Due diligence is all important when you are taking on and finishing up a commercial lease.
You have found a business to buy that matches your skills and passion. You have done your due diligence involving your accountant, solicitors, valued colleagues and family to take the leap. You have negotiated the purchase price, got your head around the most suitable tax structure for your entity and have some great ideas that will imrove the bottom line.
But another challenge looms which at the beginning seemed incidental – the lease transfer of the premises. It seems uncomplicated: meet the landlord; exchange pleasantries; talk yourself up and they endorse the lease transfer by signing the assignment of lease. But beware…you might have glossed over the “make good” clause condition on the commercial lease.
So, what’s this clause about? And wherein lies the challenge?
The “make good” clause
In broad the “Make Good” clause is somewhat vague and can mean many things to different people. Chances are you are buying a reasonable amount of plant and equipment in the established business. Make good means return the building as you found it. Hardly complicated? But herein lies the challenge that may not be the case when you take over a lease that is some years into its term or options. The vendor of the enterprise you’re buying may have upgraded aspects of the commercial space to customise the environment to their unique wants and needs. They may have installed any number of specific plant and equipment. All of which makes perfect sense until you ask yourself, “How do I make this good?”
Your next steps
Put your problem-solving cap on and ask yourself a few questions. What did the commercial space look like before it became the entity under consideration? What does the landlord expect if the vendor was to vacate as distinct from sell?
“List every item in detail and create a ‘make good’ provision in your accounting entries.”
These types of questions are essential to establish a base line, especially given you don’t have the benefit of having been there at the commencement of the original lease. How are you going to challenge any “make good” claims when you vacate and move to a larger commercial setting because you are going to hit this enterprise’s potential out of the park? What if it does not play out the way you want and you decide not to renew the lease and cut your losses?
The reality is that a landlord may want to take the last of any capital you do or don’t have to spend on “make good” repairs or removal you were not aware you had signed up for. If your enterprise goes well it may be easier to put such the extra cost down to experience, but if things do not work out with the business it could cost you your family home!
Establish very clearly what you actually are buying. Understand and go through the enterprise’s plant and equipment thoroughly, ask questions, understand the answers and make sure every item is documented from the vendor. You have a depreciation schedule and any item on the depreciation schedule you own, right? Yes, but in reality you might end up donating this to your landlord rather than paying to remove and make good the damage caused by your fit out.
A case in point
A reverse cycle air-conditioner has been very important in your café every 40-degree day but now that you’re moving on it has been depreciated down on the asset register to a third of its initial purchase price. The installation cost was not documented so it’s awkward to get back the labour to install it, so it owes the business and after some research it becomes obvious the unit has a second-hand market value of less than half that. The remaining problem is you have to get it off the roof. So, you find someone who’ll do the job for a not insignificant cost. After two other potential service providers fail to show up to quote, you somewhat reluctantly except the initial quote as fair market value.
So, the air-conditioner unit is off the roof… and you’re left with a hole in it! Tempted as you might be to question the service provider over why this “little detail” wasn’t alluded to in their quote, you’re faced with a somewhat urgent repair, together with said repair’s urgent cost because the blue sky is becoming darker by the moment.
Welcome to the pointy end of commerce – all this has cost you a lot more time and effort than just walking away from the air-conditioner as a donation to your landlord!
And what about the gutters? You’re taking on a new premises which has blocked, rusted gutters – the landlord pushes the responsibility back on the previous leasee as they failed to get the gutters cleaned each year, which is not wear and tear, rather it is neglect and, therefore, most likely not the landlord’s problem.
So, you might ask for those you’re taking over the lease from for some compensation from the purchase price for repairs. Hmmm…something to ponder. But what if the gutters were rusty at the commencement of their original lease? You wouldn’t know because you weren’t party to the original lease, but the original leasee had the building inspected and documented the rust. They have the knowledge and proof…you may not when vacate time comes. You’re stuck in a vicious circle.
Forewarned is forearmed
In short, establish what you are buying and what it would cost to take it with you. List every item in detail and create a “make good” provision in your accounting entries. Importantly, get professional advice on these matters from your accountant and solicitor. Don’t wait until the time comes to vacate to try and budget for vacating – clearly establish before you take over the premises what will have to stay and what will need to go, and work out what removing those things that will go will cost you.
Talk to your landlord and the vendor and ideally come up with an uncomplicated written agreement that leaves no-one in any doubt what “make good” looks like before assignment of lease so it becomes part and parcel of that agreement.
Establish a baseline in terms of what the property will look like on the vacate date. Use technology – take photos, shoot videos, make lists on paper. Do whatever it takes so it is absolutely clear you and your future landlord know what is involved in the make good.
Ensure any repairs needed at the point of lease transfer are done prior to assignment by the vendor, and agree on these with the landlord in advance, otherwise you might end up picking up the cost when all the fun is over. Negotiate with the vendor a dollar discount on the purchase price for repairs that may not be pressing, but that will impact on the make good clause downstream.
Buyer Beware! Good Luck. This could be the making or breaking of you. Welcome to the unforgiving world of small business.
Disclaimer: Readers should check with their own legal counsel and accountant before entering any commercial lease agreements, the writer does not warrant nor guarantee the content of this article.
Graeme Sedgwick, marketing communications specialist and author of Engage to Create Your Future
This story first appeared in issue 28 of the Inside Small Business quarterly magazine