For any new business that will operate from a physical location—be it an office, a storefront, or a kitchen—you’ll have to sign a commercial lease agreement. And, let’s face it, these agreements often are boring to read and hard to understand. So, you just get a lawyer to review the contract and if they say it’s ok to sign, you sign, right?
Wrong.
At least, we don’t recommend it. It’s important for you to have an overall understanding of the contract. This way, if you need new signage for your store or have a lot of snow piled up from a snowstorm, you’ll know who’s responsible for what, between you and your landlord.
This blog post will help you get a high-level understanding of what’s in most commercial lease agreements. You’ll still need to read your contract, and you should ask a lawyer to review it for legal wording. But, by the time you get to the end of this post, we hope you’ll know the shape of the forest so you can more easily focus on the trees.
- How We Found the Contracts Analyzed Here
- A Commercial Lease Agreement Typically Starts with Identifying the Location and Permitted Use
- The Agreement Will Have an Initial Term and Maybe a Renewal Term
- The Agreement Will State the Amount of the Lease
- Usually, Only the Landlord Has the Right to Terminate the Lease Early
- You Might Have to Pay for Other Items in Addition to Your Monthly Rent
- What if You Need to Remodel or Reconfigure the Interior?
- A Commercial Lease Agreement Will Also Clarify Other Responsibilities
- The Agreement Will Address Some Other Miscellaneous Items
- You are Expected to Negotiate, so Don’t be Afraid to Ask for Changes
- Commercial Agreements are Less Forgiving than Consumer Agreements, so be Sure to Understand What You Sign
- We Turn Our Attention to Web-Based Businesses Next
How We Found the Contracts Analyzed Here
To write this post, we found several template contracts on the internet and looked through them for what commercial lease agreements typically cover. These are, of course, just example contracts. If you’re going to lease your space from even a mid-sized leasing company, they’ll probably send you their standard contract tailored to their needs by their lawyer.
This means, almost certainly, your contract will cover additional items not mentioned in this post. This is yet another reason why you should read your contract. There is really no way to get around it.
So what’s in a typical commercial lease agreement?
A Commercial Lease Agreement Typically Starts with Identifying the Location and Permitted Use
Every commercial lease agreement will state the location (i.e. address) of the place you’re leasing and how you’re allowed to use that space. Sometimes, the wording is vague, and you can use the location for anything that’s not illegal or against local code. Other times, the wording can get specific.
We didn’t see it in the batch of agreements we looked through to write this blog post, but some retail leases can have exclusivity added to location and use.
For example, the landlord of a strip mall might agree that they won’t lease space in the same mall to a business similar to yours. So, if you wish to open a Chinese restaurant, you won’t have to worry about someone opening another Chinese restaurant next door. You might not be able to stop an Indian restaurant from opening next door, though.
The Agreement Will Have an Initial Term and Maybe a Renewal Term
The agreement will specify how long the lease is. Commercial lease agreements are often for five years or longer.
Sometimes, the agreement will also have a renewal term or option to renew. This means when the first five years are up, you can notify your landlord that you want to stay, and you get to keep the same lease. You might have to pay a higher monthly rental amount, but this can be negotiated.
If you’re a new business, be careful about figuring out the length of the initial term. About 20% of new businesses fail by their second year and about 50% fail within the first five years (see chart from US Bureau of Labor Statistics). As we’ll explain below, even if your business fails, you might still be responsible for paying for the entire term of your lease. You don’t want to be stuck in this situation.
Even if you don’t negotiate a renewal term, you can, of course, stay at the same location. You’ll just have to negotiate a new lease.
So, be sure to calendar the end date of your lease. This way, you can start renegotiating early. Then, you wouldn’t be working against a tight deadline that forces you to pick between paying a much higher rent or move out with very short notice.
The Agreement Will State the Amount of the Lease
Every commercial lease agreement will state the lease amount, along with the payment due date.
Typically, you’ll have a base lease, which is the specific dollar amount typically due each month. In some contracts—especially retail contracts in shopping areas—you’ll have an additional lease amount.
This additional amount is usually based on a percentage of your net or gross income. It can be paid monthly, quarterly, or yearly. The exact amount of the additional payment fluctuates as your business volume fluctuates.
There’s a third type of lease called the net lease, which usually costs the least. Here, you’ll typically have to take care of all the maintenance and maybe some other expenses usually paid by the landlord.
For example, in a typical lease, the landlord must maintain the parking area. In this third type of lease, you must maintain the parking area. That’s why you get a break in your lease payments.
Read your lease carefully. Some leases say if the building is damaged, for example by a fire, you’ll still have to pay partial rent. Others will say you won’t have to pay anything. Be sure to understand what you might have to do.
Usually, Only the Landlord Has the Right to Terminate the Lease Early
In any contract, one or more sides can sometimes end the contract early for various reasons.
The Landlord Has the Right to Terminate the Lease Under Several Scenarios
Usually, only the landlord has the right to end the lease early. If you fail to pay the lease, then of course they can terminate. Depending on whether your state law allows it, your landlord might have the right to take everything on your premises (e.g. tables and chairs) as repayment for the missed lease.
If the entire building burns down, for example, the landlord usually can terminate the lease as well. So, be sure to understand under what circumstances your landlord might end your lease. These circumstances usually aren’t found in the one place in the lease, so you’ll have to read the entire document.
The Tenant Usually Does not Have the Right to Terminate the Commercial Lease Agreement Early
Usually, you don’t have the right to terminate the lease. This means that if you sign a five-year lease but go out of business after the first year, you’re still on the hook for the rest of the lease. The lease agreement usually doesn’t explicitly state this. Instead, you simply won’t be able to find a scenario under which you can terminate early.
If you give up your leased space, some leases allow the landlord to go find another tenant. If that happens, you might not have to pay the rest of the lease. But, if the new tenant’s lease payment is less than your payment, then you might still have to pay the difference.
Some leases will let you sublet to a new tenant or find a replacement tenant. This provision is not always in the lease, so you might have to negotiate for it.
Termination and what happens afterward are very important in a commercial lease. Be sure to read all the relevant sections and understand what you’re agreeing to.
You Might Have to Pay for Other Items in Addition to Your Monthly Rent
Sometimes, you’ll have to pay a security deposit. Other additional payments include late fees, insufficient funds/bounced check fees, and similar.
Be aware of these additional payments so you can budget accordingly.
What if You Need to Remodel or Reconfigure the Interior?
Usually, you’re allowed to change or reconfigure the leased space to fit your business’s needs. For example, if you’re opening a restaurant, you’ll need to build a commercial kitchen, if the previous occupant wasn’t a restaurant. You’ll also need to put up a new sign for your business.
With very little exception, the landlord has to approve your changes. Typically, you’ll want the lease to say that they’ll approve the changes quickly. You don’t want your remodelers to be ready for work but the landlord still hadn’t approved the changes.
Usually, after you remodel, the new fixtures belong to the landlord once your lease ends and you move out. This should be specified in the lease.
A Commercial Lease Agreement Will Also Clarify Other Responsibilities
The agreement will also spell out who is responsible for payments like:
- Utilities
- Maintenance of major systems like heating, plumbing, electrical
- Obtaining exterior insurance (personal injury, casualty, property damage)
- Tenant’s other insurance responsibilities and policy limits (personal injury, casualty, property damage)
- Exterior and parking maintenance
- Real estate taxes
- Major and minor maintenance and cleanup of interior and/or exterior
For the items the landlord must maintain, you’ll have to agree to give them a right of entry so they can come onto your premises and fix things for you or for the other tenants.
The Agreement Will Address Some Other Miscellaneous Items
Lastly, most commercial lease agreements will set out your rights if the landlord sells the building. It also addresses the rights of the other party if one party declares bankruptcy.
You are Expected to Negotiate, so Don’t be Afraid to Ask for Changes
As you read through the agreement, mark up the sections you’re uncomfortable with or have questions about. Go to the landlord and get clarifications or propose changes that you can live with. If they refuse to make changes, at least you’ll understand the contract language better. This way, if you have to take some risks, you do so with your eyes open.
The Law Considers a Business Owner a Sophisticated Contracting Party
As a businessperson, you are now considered a sophisticated party under the law. This means that the law assumes you know what you’re doing. It treats you as someone who’s been negotiating agreements for decades. Never mind that, just yesterday, you didn’t have your business, so you weren’t a sophisticated party.
Sophisticated parties are supposed to negotiate. So don’t be shy. Haggle away.
When Negotiating, Look at the Agreement as a Whole Instead of as Separate Sections
When negotiating changes to the agreement, you don’t always have to change the part that’s making you uncomfortable. Sometimes, you can tweak two or three other sections to get to something you can live with.
For example, let’s say the lease is for five years. The monthly rent has a base payment and an additional payment based on your sales. You also have no right to terminate the lease or to sublet in case you go out of business.
You can try to negotiate this agreement by proposing a one-year lease with an option to renew for four more years. So, the total is five years but if you go out of business in the first year, you won’t have to pay the other four years.
If the landlord insists on five years, maybe you can ask them to not lease to a similar business in the same shopping complex so you have less competition. Maybe you can negotiate the rent so you only have to pay the base payment for two years and add the sales-based payment to the last three years of the lease.
If you go out of business and the original lease doesn’t let you sublet, maybe you can convince the landlord that you should have a right to sublet the space. This way, you don’t end up paying rent for a business that’s no longer in operation.
If You Don’t Ask, You Don’t Get
Every item in your commercial lease agreement is theoretically negotiable. Most business-to-business contracts are. Some landlords are easier to work with, but others tend to stand pretty firm.
A lot of what a landlord is willing to do can depend on the location of the space (e.g. hottest shopping area of town) or the size of the leasing company. You won’t know how flexible they are until you ask. The worst they can say is no.
But they might also be able to suggest something that both of you can live with.
Commercial Agreements are Less Forgiving than Consumer Agreements, so be Sure to Understand What You Sign
If you’re an ordinary consumer, the law protects you a lot when signing a contract. Some consumer rights simply cannot be negotiated away, no matter how hard a big company tries. But, with business-to-business contracts, you can negotiate just about anything.
So, be very careful when you sign a business-to-business contract. You have to understand the agreement, and you should get a lawyer to review the agreement. Lawyers understand the difference between, for example, best efforts vs. commercially reasonable efforts and they know which is best under what circumstances. Commercial leases can be expensive and can last many years. Don’t skip reading the agreement and don’t skip the lawyer review. You owe it to yourself to understand all your risks.
We Turn Our Attention to Web-Based Businesses Next
We next turn to businesses that mainly operate online. Specifically, we’ll go over a few DIY items for opening a small, beginner online store.
The easiest way to do this is to piggyback on some of the bigger internet platforms like Facebook marketplace, Etsy, eBay, and similar. We’ll have articles on how to sign up with these platforms.
But, before you sign up, you should have at least a few pro or near-pro quality photos of the items you plan to sell. You can hire a freelancer for some pro-level photos, or you can do it yourself.
Let’s look at how to do DIY product photography. You won’t have to spend a ton. Our entire DIY photo studio costs less than $20. We used our smartphone camera to take the pictures and free photo editing software to enhance the photos. Anyone can do this.
DISCLAIMER: This article does not constitute legal or accounting advice. Instead, it contains general information. The information gives you the background you’ll need to hit the ground running when you do go get advice from a lawyer or accountant. Only lawyers and accountants properly licensed in your state/country are qualified to give you legal or accounting advice.
Questions? Comments?
