[New Biz] The Office Lease: Practical Considerations

I signed the commercial lease for the office space. I'm no Real Estate lawyer, so I'm not going to get into any of the nuances of lease negotiation or legal terms.

Of course you know that if you plan to rent office or retail space for your business, make sure you have a Real Estate lawyer take a careful look at the lease (duh). More importantly, make sure the person reviewing the lease is familiar with the local laws, rules and practices in your specific area. So for example, if you use a law firm in Manhattan but are renting office space in a satellite office in Rochester, hire a firm in Rochester to negotiate your lease.

I had a lawyer-colleague review the lease and it cost me less than $2,000. This is someone with big-NYC-firm experience who has her own solo practice now. I've heard lease reviews and negotiations costing $10,000+ as well. It depends what you are leasing and the law firm you hire.

In addition to the obvious things like price per square foot and term, here are some key business items that were important to me:

• Option to Renew. I was getting a 10-year lease. However, if I end up selling my business, it will be far more valuable to the buyer if there is an option to renew the space. If the commercial real estate market is hot when the lease expires, the landlord could ask the business to leave after the lease expires. If suitable space is not available, there's no business. The option buys the business another 5 years.
• Landlord's Obligation to Pay Build-out Expenses. The landlord is paying for the build-out (well, actually, I'm paying for the build-out over time, he's fronting the cash). I needed to make sure everything I needed him to do (and pay for) was in the lease. There's no renegotiating after the lease is signed.
  
• Limited personal guaranty. My landlord won't rent without a personal guaranty unless he gets six months security deposit. Not exactly the best use of cash. That being said, what I guaranteed was that I would (personally) pay the rent if the business stopped paying the rent and didn't vacate the premises under the "Good Guy Clause".
• Good Guy Clause. Without getting technical, it's a clause in your lease that lets you surrender the space without further liability to the landlord if you are unable to continue to pay for it. The Good Guy Clause was important to me because, in an economic downturn, it could mean the difference between downscaling and survival or shutting the business down and bankruptcy.
  
• Relocation Rights. If we grow rapidly and need more space, our lease permits us to relocate a smaller tenant to a similar space in the building at our own expense. Of course, this right is usually reciprocal. Another tenant bigger than us may like our view better!
  
• Assignment Rights. Again, if the business is sold, I don't want hassles with the landlord about lease assignments to the buyer. I have a good relationship with the management company and they are very flexible. But buildings get sold and you're always just end up stuck with your lease terms. I couldn't negotiate assignment without the landlord's consent (no sane landlord would permit this), but I got terms that won't hold up a deal if I find a buyer.

This isn't an exhaustive list of every line item that was negotiated, but it's a good start of things to look out for.

One more thing--and this was a surprise to me when I signed my first commercial lease--when you rent commercial space, you rent bricks and glass. Literally. When your landlord calculates the square footage of your space, they measure from the outside of the building not from the interior wall, plus, you pay for your space's pro rata share of common spaces, like the lobby, corridors, restrooms, elevators, mechanical rooms, etc. The percentage of the space that you are renting that is not the physical space in your office is called the "loss rate". The loss rate in my building is around 33%, I've heard about some buildings where the loss rate is 65%.

Urban legend or not, as I told my landlord when I signed the lease, the commercial real estate game is a nice business if you have the cash to get started.

[New Biz] "Incorporating" an Opportunity

So, I have a term sheet from the landlord, and things with the project are progressing rapidly. For a number of reasons, I need to start thinking about organizing a corporate entity for this business. This is one of the most basic things I counsel my start-up clients through--picking the right corporate entity for your business.

Clearly, this is not going to be a sole proprietorship because there is too much risk of getting sued and I do not want to be on the hook personally. For starters, I need to do business with a large number of vendors, I am going to be subletting office space to a large number of subtenants/licensees, I will eventually have employees, and there will be visitors coming into the space who could get injured.

But even more importantly, one of my goals with this business to build it with the intention that it can be sold down the road (even if I never do). I also may want to raise capital privately to grow the business down the road. Both would be tough to do this as a sole proprietorship.

That leaves me with two options: LLC or Corporation. The business is going to be operating in New York. As a LLC start up attorney, I know that even if I organize in a different state (i.e., Delaware or Nevada), I will need to qualify the organization in New York. Because New York requires LLCs to publish the formation of the LLC in a local and regional newspaper (which will run me about $1,600), I'm going to save my money and form a corporation. Perhaps if I had a partner on this project, I would have considered a LLC more carefully because of the flexibility in managing a LLC. But since it's just going to be me for now, I can get the same "flow through" taxation benefits through a corporation by making a S-corp tax election, and filing it with the IRS and the state.

Since I am only issuing shares to me, and not planning on taking on equity investors, when I formed the corporation, I just authorized a minimal number of shares of common stock at a small par value ($.001).

The state has a new online fill-in form to organize a business, but after looking at the form more carefully, I didn't really like it, especially since you couldn't choose a par value (can only select no par value stock). It was a little tricky to find and use as well.

By the way, when I filed my Certificate of Incorporation with the Secretary of State via fax, I requested 24-hour expedited service. If you get your documents in before 2PM, you will have your documents back the next day. If you do not elect to use this service, it can take 10 to 15 business days to process. The extra cost was $25--money well spent. FYI, you can also pay for same-day ($75) and two-hour expedited service ($150).

I filed, and got my response the next day. LFIS, Inc. is officially organized.

I applied for a tax identification number with the IRS, and made my S-corp small business tax elections with the state and federal government. I put together a quick set of bylaws, initial board minutes and stock certificates to make sure I have my "corporate formalities" covered, and I'm good to go!

[New Biz] Ready, Fire, Aim!

I was previously talking about preparing financial models.

One note, while some of my clients are reluctant to do financial models prior to getting started, I have a number of clients who obsess about it so much, they never get started because they spend all their time getting the financials perfect.

My friend and marketing consultant, Travis Greenlee, uses the expression all the time "Ready, Fire, Aim". Basically, get comfortable, then take action, then adjust along the way.

As a lawyer, I'm in the perfection business (I get sued personally if the advice I give to a client is not 100% correct). "Ready, Fire, Aim" is a difficult concept for me to practice, but, when I do anything outside the actual practice of law, I've learned to do it (I got the term sheet on the new office space from the landlord), and so can you!

By the way, if you don't know where to start when creating a financial model, or your are such a financial champ that you need permission from someone else to take some action (I know, I get like this too), get in touch with my friend Rosalind Resnick of Axxess Business Consulting. Rosalind is "the real deal". She is a true entrepreneur and an Internet pioneer. She started, built and IPO'd her company, then sold it for a very large sum (she can tell you about it) to a competitor.

She now helps entrepreneurs build their businesses simply because she loves doing it. There are a lot of hacks out there who claim to be able to write busienss plans and prepare financial models. If you're serious about your business, talk to Rosalind before going anywhere else.

[New Biz] Will it Work? Creating a Financial Model

It's not exactly a legal concept, but one of the things I try to get my start-up clients to do before starting their business is to put together a very clear financial road map before doing anything. You would be surprised at how many people skip this critical step.

I should also add that this is not a completely new business concept for me. I am presently a partner in a company that holds the lease where my office is currently located. That business is run more like an "expense co-op", not a for-profit business. But nevertheless, I created the operations and financial systems we use to run the office suite, I played an integral role in the build-out and marketing the space, and I am intimately familiar with the economics of subletting office space. This new concept is just an extension of what I am doing already, which is also a "best business practice":

Make sure you have some experience in what you are trying to do, and actually enjoy doing it before starting the business.

Space was available in my office building, but empty space, even downtown, was going fast. I needed to move quickly if I wanted the best, and most affordable space. For strategic reasons, I specifically wanted the identical space I have already, just on the floor below where my office is now. There was no time to put together a formal business plan, but I needed to get clear around the numbers to see if the idea would work before committing to renting a space for 5-figures a month.

I got a quote from the Super in the building on the range of current rent rates in the building and learned that rents for the same amount of space I presently lease have increased by 40% in two years.

I had my bookkeeper run all the expense numbers for the previous two years in my existing space. I then I went back to my records to see what the build-out costs were, making adjustments for things I would do differently.

Then, I added in a factor for advertising (we didn't advertise to fill our current space), 15% inflation from the old numbers and a 20% fudge factor on the build-out expenses. In terms of revenues, I ran a worst, middle and best-case scenario and determined my break even point for each scenario based on my experience renting offices in my current space, and what other people were offering for similar spaces.

Running a simple spreadsheet, I learned that I needed to rent between 50% and 60% of the offices to break even. Anything over that, including "add-on" services and non-rent sources of revenue were extra profit.

From experience, I know that once an office is rented, for a number of reasons, professionals are reluctant to move. So even if renting the offices takes me longer than expected and I ran at a loss for a short period of time, I could make up the difference over the life of the lease time because it was unlikely to have more than a 10% vacancy rate at any one time.

The only unknown was marketing this value-add system I plan to create, and whether there was a demand for it. Basically, I did some preliminary market research and talked to some lawyer buddies and networking contacts to see their reaction. Nearly all were enthusiastic about the concept, but reluctant about the overall risk in taking on the project (which I expected because lawyers, who spend the majority of time getting paid to spot and minimize risk for clients, are often terrified of taking any risk themselves).

So my financial model, while clearly not perfect, demonstrated to me that there was a high probability to generate a good profit from the model, and while there was some up front risk, most importantly that I would have to fill 60% of the space in 90 days, over time, it was going to be easy to recoup any start-up losses, and that if I wanted to grow the business by taking on more space, most of my start up investment in equipment could be leveraged, thus increasing overall profit margins (to a point).

My analysis got me comfortable enough with the number to the point where I was willing to invest my own money on the concept. My next call was to the landlord to start negotiating a lease.

[New Biz] Capitalizing on a Market Inefficiency

The Big Idea:

Without giving away all of my secrets, basically, I found an inefficiency in the marketplace relating to the commercial office space that was available to solo and small firm lawyers.

My law practice is currently located in a great and affordable space in the financial district of Manhattan. However, I was recently looking to sublet office space closer to Grand Central to try to minimize my commute. As you may know, commercial rents have sky-rocketed in New York, and they have grown at a much faster pace in Midtown as compared to other areas of Manhattan.

The sublet spaces I saw that were (marginally) affordable, were horrible, and the nice spaces were completely out of reach. So much so that, for the same price it was going to cost me to move my office to Midtown, I calculated that I could lease a very nice car and pay for a driver to take me directly to my downtown office every day. No joke.

I figured that I can't be the only lawyer in New York experiencing this problem. So instead of moving to Midtown, I decided to rent another 5,000sf to run a lawyers only professional office suite in the downtown office building where my office is presently located.

And while I am clearly not the first person to come up with this idea, what I plan to do is to put systems in place to resolve many of the common frustrations solo and small firm lawyers have with marketing, practice development and small firm economics. Instead of just selling a commodity (office space), I will be selling the value-add of community, support and activities that will help solo and small firm lawyers be more successful.

I'll expand more about the business model later on.

[New Biz] Cobbler With Holes In His Shoes?

It's fairly common among entrepreneurs, especially for those in a service business, that the work you perform for your clients, you tend to slack-off on when it comes to yourself.

For example, I have a friend who is a very prominent and trustworthy CPA, and she doesn't pay her own bills on time or balance her personal checking account.

Well, this month, I started [another] new business, and when it comes to making sure that the legal foundation of the business is sound (like I preach to my clients), I don't want to be the "cobbler walking around with holes in his shoes."

So what I thought would be a great idea was to give you some perspective about running the legal side of a start-up business from the perspective of a business lawyer! (Frankly, it's also a way to force me to "keep it straight" when it comes to getting the legal stuff right for this new business.)

The line of posts relating to this business will have "[New Biz]" in the subject line.

In the next few posts I will be talking more about the concept, incorporating, taking on partners, raising investment capital, signing a commercial lease and vendor contracts.