The Best Advice I Ever Received
In the month before my AV rental business launched, I spent an hour with a friend of mine who was running a very successful digital marketing agency - I wanted his input on my business plan.
He shared a story with me of how his business had taken on a large office space during a period of expansion. They didn’t need that much space at the time but, based on the past few years, they're expected to continue growing. Plus a big office in a great location looks impressive to potential clients. Right?
The problem was, that the growth didn’t continue. The business was spending huge amounts of money on rent (that could have been invested into growing the business instead), and they couldn’t get out of the lease. If you’re not growing you’re dying and that lease nearly killed their business.
He cautioned me to be careful about taking on more warehouse and office space than we needed. We were only taking on 500sqft at the time (about the size of a very large garage) but I evaluated that decision carefully.
Over the years I remembered his advice. We never took on significantly more space than we needed at the time. After all, it’s much easier to go to a landlord and say “Please can we break our current lease early to pay you more money for a larger space?” than it is to say “We can’t afford our rent this month”. We broke a lease early to move to a larger space in this way a number of times over the years.
But the decision around how much space you need isn’t always easy and my team were often frustrated that I wouldn’t agree to take on more space faster. We always waited until our current premises were at absolute capacity before we moved. Often this resulted in a re-arrangement of the layout of the current space which meant we could continue in our current space (relatively) comfortably, without increasing our overheads unnecessarily. At other times, it reduced the efficiency of the warehouse team because we were really at capacity. It’s a fine balance, but I was (perhaps overly) cautious because leases are a major liability.
When you are negotiating a lease for your business premises you don’t have to take the first offer that the landlord presents. Typically they will be trying to tie you into a lease for as long as possible (typically between 5 and 10 years). Usually there will be annual rent increases.
For some businesses that have large fit-out costs, where they are not likely to need to move to a larger space in the future as a result of business expansion, or where location is a vital part of the business (e.g. a shop or restaurant), this can be ideal.
But for SMEs who are looking for office or warehouse space, things can change fast. There can be periods of growth, there can be periods of cutting back, there can be a complete change in the business strategy that means different premises are required.
Break Points - Your Get Out of Jail Free Card
The first thing you can do is to negotiate down the length of the lease. But if this isn’t possible (or you think you might want to stay at the same premises for a long time) you might consider negotiating one or more ‘break points’ into your lease.
A break point gives you an opportunity to break the lease early, and usually for some kind of fee which tends to vary between 2 and 6 months’ rent.
I successfully negotiated 6 year leases with breaks every other year, or every year after the first three years of the term. We used them on two out of the three leases we signed.
Service Charges - The Hidden Cost They Forgot To Mention
When comparing premises you will often see the price quoted per square ft. Be careful. This may just be the rent. There is likely to be a service charge on top of this.
The service charge (in theory) covers things like site maintenance, site security, site electricity, site fire systems, site safety, insurance, and so on. And the service charge can be as much as the rent in some cases.
Service charges can also be increased. Ensure you understand how any future increases will be determined before you sign a lease.
So when you are considering how much you can afford, and comparing premises, make sure you ask about the service charge!
It’s not all about the quoted price per square foot. Rent will typically increase each year although I managed to negotiate periods of up to three years without rent increases.
Remember that rent increases are compound. So if the contract says your rent will go up by 5% per annum, with a starting rent of £10 per square foot, your rent payments would look like this:
Year 1: £10,000
Year 2: £10,000 x 105% = £10,500 (increase of £500)
Year 3: £10,500 x 105% = £11,020 (increase of £520)
Rent Free Periods
Rent-free periods are designed to give you some time to fit out your new premises before you start paying rent. For shorter leases on smaller premises, you can usually negotiate between 1 and 6 months rent free or at 50% rent. If the premises are in poor condition and you will be doing a significant amount of work, you may be able to negotiate a more preferential rent-free period.
The good news is, if you can do your fit out faster than your rent-free period, then you are effectively just getting discounted rent!
Remember to ask about the likelihood of negotiating a rent free period when you are comparing premises as it can make a significant difference to your overall cost.
Dilapidation (you'll hear these referred to as 'dilaps') refer to the things that you need to do at the end of the lease in order to return the premises to the state in which you found them. Often, the lease will include a number of requirements including things like a requirement to repaint the premises in specific colours at the end of your lease, or to remove any changes that you have made to the premises.
You should agree, in advance of making any changes to the premises, which changes would need to be reversed or whether the landlord is happy that you are upgrading their premises at your own expense. Things that you consider to be an upgrade, may not be considered an upgrade from your landlord’s perspective.
For example, I know someone who upgraded a 20 year-old kitchen that was falling apart to a brand new one during their tenure. They were required to keep the old kitchen, strip out the new one, and put the old one back in at the end of their lease. This is pretty extreme but shows that it pays to be careful.
I have been offered leases that required us to paint the inside of the premises every two years. Be aware of clauses like this that could add significant unnecessary expense and hassle. If you chose to break these terms because the landlord does’t enforce them, it could have a knock on effect. For example, your break clause may only be valid if no other terms of the lease have been broken.
Consent to let
If your business requirements change or you can no longer afford your premises a good option may be to let some or all of the premises to another business. However, many leases include a clause that prohibits this. Other leases prohibit it without the consent of the landlord. The advice I received was that it was OK for the lease to say that landlord’s consent was required but that this should be followed with the phrase “such consent not to be unreasonably withheld”.
This was a massive sticking point on one lease that we were about to sign - the landlord would not include a clause that wold allow us to sublet (even with their consent) and resulted in us turning down the deal and selecting slightly more expensive premises.
Remember, Your Customers (Probably) Don't Care (Much)
Your customers probably don’t care about your premises as much as you think they do. OK, if you are a hotel they probably do care. But for many businesses, customers will rarely see your premises and are more worried about the quality of service you offer. If you can offer a better service at a better price because you are not forking out for unnecessary rent, your customers will likely be happier.
So, above everything else, pick something you can really afford and that works well for your team.