Landlords as a species tend to be risk-averse creatures; more so if they are considering granting a lease to a newly incorporated company or a foreign entity. The technology sector is one of the fastest growing areas in UK business, having seen more than tenfold growth since 2010 and it shows no signs of slowing.  As a result, new tech companies are being incorporated on a daily basis, with many needing to take leases of new premises.

Tech start-ups are, by their very nature, nascent, and therefore do not have the financial history of established UK companies.  This means that landlords can be reluctant to offer leases to such entities without first carrying out financial due diligence and, frequently, requiring some form of additional security to mitigate against the risk of tenant default.  In this article we explore the most common types of security likely to be requested and their relative pros and cons.

  1. Rent Deposit: probably the most commonly used method of security. A tenant provides a cash deposit to the landlord (often around 6 months’ rent plus a sum equivalent to VAT), which is then held by the landlord in a separate bank account and can be used to cover any failure by the tenant to pay any rents or comply with its lease covenants.  Typically a rent deposit is held for the duration of the lease or until assignment, though in some cases could be held until a ‘profits test’ threshold is satisfied (often profits being at least 3x rent for 3 years).  Most deeds will allow the landlord to draw down on the deposit if the tenant is in default and also require the tenant to ‘top up’ the deposit in such an event.  Landlords like deposits as they have immediate access to cash, without the need to bring any legal proceedings.

Given their prevalence, rent deposit deeds are relatively standardised and uncontroversial, and so tend to be agreed at heads of terms stage and can be documented quickly.

The obvious downside, particularly for a newly incorporated entity, is that the tenant has to front up cash from the outset, which is then tied up until the point of release.  With rents, particularly in major cities, being a large proportion of a company’s outgoings, this additional lump sum can be prohibitive for tenants.  This is where some of the other security types can come in.

  1. Parent / Group Company Guarantee: as the name suggests, there needs to be a related company that is willing to agree to indemnify the landlord against any losses suffered by the landlord as a result of a tenant default. This guarantee often includes an obligation on that company to actually perform the tenant covenants itself (including taking a new lease in place of the tenant if it folds) if the tenant defaults.  Most times, a guarantee is incorporated into the lease itself, though can occasionally be a separate agreement,  If the tenant is taking an assignment of an existing lease, the guarantee is normally given in the licence to assign.

If available, guarantees can be a more attractive alternative for a tenant as there is no upfront cash payment required which ties up a company’s funds at a point when they may need it most.  There can be complications however: firstly, there needs to be a parent (not something many newcos have), the parent needs to be sufficiently financially viable, and, ideally, based in the UK (to give the landlord sufficient comfort for enforceability purposes).  Finally, tenants should consider which entity is actually put forward to give the guarantee: if the ultimate parent is to provide the guarantee, this could cause complications on assignment: many leases stipulate that the incoming security at least matches the outgoing security.  If the original guarantor is a particularly strong covenant, finding an assignee with a guarantor to match could be problematic.

  1. Bank Guarantee: unlike a parent company guarantee, this arrangement is purely financial: the bank will pay money over to the landlord if the tenant defaults but will not be obliged to perform the lease covenants or take a new lease. Often, the tenant is required to offer up a cash deposit to the bank by way of indemnity, in which case, it is of limited value above a rent deposit, however may be an alternative, and the amount required may be less.  Bank guarantees are often a fixed sum that would not be affected by subsequent rent reviews or other changes in lease terms.  Typically, bank guarantees are limited in their duration (often 1 – 2 years): landlords may not agree to this if the lease is for a longer period.
  2. Director Guarantee: these are similar to a parent company guarantee, but here an individual director provides the guarantee. These are not especially common for a number of reasons: often a director may not have the money available personally, and so charges may be required, though these might have to rank behind (for example) a mortgage over the director’s property, which is less attractive for the landlord.  Understandably, directors may not be too keen on tying up their personal assets, when one of the main benefits of having a company is the corporate veil protecting individuals from personal liability.  For a start-up though, this may be an option.  The tenant may want to limit the duration by a profits test, or have the option to switch to a rent deposit once it has sufficient cash reserves.

Each of these forms of security have potential benefits and drawbacks for landlords and tenants, and it is always important to iron the points out at heads of terms stage to avoid delays or, worse, a letting falling apart.  Factor the potential costs into your overall budget to ensure that you can still continue to operate if one of the ‘cash’ options (i.e. rent deposit or bank guarantee) is required by the landlord.  You may be able to negotiate with your landlord the amount required: for rent deposits, these are often by reference to multiples of monthly rent (3 – 6 being most common at this point).  You may be able to reduce the amount, or possibly structure the deposit to be an incrementally increasing sum.  For example, an initial one month paid upfront, with the tenant being required to ‘top up’ the deposit over time.  This could mean that by the end of the first year of the term, the tenant has to provide the landlord with, say, six months’ rent as deposit.

A further option may be to offer to pay some additional rent upfront: most leases have quarterly payments in advance.  It may be that the tenant agrees to pay an additional quarter’s rent up front to give the landlord some form of comfort.

If you are thinking of taking office space, feel free to reach out to us.

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