From my current experience in negotiating over 500 restaurant, bar and/or club leases, my former experience as a restaurant owner negotiating many leases for myself, and my current role as a landlord of restaurant space, I am very sensitive to the needs of the landlord in qualifying a prospective new tenant.
The major reason deals fail to close escrow is due to the landlord not approving a new tenant or not coming to an agreement on the terms and conditions of the lease. Landlords are very sensitive to the high failure rate of the restaurant, bar and club industry and consequently they want to deal only with prospective tenants that are financially and operationally qualified. Specifically they want to deal with tenants that have had extensive experience, usually a minimum of 3 to 5 years, in the management and/or ownership of a restaurant, bar and/or club. Additionally they want a tenant that is financially qualified which includes a good FICO credit score, usually 680 or above, a strong financial statement, generally showing a minimum $500,000 net worth including the tenant owning a home and the tenant having adequate cash reserves available above and beyond the cash required to purchase the business.
In some circumstance the prospective tenant has a strong operational background but may not have the financial qualifications. In order to overcome this problem the prospective tenant could find a guarantor. A guarantor secures the performance of the lease so that if the tenant gets into trouble then the landlord can go after the assets of the guarantor to satisfy the economic requirements of the lease.
If the prospective tenant can’t find a guarantor in some cases the tenant can satisfy the landlord by offering the landlord a large security deposit. The normal security deposit is one to two times the monthly rent. In the case of a tenant with weaker financials the tenant will sometimes be asked to come up with as much as 6 months to 1 years rent as a security deposit. This means that if the tenant fails the landlord has enough money in the security deposit to remove the current tenant, re-lease the space and cover the costs of loss of rent, attorney fees, and leasing commissions to obtain a replacement tenant. If the tenant doesn’t fail the landlord will usually give back a portion of the security deposit to the tenant after 2 to 3 years of successful performance and will hold between 2 to 3 months rent as a security deposit for the remaining term of the lease.
Another way to financially satisfy the landlord is to have the current tenant stay on the lease for a certain number of years until the landlord is comfortable that the new tenant has a proven himself to be successful in meeting the terms of the lease.
Another method which is used by landlords to deal with a prospective tenant with weaker financials is for the tenant to give the landlord a UCC1 security agreement on the fixtures and equipment of the premises. This means that a security agreement (similar to a recorded trust deed on a piece of real estate) is recorded with the Secretary of State. This puts a blanket lien on the fixtures and equipment which means the tenant cannot transfer the assets of the business until this lien is removed by the landlord.
Conversely if the tenant is strong financially and weak operationally the way to overcome this is for the prospective tenant to team up with a strong operational person and give him/her a piece of the equity tied to the operating results of the business. For a landlord to get comfortable with a prospective operational partner the landlord will want to see the proposed partners existing business operation, review the partners references and business plan including the operations income and expense projections for the first three years of business, resumes of all key management personnel for the new business and review the menu, etc. for the business.
For further details on how to overcome the most common obstacles in dealing with the landlord please contact us at 415-945-9701.