Top tips to help you negotiate Heads of Terms on a New Lease
1. Where will you be based?
One of the first questions any start up SME businesses has to ask itself is where to base its business?
The good news is that there are many options available to you — these include:
- renting out a desk in a building;
- hosting purely online and be an internet based business; or
- the more traditional approach of negotiating and leasing out or buying a shop or office unit
Each of these options has its own advantages and disadvantages but for many, having an actual office or shop remains the preference as it immediately gives their business credibility — something potential customers look for when deciding where to give their custom.
Buying actual premises in a thriving and busy area whilst extremely attractive can be an expensive option especially for a start-up business where costs are and remain a primary driving factor.
That being the case, the most frequent form of office or shop occupation tends to be by way of a lease or rent — this is where you will pay rent to the owner of a building in which you want to be based and in exchange, the owner (most commonly referred to as a landlord) will agree to let you stay and occupy the premises for a set period of time (most commonly referred to as the term of the lease).
However for a start-up business this process can be a lot more difficult than simply identifying a location and paying a rent as many landlords are professional landlords who have a lot of experience in renting out their units and shops often with an established legal team and an agent on standby ready to negotiate the terms of any form of lease on their behalf.
So as an SME business owner you are often negotiating with someone who has a lot more experience and resource than you do in negotiating a good deal.
2. What are Heads of Terms?
The terms subject to which a lease is granted are called the Heads of Terms and which will govern your occupation of the unit you have found — these are what set out how long you are allowed to stay in the lease, the rent you will pay, how often the rent will be reviewed, what you can use the premises for and similar.
3. Negotiating tips
If you have the ability to appoint a lawyer and/or surveyor to help you with negotiating the Heads of Terms then this is highly recommended. However if you do not, then here are a few helpful hints that may help you in your negotiation of the Heads of Terms:
- FRI Repair: If you are taking on a lease in a commercial unit, you will often find that the landlord will request that the lease is granted as an “FRI” or “Full Repairing and Insuring” lease.
What this actually means is that you will be obliged to put the premises in to a good state of repair when you hand the premises back to the landlord at the end of the term even if the premises were in poor repair when you took it on at the start of the lease.
This may seem unfair but there are a few things you can do manage this. For example you can agree to set the standard of repair to the condition that the premises were in when you took it on by negotiating and agreeing a schedule of condition.
A schedule of condition is a photographic record which in the main shows the condition of the property at the start of the lease and also highlights any damage so that the landlord cannot ask you to repair these nor put the premises in a better condition than as shown in the photographs when the lease ends potentially saving a tenant thousands of pounds;
- Making Fit for Use: You may find the ideal location to be based out of but find that the premises themselves do not (as currently set out) work for the type of business you wish to set up. An example of this could be because you are hoping to set up a restaurant which needs the installation of a flue for your kitchen. In this situation you would need to carry out work to the premises but may also need to obtain planning permission from the local authority and consent from neighbours to allow you to fit the flue itself — all of which takes time and involves incurring expense before you can start trading.
You may therefore be able to negotiate that the landlord enters into an agreement (called an agreement for lease) which contractually obliges the landlord to give you time to obtain the planning permission or carry out works before the lease is completed. Once you have the planning and have completed the works, you then would complete the lease.
Agreeing an agreement for lease with the landlord has immediate advantages to you but the key ones are that:
a) you are not obliged to start to pay rent until the lease is completed; and
b) the landlord cannot change his mind and lease to someone else after you have started spending money and is obliged to grant you a lease so long as the conditions are met and you are not in breach.
It is important to note that this doesn’t leave the position open ended — an agreement for lease will only give you a window of time — it doesn’t last forever and there is a legal cost associated with entering into this which means you need to consider the cost of entering into the agreement over the benefit you receive particular to your specific circumstances.
As an aside, if you have also carried out work to the premises which you have paid for, you may also wish to consider whether you need to agree that the landlord cannot use these improvements to increase the rent when you next have a rent review;
- Alterations: As a tenant you will also be concerned about carrying out alterations after a lease has been completed.
Some of the alterations you will want to carry out will be relatively minor — for example setting up partitioning to create desk hubs for your staff or an annual painting the interior of the inside to make it look presentable and tidy (something many leases will require you to do anyway).
However what many tenants don’t realise is that most standard commercial leases will require you to obtain the approval of your landlord to the work you are proposing to carry out and even often the materials you propose to use before the work can be carried out.
If you do not obtain that consent then you may be in breach of the lease and this may entitle the landlord to take enforcement action against you.
The reason a landlord seeks this control is because the landlord will want to be certain that you are looking after his property during the works and that any works you are carrying out are completed:
- to a good standard of repair
- in accordance with all or any laws that apply (such as planning or building regulations); and
- will not diminish the value of the buildings after the works have been completed.
However whilst this degree of control is understandable for alterations or works where the works being proposed are substantial (and usually therefore more expensive), having to obtain the consent of your landlord to minor alterations will in most cases place an unnecessary administrative and financial burden on the tenant since it means that before you commence the works, you will need to first obtain the landlord’s consent to the works you are proposing to carry out and also pay the landlord’s fees incurred in approving the same.
It is therefore wise to qualify in the Heads of Terms that minor cosmetic alterations can be carried out without the need for the consent of the landlord. You may also wish to clarify that you will have the right to install, remove and alter internal demountable partitioning without the need for consent.
- Exclusion of Security of Tenure: Frequently a landlord will specify in the terms of a lease that the lease must be “Excluded from Security of Tenure” or “Excluded from LTA”.
What this actually means is that once the term of the lease comes to an end then you will not benefit from what is otherwise a statutory right to renew the lease and will have to vacate the premises unless the landlord (of his own choice) agrees to permit you to stay for longer.
If you have spent a lot of money in fitting out the premises to make it work for your business then this means at the end of the term unless the landlord agrees to let you stay, the landlord may benefit from the improvements you have made for free.
It also means that the landlord has the upper hand in negotiating the terms of a new lease with you if you decide you wish to stay for longer.
The general principle is that if your business is successful, then you will build up loyal customers who know where you are based and where to come to in order to shop from you. That means you build up goodwill from being in that particular location.
If at the end of the term you are forced to leave then you may lose this goodwill and so you need to be able to try and negotiate a provision in the lease to ensure you have either a lease which has security of tenure (which forces the landlord to grant you a similar lease at the end of the term unless very specific circumstances apply) or even to possibly agree a contractual option which forces the landlord to agree to renew your lease at the end of the term.
Adopting this approach may even have the advantage of a tax saving so it is worth exploring.
- Break Clauses: Once you have negotiated the term of a lease, every SME business owner will want to plan ahead — to have a contingency so if the business does not work so that you are not stuck in a lease which commits you to paying thousands of pounds of rent.
This is where you can negotiate a break clause (also called an option to terminate or option to determine) with the landlord, which allows the tenant to terminate the lease earlier and vacate the premises.
When negotiating the Heads of Terms you should make it clear that your ability to exercise a break clause is not dependent on any other matter. The more elements on which the right to terminate a lease is dependent, the more difficult it will be to exercise. Sometime these extra conditions may have the effect of making the break clause ineffective.
A word of caution in that if you ask for a break clause, the landlord may also ask for a break clause. You should resist this because it is not necessary that if you have a break clause, then the landlord should have one also (especially if you are spending money on the premises to make them fit for your use).
These are just some of the things you may wish to consider but there are many more. The key thing to remember is that by negotiating these terms at the outset, you will save time and money — right from when you start to occupy the premises but even before during the actual legal process of negotiating the lease itself. If all of these elements are agreed early enough then the documents that are prepared by the lawyers will be closer to a form that can be signed reducing time spent in negotiating and saving on legal fees in the process.
Even more importantly perhaps, it demonstrates a commitment to your landlord that you will abide by the agreed terms going forward rather than trying to renegotiate on terms that they thought were agreed half way through the legal process (often many weeks after the Heads of Terms were agreed/signed).
This in itself is really valuable because it creates good faith between you and your landlord which is very important especially considering the length of time your relationship with your landlord will last.
As lawyers for our clients we recognise these facts and always try to be involved as early as possible. We believe that by doing this, we can offer valuable assistance in helping our clients focus on the business on selling — and less in disputes with their landlord!
As such it is and remains extremely important that the Heads of Terms are thought about carefully as early as possible.
Please contact the Trowers’ team for more information. We have also produced a series of fact sheets to help you, so click here to access our online resources.