Ninety percent of startup businesses fail.
For many landlords looking to lease their ground floor retail space, franchisee tenants are an attractive proposition for several reasons. One, there is a track record. The landlord isn’t giving an improvement allowance and paying brokerage commissions in connection with a lease to a new concept tenant that may fail and force the landlord to re-market the space again soon. A franchise is a true-and-tried concept with a brand recognition that should be able to drive traffic and justify the investments by the landlord.
Secondly, the franchisee has been vetted to a certain extent by the franchisor. In awarding territory to a franchisee, the franchisor will consider a few factors, such as, net worth, liquid cash, and operational excellence. So, the landlord is not getting an individual with just a good idea but with no clue on how to execute the idea. The franchisor will have guardrails and processes in place, which have previously proven successful, to ensure that the franchisee will be successful.
Thirdly, many franchisors will negotiate the lease on behalf of their franchisees. Though this may seem counterintuitive, this is actually another indication of the franchisor’s commitment to the success of its franchisee.
One of the most important provisions in any lease is the assignment/subletting clause. For any tenant, it is the tenant’s exit strategy in the event the business plan does not work out as contemplated. The tenant must plan out the exit strategy at the time that the lease is being negotiated. The strategy should not, and cannot be, that “I will figure something out with the landlord if I need to.” That is not a strategy; that is wishful thinking.
There are certain provisions that the franchisee should negotiate in the assignment/subletting section of its lease that are unique to a franchise. A franchisee may be successful in its current location, but for various reasons may need to sell the business. The most attractive assignees are the franchisor and another franchisee. A landlord will be more than happy to accept a franchisor as the entity on the lease since that is the “mothership” and the landlord is getting a more creditworthy entity on the lease. What about an assignment to another franchisee?
Landlords may not be as eager to allow another franchisee to assume the lease without the landlord’s consent. A tenant may argue that the landlord’s consent should not be unreasonably withheld, conditioned or delay. But franchisees should consider taking this further.
Tenants will argue that the other franchisee has already been vetted by the franchisor, so the risk to the landlord is minimal. In fact, the landlord may not even know which franchisee is operating from the location because there will be no change in the method of operation.
Below is negotiated language from a transaction that a franchisee may consider using in its lease with respect to assignments of the lease to another franchisee.
“Notwithstanding anything to the contrary herein, without the need for Landlord’s consent, but upon at least thirty [30] days’ prior notice to Landlord [provided, however, if due to the confidential nature of the transaction prior notice is not possible, then within ten [10] days following the consummation of the transaction], Tenant will have the right to assign this lease to another franchisee, so long as such franchisee meets the following requirement [and reasonable proof is provided to the Landlord]:
1. The Franchisee has at least 3 years’ experience in operating [–] [Insert the type of business in general] in [Insert the geographic area where the store is located];
2. The Franchisee has completed the Franchisor’s training;
3. The Franchisee has a net worth of [$–]; and
4. The Franchisee has deposited with Landlord an additional security deposit in the amount of [$–].”
Note that the blanks are to be negotiated and are deal dependent.
The above requirements satisfy the two main requirements for a successful operation of a franchise. First, having the financial wherewithal to run the business and make contributions into the business should the need arise. Second, and the more important requirement, having the operational expertise to make sure that the business can actually make money and be successful.
By negotiating a provision similar to the provision above, the original franchisee has carved out a reasonable and practical exit strategy. Without it, the original franchisee has failed to take advantage of one of the unique features of a franchise. And not that this negotiated provision doesn’t intend to pull a fast on the landlord. Both parties benefit and ultimately it is practical solutions to issues that allow deals to be completed.
Amol K. Pachnanda is a founding partner at Ross Katz & Pachnanda PLLC based in New York City. He helps his clients expertly negotiate their leases in order to achieve their business goals. You can connect with him on LinkedIn, where he shares his knowledge in his popular “LeasingMinute” segment.
