If your franchise operates out of a retail, office or commercial space, then you’ll need to enter a lease agreement.
The following are the three most common types of lease agreements:
Head lease: It’s when you, as a franchisee, has a direct contractual relationship with the landlord. Before signing the lease agreement, you’d have to be approved by the franchisor. For most start-up franchisors or franchisors that are inexperienced, this seems to be the safer option because it’s not as risky as leasing a property and taking on the liability that comes with that.
However, a franchisor will typically have a “cross default” clause in the franchise agreement stating that a default on the lease agreement is a default of the franchise agreement.
Sublease: In this case, the franchisor would be on the head lease with the landlord, while you would sublease that space from your franchisor. You may be required to pay them directly and the franchisor pays the landlord, but it must be disclosed in the franchise agreement. This option tends to be popular for franchisors because it’s far easier for them to take over the location when they are leasing directly. For franchisors that wish to have control over a great location, this may be a viable option.
Three-party (Tripartite) Agreement: It’s where the franchisor and franchisee go on the head lease with the landlord. This would allow the franchisor to assume the lease in the event that the franchisee decides not to renew. But landlords are reluctant to sign three-party agreements, as they typically want the flexibility to rent the space to someone else in the event of a default.
Occupancy costs are the costs included in renting a space, which include:
- Base Rent – Usually quoted as an annual cost per square foot.
- Common Area Maintenance (CAM) – Your business’ share of costs, for example, security, snow removal in the parking lot or cleaning of the common areas.
- Percentage Rent – Some landlords in high traffic retail locations will request a percentage of your gross sales for rent.
- Property Tax – Typically, you’ll pay your portion of the property tax, based on your square footage. This is usually paid annually.
- Merchants’ association or marketing fund – Large shopping malls or complexes will have tenants share costs for mall promotions and events. This is usually paid quarterly.
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