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SEARCHSigning a personal guarantee on a lease can be a frightening and daunting thought for a new salon owner. Summit Salon Business Center's Lynn Chisholm shows you when you can avoid that and how you can limit it.
Personal guarantees protect the landlord if your new salon closes. Summit Salon Business Center's Lynn Chisholm advises owners how to avoid them or put limitations on them.
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A personal guarantee on commercial property is when you, as an individual, promise to personally repay the loan or obligations tied to a commercial property if the business entity (LLC, corporation, partnership) can't. If your loan defaults, a personal guarantee can allow the lender to go after your personal bank accounts, investments, wages, and other real estate. For a stylist looking to open her first salon, this can be a daunting thought.
Always create an LLC or an S Corp, and put the lease in the company's name. If the landlord is not paying for the space's build-out or providing you with funds to complete it, there should be no need for a guarantee. Landlords usually insist on a personal guarantee for a salon starting out, but if the Landlord has not invested any money, you may be able to have this removed from the beginning of the Lease. Having a personal guarantee is an advantage for the Landlord, as they can sue you personally if your salon closes, and it adds extra stress of tying your personal assets to your business assets.
(Read other helpful blogs about lease negotiation from Lynn Chisholm: The Evolution of Commercial Leases and Its Impact on Small Business Owners; Understanding Renewal Terms in Your Lease; and Tips for Gathering Rental Rates in Your Area.
If the landlord provides you with funds to complete the build-out, they are entitled to a guarantee in a manner similar to a bank. The guarantee should be limited to the amount of the leasehold inducement or loan and amortized over the lease term.
For example, let’s say you agree to rent a 1500 square-feet space for five years at an annual rent of $20.00 per square foot. In addition, the landlord agrees to give you $50,000 toward the salon's build-out costs, provided you guarantee repayment. Now, let’s say the salon fails after two years. How much do you owe the landlord?
Well, clearly you owe the rent for the balance of the term, unless you can sublet the space. But what about the $50,000? The answer is that it depends on how the lease is written. Clearly, the landlord received rent for two years; therefore, in my opinion, the landlord is only entitled to 3/5’s of the $50,000 (or $30,000) but not the whole amount. Below is an illustration of how this clause may be written.
E.g. “Should the tenant at any time throughout the initial term of this lease be in default of this lease or cease to open for business the landlord shall be entitled to receive from the tenant a sum equal to $50,000 multiplied by a fraction the numerator of which equals the number of months remaining in the lease and the denominator of which is the current lease term.”
If Landlord doesn’t agree to this you want the personal guarantee deleted at the end of the initial term (or after 5 years if your term is longer.)
Also, ensure the money the Landlord provides you is split between Landlord Work the Landlord is paying for, but you are coordinating it as part of your build-out and Tenant Improvement Allowance, which could be upgraded lighting, flooring, and wall coverings. If the space has not been built out, remember that even though there are no lights and you are putting in upgraded lighting to what a Landlord’s base building lighting is, it is still worth something; the Landlord should provide you with a credit for lighting, painting out the ceiling or T-bar, etc. A contractor can help you determine what is Landlord’s Work and what is Tenant Improvements. This is covered in a separate article (Tenant Improvement Allowance)
About the Author:Need help negotiating your new lease or lease renewal? Summit Salon Business Center's Lynn Chisholm offers free Lease Consultation calls to help you navigate your options and ensure you're getting a fair deal. Contact her at leasing@summitsalon.com
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