How to Break a Lease with Minimal Losses
Exiting a Commercial Real Estate Lease When a Business Fails
Starting up a business is not without inherent risk, especially when you consider that nearly 50% of startups fail within the first five years. As a business owner, if you structure your business for an exit from the start, planned or unplanned, you will be better equipped to handle difficult circumstances. So what options are available to a business owner when they’re not bringing in the revenue they expected and need to get out of their lease?
Addressing Options to “Break” a Lease
There are two opportunities for a business owner to “break” their commercial lease while mitigating the impact to their bottom line. These opportunities include selling their business and subletting or assigning their lease to a new party. Following we’ve included what a business owner can expect from each of these situations and the next steps they should take.
Selling Your Business to Get Out of Your Lease
When a small business is not making any money, its value is tied to its assets. The assets of a business can trade for anywhere between 10% and 50% of their original value and are mainly comprised of fixtures and equipment. When a business owner sells their company in an asset sale, the new business owner can assume their lease. Remember earlier, when we mention building an exit into your business. If you structure your lease (and all contracts) with an assignment clause this process will be much simpler. Typically, this scenario occurs most often with retail businesses like restaurants, salons and retail shops.
Subletting Your Commercial Real Estate or Assigning Your Lease
The second opportunity for a business owner who needs to get out of their lease is subletting the commercial space to a new tenant. Subletting, however, does not remove the liability for the property from the business owner and will likely provide below market rental rates to the owner. This is where a lease assignment comes into play. A lease assignment allows a tenant to assign the entire lease to the new business owner and releases them from liability for the space. It is best to work with a commercial broker and an attorney to properly structure a lease assignment.
For business owners currently in the startup phase of their business, we suggest structuring any lease contracts with assignment clauses to help build an exit strategy into your business. For entrepreneurs who are facing a situation where they need to get out of a lease, the best case scenario is to work with both a commercial real estate broker and a business broker at the same time to optimize the chance of reaching a successful exit from said lease. Since this is an especially delicate financial situation for an owner, working with both brokers will provide the advantage of access to both of their networks, decreasing the timeline of the exit process in comparison to trying to sell or sublet on your own.
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