You Should Hire a Restaurant Real Estate Broker

We work with lots of clients who are thinking about opening their first restaurant, or who are in expansion mode. When I get one of these calls, among my first questions is “are you working with a broker?” If not, I always try to encourage them to call one of the many experienced restaurant real estate brokers that I work with. Why? It’s simple:

They Don’t Cost Anything. If you work with a restaurant real estate broker as a tenant, you don’t pay a dime. Your broker can pound the pavement and work the phones looking for available space and, if you find a good space, negotiate the business terms of the lease and shepherd the process through to signing. And, if it all works out, the landlord pays his commission. So you – quite literally – have nothing to lose.

They Know the Market. Unlike buying a house – where sale prices, along with detailed photos and precise locations, are readily available – renting commercial restaurant space can be an opaque, mysterious process. Price per square foot can vary dramatically from place to place, and landlords are often willing to give concessions (such as tenant improvement money or months of free rent) depending on the circumstances.  If you don’t know the market, you won’t know what to ask for. And you can leave a lot on the table.

They Know the Landlords. As we’ve written here before, who your landlord is can make all the difference in the world. There is no single greater relationship that will determine your success. And landlords, like people, run the gamut. Some are accommodating and forgiving. Some are tough but fair. And some are unrelenting and unforgiving. When you are signing a ten-year restaurant lease, you want to know which one you are dealing with, don’t you?

They Know the Restaurant Business. A caveat here: a good broker should know the business. And this is where you need to do a bit of due diligence. You wouldn’t hire a podiatrist to fill one of your cavities, right? You wouldn’t hire an electrician to fix your toilet.  By the same token, don’t hire someone who is used to filling office space for lawyers or accountants or dentists to find your next restaurant space. If you hire someone who knows the restaurant business, they can tell you the dead spots in a shopping center, and if the space you are looking at is one of them. They can tell you if the kitchen is suitable to your needs. They can tell you whether the demographics of where you are looking work for your concept, or if there is a lot of competition in the immediate vicinity. And if they are not sure of any legal issues (like can I get a liquor license for this location), they know enough to call a restaurant lawyer like us to make sure all questions are answered.  In short, only a broker who knows your business can make sure the terms of your deal are consistent with the needs of your business.

We work with experienced restaurant real estate brokers every day. When we get a restaurant lease from them, we know that the business basics will be covered – just as they know when they get the lease back from us, the legal terms will be airtight. We act as a team to make sure you get the best restaurant lease possible, and thereby have the best chance to succeed in your business.  If you need a referral to a good restaurant real estate broker, just give us a call. It’s one of the biggest decisions you can make to get your restaurant business off on the right foot, and we’d love to help make sure that the decision you make is a good one.

Limiting the Personal Guaranty in Your Restaurant Lease

If you are getting ready to sign a restaurant lease, you are almost certainly being asked to provide the name of someone who will provide a personal guaranty of payment on the lease.  This person, whether it be you yourself, or someone with whom you are associated, will be personally on the hook if the tenant (usually an LLC or some other corporate entity) itself does not pay.  The reason the landlord requires this is because, unless the tenant is a big corporation with a lot of assets separate and apart from this restaurant (and, regardless, we usually advise our clients to set up new entities for every location they open), a personal guaranty is the only way the landlord can have some assurance that you won’t simply walk away from your restaurant (and the lease) if business gets bad.  The landlord wants someone on the hook.

Many restaurant tenants do not realize that they do not have to agree to a full guaranty – i.e., one that will make them liable for all payments due under the lease, for the full term, if there is a default.  On the contrary, landlords will often agree to limit the personal guaranty on on the lease, and thereby limit the personal liability that can result if your restaurant does not succeed.  The two most common forms these limits take are a cap on liability, and a “burn off” provision.  Most common is some combination of the two.

A liability cap means that the guarantor’s liability is capped at some dollar amount or, more commonly, some number of months’ rent due under the lease.  For example, the guaranty could provide that, in the event of default, the landlord’s maximum recovery against the guarantor be (let’s say) 24 months of rent.  This would be true even if it takes the landlord much longer to find a new tenant or incurs significant expenses in securing such a tenant (such as in brokerage fees, rehabbing the space, or in concessions to the new tenant).  One can imagine such a cap being particularly valuable if a restaurant fails early in a long-term (e.g. 10-year) lease.

burn off provision means just that, that the lease guaranty will “burn off” at some point, provided the tenant has met all other requirements under the lease.  For example, a restaurant lease guaranty could provide that, after five years of on time payments by the tenant, the guarantor would have no further liability and the guaranty itself would terminated.

Again, most common is a combination between these two liability limitations.  In one formulation we negotiate for our clients quite often, the liability will be at some amount during the initial years of the lease, then burn off, or “burn down,” as time goes on: perhaps from a full guaranty to 24 months after some number years of on time payments; then from 24 down to 12; and then maybe eliminated altogether.  In this way, a tenant is incentivized to keep paying rent on time (especially early in the lease, when the liability is the greatest), and rewarded for being a good tenant later in the lease.

Of course the specifics of what a landlord will agree to will depend on the financial viability and business history of the tenant, but this all where an experienced restaurant leasing attorney (or restaurant real estate broker) can be immensely helpful.  The limits your lawyer or broker can negotiate for you can make the difference between bankruptcy, and being able to pick your self up and give it another try some time the future.

New Restaurant Location? Strongly Consider a New LLC.

I often say that opening a restaurant is like becoming a parent.  It keeps you up late at night, it occupies most of your time and attention, it makes you worry whenever you leave it with someone else…. But like parenthood, restaurant ownership can also get easier over time. And, when it does, you may actually start thinking, “hey, I’m beginning to get the hang of this.” If you are lucky enough for that to happen to you, you may also think like the parents of a moderately behaved toddler – “maybe it’s time to think about number 2.”

That decision (as related to restaurants, at least for these purposes) is fraught with many more issues than I could ever cover in one blog post.   So I will allow this post to cover only one such issue – whether you need to create a new entity for the new location. My answer, in almost all instances, is a resounding “Yes.”

The main reason is this: you will need to sign a new lease for your new location. And, with that new lease, comes another set of significant obligations and financial liabilities. If you don’t create a new entity, not only will your new restaurant be responsible for those liabilities, so will your first one. That is to say, if the new restaurant flops and goes out of business, but the first one is continuing to do well, failure to form a new entity can allow the Landlord for location Number 2 can go after the bank accounts and assets of location number 1. In short, Number 2’s debts can bring down Number 1 along with it.

If you create a new entity, however – call it McSwiggen’s Ale House Number 2, LLC – only the assets of that entity will be available to satisfy any liability under that Lease. The assets of McSwiggen’s Number 1 LLC will be protected by laws of limited liability (that’s what the two L’s in LLC stand for, after all). Yes, of course, you personally may be on the hook for any personal guaranty on Number 2’s lease, but the first restaurant – the one that was doing so well that it caused you to think about Number 2 in the first place – will still have the chance to live to fight another day.

To use a different analogy from the one I started with, you can build your restaurant business like an apartment building or a suburban subdivision. And if you think of your restaurants like that, think of financial difficulty like a fire. If you use the same LLC entity for each new location, financial difficulty in one will threaten to bring down them all, just like a fire in that apartment building. But LLC laws allow you to treat your restaurants like suburban homes on a cul de sac. They may all look the same, and be constructed the same, but they all stand on their own. And, while a fire in one will not be welcome to the neighbors, they’ll all still have some place to sleep that night.

Getting good advice and doing things right the first time will help you sleep at night too.  Before you open your second location, consult with an experienced restaurant lawyer to make sure you do all you can to protect the first.

 

Tough Market Makes a Good Restaurant Lease More Important than Ever

2017 has not been the easiest year for restaurants, particularly for sit down casual dining restaurants. Reports of store closures, missed earnings, and abandoned concepts have been a common occurrence this spring, as restaurants have tried to recover from its worst year since the recession. Even fast casual chains, which had been thought to be insulated from many of the challenges of the larger restaurant sector, have felt the pinch.

In recognition of this broad trend, we have been advising our clients that it has never been more important to focus like a laser on your lease, and not sign one you don’t fully understand and feel comfortable with.  First of all, restaurant owners need to make sure that the rent is affordable. As concepts proliferate (many of which are backed with investment dollars), rents have escalated in many markets. While a location may be attractive, if you cannot collect revenues of approximately 10 times your monthly rent, you are probably paying too much. When you are scouting space, be sure to keep this closely in mind. Second, as it relates to your lease terms themselves, you should be sure to focus (and push back hard) on key provisions such as:

  • Assignment rights. If you ever want to sell your restaurant, or just get out of a concept that is not working, you will need to be able to assign your lease to someone else. Make sure your lease provides for the ability to do that.
  • Guaranty limitation. You will almost certainly be personally liable for any damages to your landlord if you breach your lease. There are ways to cap that liability, however, and limit any damage to yourself personally if you have to close or walk away.
  • Default provisions and remedies. Can your landlord kick you out if you are a few days late with your rent? Do you have any opportunity to cure the default if you are late? Many leases have very strict default provisions. You can soften those to allow you to recover if you hit a rough patch.
  • Exclusivity provisions.  Competition is tough in the restaurant business, but if you can, you should keep any direct competition out of your backyard.

Certainly rents are going up and there is a lot of competition for restaurant space, but the spate of restaurant closures, as well as softness in the broader retail market (as Amazon and other online retailers force closures in that sector), can present opportunities to negotiate. And, you can negotiate.  Too many restaurant owners simply sign the lease they are provided, thinking they have no choice.  You do — especially now.

If you know what questions to ask, and what pitfalls to avoid, at the time you are looking as space and signing a lease, there is no reason your restaurant can’t be among the success stories.

Can My Landlord Lease to One of My Competitors?

GARY T. MILLS/The Times-Union -- Jan. 2012 -- Quiznos Sub recently closed at 7159 Philips Highway.

(GARY T. MILLS/The Times-Union — Jan. 2012)

My family and I had dinner this past weekend at the newest location of a locally-based fast casual restaurant chain.  It had a line nearly out the door and every table was full.  After dinner we noticed that, in the same shopping center, was an existing restaurant serving the exact same type of food.  It was nearly empty.  And I have to figure it will not long survive.

Competition can be brutal in the restaurant business, of course.  And no one can — or should — expect to be protected from competition entirely.  Competition is, after all, necessary.  And it is even desirable in many ways.  It drives innovation and fosters outstanding customer service.  If you can’t stand competition, go find another business to get involved in.

But should restaurant owners be able to expect their landlords to give them some protection?  Or at least not undermine them directly by bringing a competitor into their same shopping center?  The answer is: not necessarily.

I wrote a while back about the need to seek exclusivity provisions when negotiating restaurant leases, and for those provisions to have teeth.  Your landlord is not your partner, and not your protector.  The only way your landlord will keep your competitors out of your shopping center is if it is financially harmful for them to do so.  And those provisions have to be included and negotiated at the time the lease is being signed.

I don’t know what this smaller, older restaurant’s lease said about exclusivity – or if it said anything at all.  But I do know that if it did say anything, it was not strong enough for this landlord to hesitate in bringing in a shiny, new, well-financed competitor.  And because of that, the smaller competitor is probably going to go out of business.

A Hidden Danger in Lease Assignments and Restaurant Sales

hidden-danger-remodelingWe have written here before about important things to consider when purchasing a restaurant, and we have also written about exclusivity provisions in restaurant leases. A recent deal we were working on, however, has highlighted how those two topics work together – and demonstrated a hidden danger for restaurant purchasers that can be hidden in restaurant leases.

As part of our legal assistance of any restaurant purchaser one of the most important things that we do is review the existing lease that will be assigned to the buyer. The quality of the restaurant’s lease, after all, bears an outsized relationship to whether the restaurant succeeds, and how bad things can be for the owner if it does not. Understanding the lease you are inheriting in a restaurant purchase is therefore critical.

In this case, our client was purchasing a restaurant that specialized in a specific type of food – for the purposes of this discussion, let’s say it was a Korean restaurant. We were therefore initially pleased to see that the lease contained an exclusivity provision whereby the landlord was restricted from leasing space in the shopping center to any other restaurant that sold Korean food. That initial pleasure wore off, however, when we noted two other provisions: first, that the tenant would lose that right of exclusivity upon any event of default; and second (and of particular importance in our case), the exclusivity would not survive assignment of the lease. We were able to quickly confirm and get assurance (supported by the appropriate documents of course) that there had been no prior defaults, but we still had to address the assignment issue or our client would be buying a Korean restaurant, but would be taking over without a built-in advantage that the current owner enjoyed.

Thankfully, in this case, the landlord agreed – as part of the assignment – to extend the same exclusivity provisions to the buyer that it did to the seller. It should provide a cautionary tale, however, on the importance of a detailed lease review by a knowledgeable attorney. Had we not reviewed the lease, and paid attention to this provision, our client would have been exposed and vulnerable were this landlord (or a subsequent landlord) to later decide to lease space in the shopping center to another Korean restaurant — perhaps a national chain or hot new fast casual place. Maybe it would never have happened, but when you are investing in the purchase of a restaurant, especially a particular type of restaurant, there is no reason to take that chance.

In Restaurant Sales, its You and Me and the Landlord Makes Three

img_broken_handshake_540x360When involved in a restaurant transaction, the parties (understandably) spend much time and effort on examining the health of the business and the terms of the deal itself. The buyer will, among other things, study the restaurant’s revenues and operating expenses, any potential liabilities, and the condition of the equipment involved. On the other side, especially if there is seller financing, seller will examine the creditworthiness and financial wherewithal of the buyer, as well as their experience in running such a business. And both sides (of course) will focus great energy on negotiating the purchase price.

Often forgotten in this exchange of information and examination of risks is the landlord. The landlord is a necessary party to almost all restaurant deals, because almost all restaurant leases contain provisions that require the landlord’s consent to the assignment of the lease from the seller to the buyer. If the landlord does not provide that consent, the deal is off – even if the seller and buyer are in complete agreement on all terms.

For this reason, if you are considering listing your restaurant for sale, you should consult with your landlord to determine (or at least get a sense of) the conditions it might place on any such assignment. Is there a restriction on a change of format (e.g. the type of food)? Will the landlord require the new tenant to meet some threshold of financial strength? Determining these factors early on can save you from wasting time with a prospective buyer that has little or no chance of being approved by the landlord. And if you are a prospective buyer, among the first things you should ask the seller is if he has had these conversations with the landlord.  That question may save you from spending time and money (i.e. lawyer’s fees) to negotiate a transaction that will be snuffed out by the landlord down the road.

So the lesson here is that, while it may take two to tango, it often takes three to finalize a restaurant deal.

The Morris Law Firm’s Founder Featured in the Washington Lawyer’s Issue on Restaurant Law

fullsizerenderDemonstrating the critical importance and growing complexity of the legal issues surrounding restaurants, the Washington Lawyer dedicated its September 2016 issue to the intersection of the restaurant business and the law.  The cover story was entitled Behind the Kitchen Door and featured interviews with local restaurateurs, including celebrity chef Mike Isabella, and our founder, Sean Morris.

Among the things Sean was asked about was what the first thing an aspiring restaurateur should do when considering opening a restaurant:

 

Sean Morris, founder of the Morris Law Firm, LLC, in Bethesda, Maryland, and an expert in restaurant law, urges aspiring restaurant entrepreneurs to talk to a real estate broker and a lawyer.  ‘Those two people can enable you to survey the legal landscape and the actual physical landscape of what the local real estate market is,’ Morris says.

Sean was also asked about upcoming changes to DC’s zoning laws as they relate to fast casual restaurants, liquor licensing issues, and the pitfalls of using social media to boost your restaurant’s profile.  The magazine also picked up on Sean’s advice to shore up the four most important legal relationships that you will encounter in your restaurant business and reprinted our blog post of the topic on the DC Bar’s website.

Finally, we were very proud to have Sean featured in the magazine’s Member Spotlight for September, which not only included a full page profile, but provided Sean with the opportunity to tell the story of why he was drawn to a practice in restaurant law:

Through college, through graduate school, throughout my pre-law school days, I always worked in restaurants. I washed dishes. I bussed tables. I waited tables. I’ve worked in kitchens. … I came back to this industry because I knew it and because I loved it. It’s an industry where there are a lot of good people working really hard who could use just a little bit of help, particularly from someone who knows their business.

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If you are interested, you can check out the full digital edition of the issue here.

 

The Four Relationships that Can Make or Break Your Restaurant Business

restaurant kitchenThe restaurant business, like almost all businesses, is about relationships. And, of course, the most important one you will have is with your customers. If you don’t preserve that relationship, you won’t have a business for very long. But there are other relationships that must be protected just as jealously, because if any of them sour, they can bring down your business just as quickly as if customers stop coming in the door.

In our experience, these are those four relationships:

1.      With Your Partners (and Investors).

If you go into business with anyone else, that person has control over the success or failure of your business – regardless of whether they have any involvement in its day-to-day operations. If your restaurant is struggling, will your partners and investors have the patience to allow the plan to work, or will they want to bail out at the first sign of trouble? And, if they do bail out, can they pull their money out and leave you with all the responsibilities and liabilities? Alternatively, if the business is doing well, will they insist that the profits be paid out in distributions to the partners, or will you have the ability to put that money back into the business to enable it to grow and thrive? And, regardless of whether you are succeeding or failing, how will decisions be made about how the restaurant is managed? What if there is a deadlock – can a decision be made at all?

These are all questions that must be answered well before you open your doors – and well before the first sign of discord. That is why we advocate that preparing a written operating agreement should be among the very first things you do when you embark on your restaurant business. If you are in agreement on all these things – great, finalizing the agreement should be easy. But if you’re not, it’s better to find out sooner rather than later.

2.      With Your Landlord.

Perhaps no single person (or entity) has more control over the future of your restaurant business than your landlord. A tough-nosed landlord can stick you in default over the slightest deviation from the strict terms of your lease, whereas a more lenient and accommodating landlord can work with you through rough patches and allow your restaurant the time it needs to get up and running and the room it needs to prosper. So while you need to understand the terms of your lease, you also need to understand who your landlord is – and how they operate – before you sign your lease.

But even a lease with a well-meaning landlord needs to be reviewed thoroughly and completely – every word – because landlords can change, and what today is a small local landlord with a reputation for working with their tenants can tomorrow be an out-of-state investment trust that does not care that you’ve had a few tough months and it always picks up in the Spring. In those cases, your only protection will be your lease. Indeed, the lease you enter into with your landlord is probably the document that will have the greatest impact on the success of your restaurant. For all too many restaurants, whether they succeed or fail is predetermined at the moment the lease is signed. Make sure you not only sign a lease with a good landlord, but that that lease itself is top notch too.

3.      With Your Employees.

As with any service business, a restaurant’s employees are its lifeblood. They are its face to the world and, without them, the food doesn’t get prepped, cooked, plated, or served. Without good employees, even a perfectly formulated restaurant concept will assuredly fail. But taking care of your employees means more than just showing them gratitude, paying them well, and giving them appropriate time off. It also means complying with the letter of the law when it comes to wage and hour and other employment laws.

Federal and state lawmakers, for good reason, have made it a priority to ensure that unscrupulous employers do not take advantage of low wage workers, and the restaurant industry’s heavy reliance on tipped employees makes them a target for government regulation as well as lawsuits from disgruntled employees who may not have been properly paid. To protect themselves, restaurants must keep impeccable employment records and strictly adhere to all employment and wage laws. Take a lesson from those who haven’t, and have paid dearly.

4.      With the Government.

As businesses that prepare food for public consumption, and often serve alcoholic beverages to go along with that food, restaurants are among the most highly regulated small businesses in the country. From food safety permits to liquor licenses, there is almost nothing that restaurants do that does not require government approval or subject it to government oversight. The IRS is also notorious for making restaurants among its favorite audit targets. As with the employment issues highlighted above (which is another area of government oversight and regulation) strong compliance programs are essential. No one is ever going to be perfect, but if you are found to have violated a law, it is better to be able to show it was in spite of your best efforts at compliance, not because of a lack of such efforts.

 

What are Your Options? Negotiable or “Market Rate” Lease Renewal Provisions

timetorenewIn a changing real estate market, especially one with rising commercial property values and rental rates, whether you have a renewal option in your commercial lease and the terms of any such option can be critical. It is highly preferable to have an option provision that specifies the rate of any renewal, e.g. some set percentage over the last year of the initial term. It is not uncommon for a lease to say the renewal will be at “market rate” or something similar, then it will be subject to negotiation and agreement between the Tenant and Landlord, leaving the renewal subject to negotiation and agreement between the Tenant and Landlord.  Of course, when this is the case, it largely turns the renewal “option” into simply an exclusive right to negotiate and takes significant control away from the tenant.

If your lease has a market rate or negotiable option provision, here are a couple of things to keep in mind:

  • First, see if there is any provision in your lease that requires the landlord to give you notice of its proposed renewal terms in advance of the date by which you have to give notice of your intention to renew. If there isn’t any such requirement, still go ahead and request that the landlord let you know as much in advance as possible what renewal rate it will be requesting. That will give you a little more time to negotiate with the landlord, or will give you a heads up that the landlord may be looking for much more than you are willing to spend. If you will need to move at the end of your lease, having that bit of extra time may be invaluable.
  • Second, understand that you really have two deadlines: the actual end of the lease, and the date after which it will be impossible for you to find new space and have it ready to move into if you can’t work out a deal with the landlord on your renewal. Is that 6 months before the end of the lease? 9 months? More? You need to have a good sense of this, because if you let that deadline pass, you may be stuck taking whatever deal the landlord is offering because you don’t have anyplace else to go. With restaurant leases this timing factor is critically important because the permitting and buildout requirements of new restaurant space will require much more lead time before any move.
  • Finally, pay close attention to your lease’s holdover provisions. Almost all commercial leases I see in my practice contain drastic rent increase provisions if you stay in the space beyond the end of your lease, with it being common for rent for any holdover period to be 200% the last year of the initial term.  If that is the case in your lease, you must make sure, if you cannot negotiate the renewal term, that you are ready to move when the initial term of the lease is up.

Of course, many of these terms are subject to negotiation at the time you sign your lease and that is the best time to address them. But if you must deal with them later, you should work with your real estate lawyer to ensure you are able to renew your lease on favorable terms or, failing that, have as much time as possible to find a new space.