LEASES TIPS & TRAPS FOR FRANCHISEES
Many franchised businesses are conducted from premises that are leased, with either the franchisor or franchisee required to sign a lease to obtain the right to occupy the premises.
It is important to remember there is no such thing as a “standard lease”. Lease terms, especially the commercial terms, are negotiable and to a certain extent, the non-commercial terms are also negotiable, especially for premises that are not located in shopping centres.
Where premises are located in shopping centres, usually the terms of the lease are not easily changed. However, in the current economic climate, we have found that shopping centre landlords have become more amenable to making changes to their leases.
Once you have decided to purchase a franchised business that is to operate from fixed premises, the main questions that should be asked are: ‘Who will find the premises?’ and ‘Who will hold the lease for the premises?’ The decisions are usually made by the franchisor with little or no input from the franchisee, especially where the franchised business being purchased is an existing business with a lease already in place.
Even with new or “greenfield” franchises, franchisors generally wish to control the site selection process. In such a case you should quiz the franchisor about its site selection process and the factors taken into account in selecting the particular premises.
The most common property holding options in franchising are:
- The franchisor holds the head lease and grants the franchisee a licence to occupy;
- The franchisor holds the head lease and grants the franchisee a sub-lease;
- The franchisee holds the head lease and the franchisor and franchisee enter into a separate agreement with the landlord under which the landlord must transfer the lease to the franchisor if the franchise agreement ends (if the franchisor so requires).
- It is most common for the franchisor to hold the head lease and grant the franchisee a licence to occupy. The main reason for this is that the franchisor is able to maintain control over the lease, the franchise site and the renewal of the lease.
The disadvantages for the franchisee are:
- The franchisee may have no control over or say in the terms of the lease. The lease may be presented on a “take it or leave it basis”.
- If the franchisor becomes insolvent during the term of the franchise agreement the site will almost certainly be lost, eliminating the opportunity of operating a debranded business or other business from the site.
- Where the franchisee is to hold the head lease the franchisee will have more control over the selection of the premises and the lease terms (unless, of course, the franchisor insists on sourcing the site and negotiating the lease terms).
Irrespective of who holds the lease, when sourcing premises and negotiating a lease, the considerations are the same.
Tips for Sourcing Premises and Negotiating Lease Terms
Tip 1: Do your homework:
- Ask whether the premises are suitable for the conduct of the business – for example, is adequate car parking available
- Are the premises readily accessible?
- Are the premises in the correct precinct of a shopping centre?
- Ask whether local town planning laws allow for the proposed use of the premises. You should also contact the local council and make your own investigations.
- Query the trading hours and, where relevant, the access hours? This is especially important for premises in strip shopping locations.
- For premises in shopping centres, obtain traffic flow information from the landlord. Better still, ask neighbouring tenants what the traffic flow is like and make as many enquiries as you can, including visiting the centre at different times and on different days of the week to observe the flow of traffic.
- For premises in shopping centres, ask whether there are any refurbishment plans under consideration and if so, the timing and scope of the works.
- Consider engaging a valuer to determine whether the rent being sought by the landlord is actually a fair market rent.
Tip 2: Obtain Lease Documents Early
Obtain the relevant documentation from the landlord as early as possible. Make sure you obtain:
- A copy of the proposed lease. In parts of Australia where retail legislation applies, a copy of the lease must be provided at the negotiation stage.
- A disclosure statement. This statement gives you an information summary about the premises, the outgoings that are payable, the commercial lease terms and, where the premises are in a shopping centre, details of the centre.
- If you are presented with a Letter of Offer or Agreement for Lease, make sure you seek advice from your lawyer as you may be signing a binding agreement for lease without realising it and may also waive your rights to negotiate the legal and commercial terms.
- Seek advice in respect of these documents from your lawyer and accountant.
Tip 3: Read the Lease yourself
There is no substitute for you reading the lease:
- Consider the commercial terms. You need to do your own research. Talk to neighbours to obtain as much comparative information as possible. You may even consider engaging the services of a professional who can undertake the negotiations on your behalf. In those states and territories where leases are required to be registered, copies of leases are readily available.
- The term of the lease is an important consideration. Is the term sufficiently long enough to allow you to obtain a return on your investment? Most retail legislation around Australia requires landlords to give tenants a minimum five year term. In the franchising context, there is another consideration and that is whether the term of the franchise agreement and the term of the lease marry up. Often they do not, and you need to understand what occurs if the lease expires before the franchise agreement does. Does the franchise agreement allow the franchisee to relocate and if so, where and at what and whose cost?
- Consider the permitted use and whether it is broad enough to allow you to carry on the franchised business.
- Consider the rent review mechanisms, fixed, CPI, combination reviews (where allowed by law).
- Consider the market review rent provisions. Make sure you look at these clauses carefully. The valuer should not be able to take into account the tenant’s fitout and goodwill when assessing the market rent.
- Consider relocation clauses and demolition clauses and how these clauses apply. These clauses essentially allow for an early termination of the lease and, as a result an early termination of the franchise agreement where the term of the franchise agreement is linked to the term of the lease. You should ensure that the relocation clause compels the landlord to move you to premises that are of a comparative size and location and that all your costs associated with the relocation are paid for.
- Consider the ‘make good’ clause. More and more landlords are agreeing to allow tenants to leave their fitout at the end of the lease term. This can save tenants a significant amount of money.
- Consider whether the landlord will make a financial contribution to your fitout. In recent times we have seen a significant rise in landlord lease incentives and contributions.
- Consider the tenants obligation to redecorate. Try and negotiate a more favourable clause, for example, ‘that the tenant is only required to redecorate if reasonably required and then only no more than once every 5 years’.
- Consider the obligations to maintain essential safety measures. Ensure, where possible, that the lease spells out it is the landlord’s responsibility to maintain and pay for the costs of maintaining essential safety measures.
- In shopping centre leases, consider how a kiosk outside your premises could affect your business and exposure. Try and negotiate a clause that no kiosk is to be erected within a certain area outside the premises you are intending to lease.
- In shopping centre leases, be wary of percentage rent and turnover rent clauses and make sure you understand how these clauses actually work.
In summary, there are a lot of factors to consider when selecting suitable premises to operate your franchised business from. More and more people are choosing to engage professionals to select a site for them and to negotiate the commercial terms.
Whether you choose to engage a professional or negotiate the commercial terms yourself, remember always to have your lawyer and accountant check the documents you are being asked to sign before it is too late and you are locked in.