Business owners are sometimes asked to sign a personal guarantee for their commercial office or industrial lease. There are times when this makes sense. However, there are ways to avoid a personal guarantee for business leases. Below we’ll cover some of these strategies.
For more information on what a personal guarantee is and when it may apply, check out our article “When Should Tenants Sign a Personal Guaranty”.
What Matters to Commercial Landlords
Executing a commercial lease involves some measure of risk for both parties. The specifics of each deal can vary, but landlords are generally concerned with a short list of items.
- Repayment of their upfront costs. These cost may include legal/attorney fees, construction costs to prepare a commercial space for lease, brokerage commissions, and more.
- Securing a long-term tenant that can cover their lease obligation. The landlord is agreeing to deal terms that require the tenant to pay a specific amount of rental costs over a specific period of time. The landlord would like assurances that the tenant will be able to make those payments.
- Strengthening the financial performance of the property. If the property is financed then a lender may have specific requirements to underwrite leases. The stronger the credit of the tenant the more secure are the finances for the property. The landlord desires tenants that can meet the obligations of the lease and strengthen the financial performance of the property.
Let’s discuss some ways to avoid a personal guarantee for business leases.
Increase the Security Deposit or Prepaid Rent
Most commercial office and industrial leases involve the tenant making a security deposit. In many cases this deposit will be equal to the last month’s gross rent according to the lease. The landlord will hold this deposit until termination or expiration of the lease, and it will be used to cure events of default by the tenant. One way to avoid a personal guarantee is to offer the landlord a higher security deposit. This provides additional collateral to the landlord upfront. It may be enough to simply offer an additional 1 or 2 month’s security deposit to avoid signing the personal guarantee.
Another approach here is to offer additional prepaid rent. In most commercial office and industrial leases the tenant will cut a check for the first month’s rent immediately upon lease execution. The tenant may be able to avoid signing a personal guarantee by offering a larger amount of prepaid rent. The advantage of prepaid rent from the tenant’s perspective is one of cash flow. Prepaid rent will be applied to the first rent payments owed following any free rent period. This means the tenant will not be tying up cash for the duration of an entire lease. The landlord may prefer a larger security deposit for this reason.
Either way, offering a larger security deposit or prepaid rent deposit shows that the tenant is serious about making the deal and has the financial means to do business.
Lower the Landlord’s Upfront Costs
Another way to avoid a personal guarantee for business leases is to lower the landlord’s upfront costs. As noted above the upfront costs will be a significant factor for the landlord underwriting the deal. If those costs are lower then the deal presents less risk to the landlord. The tenant could offer to pay for some of those costs in exchange for concessions of equal value. Here are some examples of this in practice:
- The tenant may agree to pay for the construction costs for getting the space ready for occupancy
- They could offer to pay some or all of the brokerage commissions
- The tenant may offer to use it’s attorney for drafting the lease to reduce legal fees for the landlord
I’m sure there are other creative ways to cut the upfront costs, but you get the idea. The key here is that the tenant should receive a concession from the landlord of equal value. If the tenant pays construction costs of $50,000 the landlord should offer a reduced rent or additional months of free rent valued at $50,000.
Offer a Letter of Credit
If none of the strategies above will suffice the tenant may consider offering a letter of credit, or “credit letter”. This is essentially a promise from a bank that the borrower will fulfill it’s obligations. In the context of a commercial office or industrial lease this means the tenant will make all it’s rent payments and fulfill all obligations required under the lease. For an expanded definition of a letter of credit, check here. Now, in order for a letter of credit to work, the tenant will need to have some decent assets available for use as collateral. The bank in question will need access to those funds or assets for the entire time the letter of credit is active.
There are times when a tenant will need to sign a personal guarantee. However, it is always good to have strategies available which avoid a personal guarantee for business leases. These can include providing alternative collateral in the form of security deposits and prepaid rent. This can include crafting ways to lower the landlord’s upfront costs of the lease. This may also include involving a bank to issue a letter of credit. It’s all about managing risk for both parties and finding common ground to get the deal done.