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Taking leasehold premises for start-ups: avoiding the beartraps

Posted: 31/01/2019


Start-up companies and entrepreneurs form a significant part of the UK economy. The October 2018 budget announced the extension until 2021 of the British Business Bank’s Start-Up Loans programme to make it easier for this sector to harness funding. Research by Moore Stephens in the same month revealed a significant increase in those over 22 who choose to start their own business, citing one reason as the increased availability of flexible workspace. 

Whilst start-ups may begin at the kitchen table or in serviced offices, many soon outgrow them. Those which need bespoke facilities (eg labs, manufacturing lines or storage) must source these early on from a third party landlord. Likewise businesses that need larger, exclusive occupation of office space. In some areas there will be plenty of choice of premises; in others competition can be fierce (eg Bidwells reported that in 2017 the vacancy rate for lab space across the Golden Triangle was running at less than 5%).

Landlords who know how to package their property in a way that appeals to start-up sensitivities will be ahead of the game. Conversely, entrepreneurs who are well informed about potential beartraps in a draft lease can strike a better tailored, more predictably priced deal. This article provides a checklist of things to consider, from the tenant’s perspective, with the overall aims of most start-ups being set out in the list below.

Start-up priorities

  • Flexibility of commitment. Start-ups prefer shorter leases, or the right to break early without penalties.
  • Certainty of aggregate cost. With tight cashflow, there must be no hidden surprises. That cost includes rent and rates but also less obvious costs such as service charge, contribution to common facilities and potential repair costs (based on what the tenant has to repair and what state the property is in).
  • Freedom to adapt the premises physically, so they are fit for their proposed use, without delay or cost.
  • Excellent connectivity. No business can survive for long without swift and reliable broadband and telephony, so premises where this is already established, or can be brought in easily, will be attractive.
  • Speedy completion. Start-ups are often in a hurry to get in.

Lease length

Start-ups, particularly in the scientific or IT field, often derive seed funding from annual grants. If the award is not renewed, they may need to scale down operations quickly. So a fixed five or ten year lease leaves them potentially exposed. However, a contracted-out, short fixed term means potentially distracting upheaval if they are forced to move out whilst business is thriving. Landlords can solve this dilemma by either offering a longer term with regular break rights (eg five years with a rolling break right on three months’ notice after 18 months) or a shorter term with an embedded right to renew on like terms. The former is more popular in the R&D market. 

Cost predictability including repairs

Coping on a tight budget makes it important for new businesses to plan for overheads. They will look for fixed rents without review, which plays well with a shorter lease term. Bearing in mind the heavy burden business rates can impose, the tenant may also want to fix its contribution to rates as part of an all-inclusive rent, leaving the landlord with the risk if rates rise.  

If they are taking part of a larger building, or one building on an estate, the tenant will prefer a fixed service charge contribution. The landlord could meet this by offering an all-inclusive rent, a fixed service charge or a capped service charge (which allows for increase within a maximum parameter). All options are potentially dangerous if the landlord has let the rest of the building/estate on a conventional service charge scheme because they leave the landlord with the risk of a service charge deficit on the start-up’s unit, which it cannot wash down to other tenants. 

If your start-up company baulks at the cost of a full survey (and its lender is not insisting) you might remind them that the costs of unexpected repairs can soon derail their budget. Where they are taking a lease of whole, it is likely to make them liable for all repairs. It is short-sighted not to assess the state of the building at the outset so they know what costs might materialise. If there are areas of concern, the tenant may ask for clauses to soften the repair burden, such as an exclusion of fair wear and tear, tying the repair obligation to a schedule of condition or excluding that particular item from the tenant’s repair obligation altogether. The last of these is the most suited to a new build, where the well-informed tenant may want to exclude its repair liability (or obligation to contribute to the costs of repair) for damage arising from inherent defects in design or construction. Landlords may offer, instead, a collateral warranty allowing the tenant to sue the architect or building contractor for those defects. This is not an attractive option for a start-up as it involves delay, dispute and legal costs, without relief from the repair costs in the meanwhile. 

Fitting out – cost, delay and reinstatement

Start-ups often take premises that will need adaptation to suit their business. Technical and scientific companies may need to fit out a lab with specialist, expensive equipment with implications for the building’s common services or EPC (possibly enhanced air conditioning, so plant on the roof and in risers; biosecurity entry systems; adapted lighting). It is tempting (but a bad idea) for tenants to rush into completing the lease without also agreeing up front the terms on which the landlord will permit these works to proceed. They may believe the goodwill generated during lease negotiation means the landlord will agree the licence for alterations quickly, post-completion, once the tenant finally produces fit out plans and specification. This is a dangerous assumption. In a tenant-friendly market, it is the carrot of lease completion that encourages the landlord to agree fit-out works and issue the licence (often without charging extra). Once the tenant is in, and reliant on the alterations clause, they may have less room for manoeuvre on what to propose, be unable to influence the speed of consent easily and will have to pay the landlord’s costs. 

Start-ups also need to think ahead about the cost of reinstatement. Landlords will wish to ensure that, at the end of the lease, the property is left in a state that will not put replacement tenants off (or the tenant pays compensation for dilapidations so that the landlord can fund the necessary re-fit). The landlord’s focus on this will be more pronounced if the start-up wants to do bespoke alterations (such as conversion to a lab).

Connectivity

Most businesses need good broadband and telephony. Tech companies all the more so. This means the tenant must check out whether the services to their target building are adequate, or can be improved by bringing in more kit or a new supplier. Where they are taking a lease of part of a building, this can be a lot more complex than they expect. There may be an exclusive service deal with the existing supplier or physical constraints on available space in risers, the roof or communal basement. Tying down an agreement with all the relevant parties to permit what the start-up wants can be a slow process and they will bear the legal costs. 

Nor can they relax if taking a lease of an entire building. Whilst they will not have to negotiate with other tenants, they may find that a telecoms supplier needs permission (wayleaves) from others for cables to cross their land. So the tenant should always check the quality of mobile coverage in the area and whether telecoms suppliers already have services in the adjacent public road. Fortunately there are relatively cheap standard searches to do this. 

Speed of deal

Understandably, once they have found the ideal property, start-ups often just want to get in and going. The best way to do this is for both parties to be utterly clear at the start of negotiations with the agents. Do not wait until the deal has gone to the lawyers to draw your red lines. Also remember that, if signing up for a building still under construction, there will be an agreement for lease as well as a lease and licence for alterations to negotiate, which will take longer and cost more. 

As ever, the way to stress-free, quicker and cheaper agreement of property deals for start-ups is “be prepared”!

This article was published in Estates Gazette in January 2019.


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Penningtons Manches LLP is a limited liability partnership registered in England and Wales with registered number OC311575 and is authorised and regulated by the Solicitors Regulation Authority. San Francisco is an associated office.

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