July 2011 Archives

July 22, 2011

The Commercial Lease and Your New San Diego Business

Continued from "Choosing the Right Business Entity for Your New Business".

Now that you have a business plan and the capital to get started, the next step is to secure necessary raw materials, wholesale goods, manufacturing equipment, vendors, licensing, contracts and other necessary procurements all of which will be unique to your business. Securing a commercial lease on the other hand is common for virtually all businesses and, unless you plan to operate out of a home office, will have a critical impact a business' success. First, by entering into negotiations for any commercial lease, you are making a fundamental choice about the location of the business. The location chosen can make or break any new venture. Second, the particular terms of the lease impact the bottom line. Rental payments, annual rental increases, inducements, common area maintenance expenses (CAMs), the term of the lease, options to renew and other rights and obligations set forth in the lease directly impact profits. Lowering monthly rents is obvious, but there are other less obvious costs that new tenants must concern themselves with many of which are intertwined with CAMs. For instance, most commercial leases require tenants to cover property taxes as part of the annual CAMs. Tenants are often shocked to learn later that the property was sold and a lump sum property tax was due sometimes tens of thousands of dollars or more per tenant.

513776_quiet_sunday.jpgOften, entrepreneurs fall in love with a particular location and begin to negotiate for a lease from a weak position. If prospective tenants have no other options, they are typically willing to accept almost anything from the landlord so long as the rental payments seem reasonable. This is a mistake. The better approach is to choose among multiple locations all of which have positive features. Of course, there is almost always a "better" location for the entrepreneur, and there's nothing inherently wrong with pursuing choice one first. However, knowing that other options exist better equips the entrepreneur to walk away from really bad deals. On the other hand, unrealistic expectations about lease terms can be just as detrimental to a new business. It remains important to understand relative bargaining power and make reasonable determinations about acceptable lease terms. Landlords also have other options, and are generally savvy real estate professionals. They understand what the market will bear and work from there. The negotiation requires tact and subtlety, and most importantly a hierarchy of priorities.

Because the commercial lease is of critical importance to any business, it is best to consult with an experienced San Diego Lease Lawyer before signing any lease. If hiring an attorney is not practical, take the time to review your proposed lease and diligently research all of the issues you are unclear about. There is a wealth of information available on the web.

Continued in "Starting a New Business In California - Hiring Employees".

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July 14, 2011

Recapture Clauses in Commercial Leases

Almost every San Diego business owner has had to negotiate a commercial lease at one time or another. Whether with the assistance of a San Diego lease lawyer or on their own, they are presented with a myriad of confusing terms and conditions. Business owners typically focus on the major terms of the commercial lease (rent, common area maintenance expenses, term of the lease and options to extend), and let their attorneys sort out the rest. While it is good practice to consult with an attorney before entering into any contract, business owners benefit from a basic understanding of the commercial lease as a whole and how its terms interrelate. This article takes a brief look at one common clause - the recapture clause.

997479_french_cafe.jpgA recapture clause allows a landlord to terminate the lease and take back possession of the premises upon the occurrence of certain conditions. It is usually associated with complex "assignment and subletting" clauses that allow tenants, upon landlord's approval, to assign their lease or to sublet a part of the leased premises to a third party. Landlords like to include "recapture clauses" that are triggered by a tenant's mere request for the approval of an assignment or subletting.

The "recapture clause" issue arises because landlords know that tenants' desires to assign or sublet are usually motivated by profit. When the commercial real estate market is hot, tenants can assign their lease at rental rates above what they are currently paying or sublet a portion of the premises at exceptional rates. Recapture clauses allow landlords to step in and take the profits for themselves. In essence, landlords are able terminate the less profitable lease. Tenants then are better off without such clauses and existing tenants need to carefully review their leases before requesting approval of an assignment or sublease.

As with all commercial lease terms, favorable language for either side will depend on the parties' relative bargaining power. Landlords want recapture clauses. They provide an out when existing leases are under performing compared to the current market. The fewer conditions the better. Ideally, from the landlord's perspective, the recapture clause will be triggered on any request for the approval of an assignment or sublease. However, given the complex nature of assignment and subletting clauses in commercial leases, it is most often productive for landlords to agree to more flexible language. Tenants, on the other hand, should ask that recapture clauses be omitted in their entirety although this is not a practical expectation for most small businesses. If the recapture clause cannot be negotiated away, tenants should insist on clear triggering language. For instance, landlord's recapture rights may only be triggered upon a request for a complete assignment or a request that more than 50% of the premises be sublet. This allows tenants to sublet portions of the premises without risking termination of the lease. There are other options equally appealing to both landlords and tenants. Most notably, language may be included in the lease that addresses the division of profits from an assignment or sublease omitting any sort of recapture clause.

In the end, commercial landlords and tenants have to weigh the value of these issues against all the other lease terms being negotiated. It may be that a tenant has little concern over future assignments and would much rather spend its bargaining power on other important concerns such as reduced annual rental increases. The practical result of recapture clauses after they are triggered will be the subject of another article. Consult a San Diego commercial lease attorney for further guidance.

July 7, 2011

What is a California Close Corporation?

A California Close Corporation is a corporation designed to give its shareholders more control over the operation of their business.  Instead of sitting back and letting others run the company, the owners of a Close Corporation typically act as the company's managers.  By complying with specific statutory requirements, Close Corporations can forego many of the corporate formalities other corporations are required to comply with.  This in turn reduces the risk that others will be able to pierce the corporate veil and reach the owners' personal assets.  Section 300 of the California Corporations Code states: "The failure of a close corporation to observe corporate formalities relating to meetings of directors and shareholders in connection with the management of its affairs, pursuant to an agreement authorized by sudivision (b), shall not be considered a factor tending to establish that the shareholders have personal liability for corporate obligations".  However, shareholders who manage the Close Corporation are subject to the same fiduciary duties any director of officer of a corporation has.  

447109_static_business.jpgThe California Corporations Code imposes the following requirements for qualification as a Statutory Close Corporation:  

1.    The Corporation cannot have more than 35 shareholders.  However, for the purposes of satisfying this requirement, spouses are considered to be a single shareholder as are corporations, trusts, partnerships or other business associations unless the primary purpose of the entity was to acquire the close corporation's shares.  

2.    The Articles of Incorporation must include a provision that the corporation cannot have more than 35 shareholders and specifically state that the corporation is a close corporation.

3.    The corporation's share certificates must contain a conspicuous legend stating: "This corporation is a close corporation. The number of holders of record of its shares of all classes cannot exceed 35. Any attempted voluntary inter vivos transfer which would violate this requirement is void. Refer to the articles, bylaws and any agreements on file with the secretary of the corporation for further restrictions."

4.    The Shareholders must enter into a written agreement setting forth the matters upon which the shareholders, rather than the board, will exercise control.  The shareholders' agreement must be lodged with the Secretary of the Corporation and available for inspection by prospective purchasers.  It is common for Shareholders' agreements to include buy-sell provisions limiting transferability of shares providing existing shareholders with a right of first refusal.  Moreover, close corporations may provide for greater control by minority shareholders and disproportionate distributions of profit.  

In addition to these statutory requirements, Close Corporations cannot go public.

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