In the traditional world of commercial leases, established tenants usually rely on their own signatures or those of affiliated guarantors to satisfy landlord credit demands. But in the case of start-up tenants, any credit approach that relies on such devices is sometimes of little value to a landlord–especially since such companies typically have no parent company or any significant net worth.
Fortunately, there are ways that landlords can secure their interests while making space available to start-ups, which are at a disadvantage over more established tenants for rental worthiness. This is especially true in today’s economic climate where new companies are viewed with uncertainty.
As a rule, start-up tenants have to post credit instruments to secure their commercial lease obligations, and landlords have demanded that such credit instruments be capable of liquidation upon a tenant default. Several mechanisms exist to enhance the viability of these transactions. The two most successful are:
Letters of credit
These are irrevocable credit instruments that are issued by third party financial institutions. Because of commonly accepted banking practices and regulatory laws, letters of credit can typically be drawn upon by the landlord expeditiously with minimal effort or expense.
Draws upon a letter of credit are usually enforceable even if the tenant declares bankruptcy, since it involves a third party obligation (the financial institution) and is not directly an asset of the bankruptcy estate.
These are credit instruments issued by a third party insurance or surety company. If carefully drafted, lease bonds can be made to resemble an irrevocable letter of credit. However, even under such circumstances, a lease bond represents only a promise from the third party to pay and is not sufficiently regulated to be drawable in the same manner as a letter of credit. To the contrary, it’s not uncommon for a lease bond to be enforced only after a lengthy legal battle.
Accordingly, due to liquidity concerns, landlords usually prefer letters of credit over lease bonds. Either way, these instruments make it easier for start-up companies and landlords to enter into beneficial arrangements. Make sure your commercial leases are properly drafted and negotiated to be secure and attractive to both parties.