the assignee, which may take the form of a guarantee, or a rent deposit. The landlord also has the right to refuse their consent to an assignment should they have any concerns or should the assignee not pass due diligence.
When consent is given, it is done so via a document called the ‘Licence to Assign’. However, on a modern Lease, there may also be need for an Authorised Guarantee Agreement.
Understanding Authorised Guarantee Agreements
An Authorised Guarantee Agreement (AGA) is a document that the assignor signs with the landlord to verify that the assignee takes over responsibility for the lease obligations. This will include handover of rent obligations, any compliance with repair and maintenance obligations etc. However, it is worth noting that on a legal front that in the case that the assignee defaults on these obligations, then the landlord may have the right to pursue the assignor for any losses suffered (this is part of the reason that due diligence is taken so seriously during the sales process). As such, its often best to consider the AGA as a way to provide the landlord with protection and collateral when the busines changes hands.
What happens if the buyer is not happy with the existing lease?
If there is insufficient time left on the existing lease term to justify a change of hands, or if the landlord is in anyway unhappy with its terms, they have the right to decline an assignment. However, the buyer also has the right to negotiate a new lease with the landlord. This is something that we have expertise in at Hilton Smythe, and we are confident in our ability to negotiate mutually beneficial terms between landlord and buyer. In our experience, we find that landlords are happy to take advantage of the opportunity to negotiate a new, lengthy contractual term, guaranteeing them income.
