5 Things You Should Include in a Letter of Intent

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5 Things you Should Include in a Letter of Intent

Most franchisees and/or small business owners lease space for their business. In this post we’re going to cover 5 basic clauses to make sure are in your Letter of Intent. These clauses are important to negotiate up front in your Letter of Intent so that you don’t waste your time, resources, and give up your leverage negotiating them when you get to the Lease.

A letter of intent is an outline of an agreement between two parties. The parties are the Tenant (presumably you) and the Landlord or the Landlords representative. The Letter of Intent, abbreviated as LOI, is considered to be a gentlemen’s agreement in that its non-binding, but it represents a TRUE interest in moving forward with a real estate transaction. An LOI is a precursor to the lease agreement which is binding. You can think of an LOI as the cliffs notes version of a lease.

There no universal standard format for a Letter of Intent, but here are some standard clauses that you should make sure are covered:

1.  Rent

The cornerstone of the negotiation. The first question everyone asks. How much is the rent. In most cases the Landlord or broker will quote you a rent rate in price per square foot.
Lets work through an example:
You are interested in a 3,400-sf space for your franchised restaurant. The Landlord’s representative has told your broker that the base rent is $25 psf.

Let’s calculate the base rent:
3,400-sf x $25 psf = $85,000 annual base rent.

If you want to figure out your monthly rent payment simply divide that number by 12.
Of course, you want the rent to be as low as possible, but a reasonable rate hovers around 10% of occupancy. So whatever your gross sales are, you want your rent to stay lower than 10% of that number.
The bigger issue surrounding rent is how the space will be tendered to you. Meaning how the Landlord will deliver the space. Will it be given to you as-is? Or will the Landlord be required to fix it up before they turn it over to you.
This condition is covered in what’s called a Workletter. A Workletter is often attached to the Letter of Intent as an Exhibit and covers items such as HVAC, water, sewer, and electrical.

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2. Permitted Use

In this clause of the LOI, you are asking the Landlord to agree to your specific use of the space.
So if you’re opening an arcade that serves alcohol, you have to describe that use specifically. So you’d write something like “an arcade selling alcohol for on-premises consumption, merchandise, and food items. You should go on to talk about other vending machines and any other ways you’ll be using the premises.
This is important because while you may be in the clear from a zoning perspective with the municipality, that does not guarantee that your use in specificity is allowed by the Landlord or the Landlords other Tenants as bound to him by other leases.

3. Lease Commencement and Rent Commencement

These two sound like the same thing, right? You’d like to believe that your rent should start on the same day your lease starts, and you’d like that to be the first day you open for business. Its not. Lease Commencement and Rent Commencement are two separate things.

Lease commencement is the day that your lease starts. Landlords like to make this the day that they hand the keys over to you, whether or not you have construction to do to the space.
Rent Commencement is the day that your rent starts. If you’re like most people, you want to put that day off until you are making some money. It can be tricky to get the Landlord to agree to delay rent payments until you’re open and operating, but you should absolutely ask for it.

4. Exclusivity

If you buy into a franchise or invest money in a small business, you naturally want to protect that asset. One way to do that is to negotiate your exclusivity in the LOI. An exclusivity clause make it difficult for the Landlord to put a direct competitor in your same shopping center.

Let’s say you owned a bagel shop on the endcap of a shopping center. And let’s say that the owner of another bagel shop saw how well you were doing in that shopping center and wanted to open another bagel shop two doors down from yours. Without an exclusivity clause, they could technically do this. Now a savvy Landlord will initially object to this, but for the right rent rate or if the Landlord wants you out of the Center, he landlord could let this happen.

And now onto everybody’s favorite topic…

5. Guaranty

So, I get a lot of questions about Guaranty’s and just to get this out of the way, I’m not an attorney.

Typically, a Landlord will ask for a Guaranty in almost every case unless your company is a conglomerate of some sort. A Guaranty does exactly what it sounds like, it guarantees the Landlord rent payments or reimbursement of an assets if you flake out and default on your lease. The nitty gritty detail of the Guaranty is spelled out in your lease, but you can negotiate the terms of the guaranty in your LOI. So you could potentially get the Landlord to relax on the length of the Guaranty or you could propose a burn-down of the Guaranty.

So how do these items tie into franchising?

Regardless of whether you are leasing a space as a franchisee or as a small business owner, all the items that I talked about here are important. The advantage you have if you’re a franchisee, is that your franchisor will be able to provide you with a lot of this language. But don’t fear if you’re not a franchisee, because your broker (a good one) will also have a bank of standard language to help you as well.
There are lot of other clauses you can insert into an LOI to construct an all-around good deal for yourself. Ultimately no matter how many professionals that you hire, you’re the one that is going to be responsible for getting yourself the best deal possible.

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