What does a leasehold business mean when buying a business?

 

Buying a business is not a small task, whether you are an old hand at it or a first-time buyer. The number of businesses available, and the diversity of options, can take a significant amount of time to process.

One of the options that you will come across is choosing between a freehold or leasehold business. But what is the difference between the two?

A short definition of leasehold would be “rental”, meaning a business owner operates from premises they do not own under a rental arrangement with a landlord; in commercial property terms, that is leasehold property rather than freehold property. In the domestic environment, it would be the equivalent of choosing to rent rather than purchasing your home.

The primary driver behind looking at a leasehold business is usually budget. A freehold business requires greater funding because the purchaser is looking to buy both the business and the physical property outright, so when comparing freehold and leasehold property this route often demands more financial resources and involves more legal work around ownership. In the absence of these resources, you will need to refine your search to a leasehold business.

A leasehold business comes with a much lower price point due to the fact that it involves the purchase of the business only – not the bricks and mortar premises. This is an excellent option for acquiring a business within a restricted budget, as upfront costs and legal complexities are usually lower.

A leasehold business can still be developed, grown and altered at your discretion. You can add new services, develop new products, bring in a partnership, rebrand, etc. You will not be responsible for the building maintenance, insurance etc, unless that is specified in the building lease drawn up between the company you bought and the property owner.

Leasehold property disadvantages

An obvious disadvantage is that the property could be sold, and the new owner will want to use the property for their own business, leaving you in a scramble to find new premises; a leasehold business can also be disrupted if the landlord sells the property or declines to renew the lease at expiry.

This would not happen immediately, as the lease agreement in a commercial lease sets the duration of the lease, rent payments, and other obligations that must be honoured by the owner of the premises. The pain of sourcing new premises that meet your needs, and actually making the move, is not relished by anyone, unless you had outgrown your current premises and had a real need to move on.

You will be paying rent which will include building expenses, rates, water etc, and under the lease there may also be ongoing overheads such as service charges and, where applicable, ground rent, without deriving asset growth benefit from those amounts paid.

You will most likely have significant limitations on what adaptations you can make to the premises, as changes usually require landlord approval or landlord consent, limiting flexibility.

Commercial leasehold property business advantages

There are multiple advantages to a leasehold if you review both how the business operates and the commercial lease agreement, because that broader assessment helps you make an informed decision, and if you:

• Were lucky enough to be in strong a position when negotiating your lease and/or
• Took advice from commercial property solicitors or similar professionals to reduce risk, navigate the legal process, and ensure the lease is fair to you, and
• Have an agreeable landlord.

A leasehold business can bring huge benefits from reduced responsibility, far less capital outlay and much less stress. It is a prudent option to choose if you are just starting out in business and are planning to have multiple satellite locations of your business.

There are further options within the option of leasehold itself.

Tied leasehold

Many leases on the market are subject to trade ties, such as a brewery or pub company that is issuing leases as a landlord. The long and short of this means that you have to buy certain stock or certain volumes from them. This trade tie is not something to be taken lightly, nor should you think that you can “start with them” and source other options. This will put you in breach of contract!

Within the lease agreement, you will also have limits on how you operate the business. You will also, most likely, be responsible for the full maintenance of the entire premises. Another addition to that will be an obligation for you to take out insurance against all property and trading risks.

A tied lease will require you to pay a premium for the lease when you buy the company and pay rent for the lease duration.

Free-of-tie leasehold

This will have almost identical terms to a tied lease but with a very advantageous exception: You can purchase stock from sources of your choice.

Unlike leasehold, freehold ownership includes the building and the land, giving the owner full control over alterations without landlord restrictions. In freehold ownership, maintenance responsibilities fall entirely on the owner.

The ability to source alternatives, negotiate trade discounts and adjust your products to client’s needs increases the chance of you achieving more business profits.

There will, therefore, be a huge demand from the buying sector of the market, which will harden the prices of these leases. As these premium, free-of-tie leases are in such a demanding market, you must be researched, financially ready, and ready to decide as you will need to proceed with a purchase swiftly, as the market will snap these up quickly.

Do your leasehold research

As with all big-ticket and/or business acquisitions, before you take the time to view a business for sale or invest substantial time in it, it is prudent to do your homework thoroughly.

The following questions are examples of research that should be considered:

• Is the geographical location suitable for you, your staff and your clients?
• Is it close to service providers and suppliers? What is the crime rate?
• Is it near transport options for your staff?
• Is there a vibrant local economy, or is it not relevant? Do you trade directly to the public and, if so, are there suburbs of high disposable income families in the vicinity?
• Is it a growing or declining area?
• Is the area satiated with businesses such as yours, or what is the presence of the competition? Take time to assess this as some businesses have diversified, and their core businesses will be supported by a subsidiary business that might fall into your sector.
• The Valuation Office Agency (VOA) can help with business rates and valuation checks.
• Have you ascertained the Unique Selling Points (USPs) of the business and whether they are scalable?
• Have you used an accountant to calculate the ROI, including the impact of the type of lease you will inherit?
• Have you checked the existing lease for the remaining term, security of tenure and rent review provisions?
• Have you reviewed audited accounts from previous years as part of your due diligence?

 

Leasehold Affordability

As with properties and other complex items, the cost of buying a business does not end at the advertised price.

There will be physical setup costs, stock costs, interior design fees, marketing fees, fixture costs, legal costs, surveyor fees, accountancy fees and licensing fees whilst maintaining an unthreatened bank balance of working capital.

When you want to initiate negotiations regarding the purchasing of a leasehold business, the lease agreement is a legal contract between the landlord and the tenant that sets out the term, whether rent is payable as monthly rent or quarterly, and the tenant obligations.

When you sell a leasehold business, the lease for the commercial property will usually transfer to the new owner by lease assignment, subject to landlord consent and the conditions in the tenancy agreement. This legal process may also require the landlord to carry out due diligence on the new owner, including references or background checks, and in some cases to document the transfer through an authorised guarantee agreement rather than a new lease. Y

You will need to have documentation prepared and audited, which demonstrates to the Landlord that, in addition to the purchase price, you can cover all of the above items plus any others they may list; if the buyer is a limited company with limited assets or trading history, the landlord may also ask for personal guarantees or a rent deposit deed. Some buyers use a business broker to help sell the leasehold business and make the process easier.