By Mark Shipman & Doug Alexander
You just started the initial negotiations on purchasing a dental practice. In addition to discussing the purchase price of the practice, the goodwill, and the equipment, there is a single line on the letter of intent that says you will assume the existing lease agreement or that you will agree to enter a new lease agreement. Oftentimes, leases mistakenly take a back seat to the sale documents in a dental practice purchase. This is a mistake that should be avoided. Your lease is an important business asset that you need to keep pace with, no different than maintaining and expanding your patient list, or upgrading your dental equipment. The initial negotiation for the practice purchase is the best time to negotiate lease terms that will enable you to grow your new practice. Below is an overview of some key elements regarding a lease that you should consider at the time of a practice purchase.
Term (Length) of The Lease
There are many questions to consider regarding the term of the lease. If there is an existing lease in place, when does the current term end, and are there options to extend or renew the term? Taking over a lease mid-term with 3 years remaining and no option to renew could put you in a difficult position in 30 months. Better to build in an option to renew for 3 – 5 years, with additional renewal terms to ensure you won’t have to engage in a costly move. In most cases, if you are financing the purchase of the practice, your lender will insist on a lease term that is at least as long as the term of your loan. If you want to consider relocating your practice before your loan is paid off, then you should negotiate a shorter initial lease term with options to renew. That option will enable you to stay at the current location for the term of your loan, but be sure to get approval from your lender.
If you are entering into a new lease, you may not want to start out with a 10 year term unless you are certain that you will be content with the location for a long period of time. Instead, consider starting out with a 5 year term with multiple 5 year renewal options. Building in this type of flexibility will enable you to evaluate whether this location is the one that will allow you to grow your business, or time to prepare a more suitable permanent location, if needed. On the other hand, if you know at the outset that the current location is the best for your practice, then consider requesting an option to purchase the property up front.
Rent and Rent Increases
When assuming the current lease, are the current and proposed rent rates commensurate with the market? If not, now is your time to negotiate a change in the rate, and possibly change the escalator provisions as well. Almost all leases have rent escalator provisions. Some are tied to the Consumer Price Index (CPI), others can be a lock step increase by a certain percentage each year. What does the existing lease require under the escalation clause? Are rents tied to the Consumer Price Index (CPI), and if so, which index? Does the clause have a ceiling on the CPI increases? At the end of each term, does it allow for an evaluation of rents and rent increases going forward?
With the downturn in the Oregon economy, rents in many areas have not increased but remained flat. If the selling dentist/landlord has an aggressive rent structure and escalator provisions in the current lease, then the current contracted rental rate may not be in tune with the market. This is the time to recalibrate both the rent and escalator provisions.
Maintenance & Conditions of the Premises
What does the existing lease require for maintenance of the leased premises? Are the premises a standalone building and parking area for which the landlord expects the tenant to be responsible for all maintenance; or, is it a part of a larger building or complex, where the maintenance is shared between the tenant and landlord?
Likewise, what are the conditions of the leased premises? Is it newer space that is well maintained? Is it an older building where the current tenant and landlord let things slide, failed to keep up on repairing or replacing worn items, or failed to keep track of maintenance? The landlord can often provide you with a file with the maintenance schedule and items that have been completed during the current lease.
Knowing the specifics of the condition of the premises and the status of maintenance can be very important. We cannot stress enough how many times a tenant has come to us and said, “The landlord verbally told me that we were not responsible for that element when we entered the lease.’’ Yet, the lease language is clear and unambiguous—it is the tenant’s responsibility. Or worse, the lease is ambiguous and the landlord is now taking the position that the tenant is responsible for the costly maintenance and improvements to the premises. Taking the time to fully understand the condition of the premises and your obligations for maintenance is important at the front end, so you can minimize a costly repair or avoid a costly dispute over a needed repair.
Assignment
What does the existing lease require for an assignment of the lease? Does it freely allow assignment, or is the assignment restricted, perhaps requiring the landlord to consent. May the landlord withhold consent in its discretion, or perhaps if the new tenant does not have a credit rating and net worth similar to the current tenant? May the landlord charge a fee for the assignment? If so, are the terms of the fee established in the lease, or are they ambiguous? Is there a personal guarantee in the lease and will the landlord release the underlying tenant upon an assignment?
While it seems odd that you would be thinking about a future assignment at the beginning of the new relationship, building flexibility into your lease agreement is important with respect to a business purchase, expansion, sale, or upon your unforeseen disability or death. You do not want to be in a situation where you want to bring in a new dentist to take over your practice, but the lease assignment provisions require the landlord’s consent and the landlord has decided to be less than cooperative in approving an assignment. This can be avoided if you effectively negotiate the terms for a future assignment at the time you enter into a new lease or assume an existing lease.
These are just a few of the key provisions that you should consider before committing to a lease or an assignment. Putting off the lease negotiations or treating them as unimportant can put you in a bind both in the short term and in the future. During your purchase negotiations, be sure to meet with your financial and legal advisors in order to carefully consider all the consequences of a current or new lease on your practice. If you would like assistance in reviewing and analyzing these and other lease related issues, please contact a member of our Dental Team 503-399-1070.