Landlords Need Lease Guaranties
A personal guaranty is often the last requirement to finalizing a lease deal. Most landlords will require guaranties from all of the principals of the tenant and their spouses for closely held businesses that are leasing space in a property. Though the tenant is the occupant and generating income and paying rent, the tenant itself generally has no net worth. It is usually the practice of small businesses for owners to draw out most, if not all of the income of a business so that if there is a lease default, a landlord will have no remedy. Therefore, lease guaranties are essential components to making a lease deal.
Yet, novice tenants are reluctant to sign personally, arguing that they have formed the entity specifically to avoid personal liability. They are quick to ask for lease incentives like large tenant improvement allowances and free rent, but they don’t comprehend the credit risk a landlord takes in entering these leases and providing incentives. I have come across this problem several times in the past few months with tenants refusing to provide financial statements or guaranties or having their spouses guaranty the lease. They will argue that a corporate financial statement from the start-up entity or an affiliate company should suffice. Or, they think that the wife should not sign since she isn’t involved in the business. Some offer short term (1-year) limited guaranties for longer term (10-year) leases. How is the landlord to amortize and protect its investment under those terms?
Without the non-shareholder/member spouse as a co-guarantor, the shareholder/member spouse could easily avoid liability under a guaranty and lease by transferring personal assets to the spouse. Without personal financial statements or by providing only financial statements of the startup or an affiliate company, a landlord has no idea whether the people behind the tenant have the financial ability to fund, open and operate the business and cover losses in the future and pay the debt on default. A landlord’s due diligence of a tenant and its principals should be akin to a bank’s underwriting of a loan. Rent and lease incentives are not different than a loan.
Recently, in arguing these points with potential tenants, I have had one tenant walk away from a lease and another tenant partnership split up, leaving the financially stronger partner to solely own the business and guaranty the lease with his wife. Because these potential tenants were unwilling to provide the guaranties and/or complete financial information, we knew these were not good risks and fortunately, we never got to the point of spending the time or money of preparing leases.
A landlord should raise the issue of the guaranty early in lease discussions. If the tenant’s principal won’t provide one or won’t provide adequate financial information, landlords should end discussions and move on.