Types of leases every business owner should know about before locating a company Part 2

Last week we covered five common lease arrangements for a typical company location that a business owner should know about.  Today we will discover three more of the common types of leases in Canada:

Variable Lease

A variable lease is one in which the annual rent is agreed upon in terms of how it is calculated, but the monthly rent may vary depending on the seasonal nature of the cash flow of the business. For example, there could be a very low or no rent period of three or four months because business activity is slow. The rent for the remaining months of the year would be high, to compensate for the period when the business was unable to pay rent.

Graduated Lease

A graduated lease requires an increase in rental payment every month for a specified period of time. This is usually done to assist a business in its first year of start up so that the monthly payments are related to the increase in cash flow and the revenue of the business. At the end of the graduated period, the rental payments by the tenant would then be at a fixed rate usually as in a net or triple net lease.

Percentage Lease

There are several types of percentage leases. In one type, the landlord obtains no minimum rent, but simply a percentage of the total monthly sales of the business. The landlord attempts to determine the tenants potential revenue and bases the percentage on that amount. The percentage for rent could vary depending on the volume of sales. For example, it could be set at a higher percentage for a lower volume of sales, and at a lower percentage for a higher volume. The tenant would have to calculate whether or not the base percentage could be too difficult for the business to pay, assuming that the gross revenues are obtained.

The other variation is that the landlord calculate a minimum rent based on the tenants potential revenues, but the rent paid is based on actual revenues. In other words, it is a percentage of the gross monthly revenues of the business. In this example the landlord is able to budget on a minimum guaranteed rent until such time as the tenant pays a higher rent because the revenue justifies it. In this type of lease, the landlord requires very tight accounting and reporting controls.

Another type of arrangement is for the percentage to be based on net profit. This type of arrangement has to be defined very carefully in the lease. The most common way is for the profit to be calculated before depreciation and / or interest and income taxes. There is usually a limit on the owners salary; otherwise the owner could inflate the salary paid out as a management fee or to relatives in order to increase expenses so there is no net profit. The Landlord also frequently requires that the tenant spend a minimum amount of money on advertising so that sales and net profit are generated. Another provision frequently found is that the landlord requires a minimum amount spent for maintenance so that the premises are kept in good repair and condition.

The percentage lease is commonly used in the renting of retail stores in shopping centres. The landlord therefore obtains the same benefit that the tenant obtains in terms of the large traffic volume going through the shopping centre which the landlord has established.

When dealing with shopping centre leases, be extremely careful that you obtain competent professional advice from your lawyer and accountant before committing yourself. The relationship with the landlord in a percentage lease is almost that of a partner, because the landlord has very tight controls on reporting and expenditure of monies by the business and the systems for keeping track of cash and giving out receipts. As the success of the tenant business may only be partially due to the location, it would be prudent to try to negotiate a fixed maximum dollar amount that the landlord would be entitles to receive under the lease.