Negotiating Leases for Start-Ups

Osler Hoskin & Harcourt LLP
What You Need
to Know
Negotiating Leases
for Start-Ups
October 12th 2017
Paul Morassutti - Osler, Hoskin & Harcourt LLP
Matthew Ritchie - Osler, Hoskin & Harcourt LLP

Why is your lease important?
• Governs the use of the space in which you run your business, in
which your employees work, where your customers or investors
come to visit
• Like a marriage contract, but with someone you just met and that
you have to live with for 5 or 10 years, who has more money and
power than you, and does not want to treat you fairly (or with
much respect)
2

DOCUMENTS
The Deal Terms – Letter of Intent versus Offer to Lease
• First step is to settle the deal terms before negotiating the Lease
• In Canada, convention is to use a binding offer to lease
• Contains the pertinent business terms that will be reflected in the
Lease
• Once signed there is a binding deal
• Offers may have conditions in each party’s favour(e.g. board /
senior management approval of the terms, satisfaction with the
cost of any tenant’s work that needs to be completed, satisfaction
with the Tenant’s covenant)
3

DOCUMENTS
• In the US, convention is to use non-binding letter of intent
• Tends to be shorter, but landlord can keep marketing the space and
can accept a better deal if it comes along
• No deal until the Lease is signed, so risk is that the landlord accepts
a better deal.
4

DOCUMENTS
The Lease
• Long, very landlord-friendly, and not very user-friendly
• Landlord will provide the tenant with its form of lease, amended to
reflect the terms of the offer or LOI, and the parties will negotiate
and then sign this form
• Once a binding offer is signed, tenant’s leverage (such as it was)
significantly decreases
• From the tenant’s perspective, it is therefore important to negotiate
not only the deal terms but also the most important lease terms at
the offer stage
• Focus on items that can cost tenant money or interfere with
operation of tenant’s business
5

TOP 10 LEASE ISSUES FOR EMERGING COMPANIES
1. Financial Covenants
• Tenants will need to satisfy the landlord that their financial
covenant is satisfactory, which may be difficult for a start-up
• A deposit of 2 months’ rent (first and last) is very common
• Many start-ups also need to provide a higher security deposit and
sometimes a guarantor or indemnifier
• Letter of credit or pre-paid rent can also be used
6

2. Inducements
• Tenant Improvement Allowances, Rent-Free Periods or other credits
are all inducements
• These are all payments made by Landlords to induce tenants into
agreeing to lease space BUT the cost of the inducement, plus
interest at above-market rates (currently 8 – 10%), is factored into
the rent so the tenant is ultimately paying the cost of the
inducement with interest
• As tenant is paying for these “inducements”, they should not be
forfeited unless the Lease is terminated (ex. not by a transfer or a
default that is cured within the applicable notice period)
7

2. Inducements (continued)
• Tenant must also satisfy certain conditions before payment of the
inducement, such as:
◦ Lease is signed and rent payments have commenced
◦ Tenant is occupying substantially all of the premises
◦ No liens have been registered against title to the Building as a result of
tenant’s work and the lien period under the applicable construction lien
statute has expired
◦ Tenant provides a statutory declaration of an officer stating that all
contractors have been paid, together with receipts for costs incurred (if
allowance is to compensate Tenant for improvements to the Premises)
◦ Tenant has fully completed the tenant’s work, landlord has approved
tenant’s leasehold improvements and same have been carried out in
accordance with plans approved by the Landlord
8

3. Operating Costs
• Landlord will flow all costs of operating the building to the tenants,
usually in their proportionate share of the building.
• Issues arise when landlords attempt to include costs that are not
direct costs of operating the building into Operating Costs.
• Usually the biggest ticket issue with Operating Costs relates to the
treatment of capital expenses.
• There is a list of standard exclusions that a tenant can insert in
leases to reflect the guiding principles described
9

3. Operating Costs (continued)
• For example, if a landlord replaces the roof and it costs $1 Million,
how are these costs included in a lease?
• The cost of such a capital expense should be amortized over its
expected lifespan (in accordance with accounting rules), so the
“first year” portion of a capital expense is included in the current
year and interest on the unamortized portion, plus interest, of such
capital expenses should be included in Operating Costs in
future years
• Amortizing capital expenses prevents a tenant from being tagged
with an enormous expense for capital improvements in the last year
of a Lease
10

4. Management / Administrative Fees
• Landlords will charge a fee to compensate them for handling the day-to-
day operation of the Building
• Market standard management fee was traditionally 15% of all Operating
Costs, excluding realty taxes.
• The market standard has been shifting towards 3% – 5% of the revenue
“receivable” from the Building (i.e. all rent paid by the tenants, all
operating cost charges, etc.)
• Some Landlords have a management fee on all Operating Costs (including
Realty Taxes) plus an administrative fee on all revenues of the building /
development (i.e. a double fee).
• Landlord should never have the right to add or amend management or
administrative fees during the term.
11

5. Repair / Restoration of Premises at End of Term
• Leases typically provide the Landlord with the ability to instruct the
tenant which leasehold improvements and fixtures to remove or
provide that the tenant must restore the premises to base building
standard.
• Tenants should always retain the ability to remove their trade
fixtures and personal property and should try to eliminate end-of-
term removal obligations or at least restrict them to non-standard
leasehold improvements.
• Tenant’s maintenance and restoration obligation should always be
subject to reasonable wear and tear.
12

6. Relocation / Termination Rights of Landlord
• Leases often contain rights that would permit a landlord to relocate a tenant’s space to
a different space in the same building
• Provides landlord with the ability to accommodate a prospective tenant that needs
“your” space
• Relocation will disrupt your business, will cost you money and you may get a different
layout or external view
• Best to delete it, but if you must include it, then insist that the relocated premises
should be substantially similar to your existing premises and the landlord should be
responsible for providing comparable leasehold improvements in the relocated
premises. All direct costs of such a relocation should be to the landlord.
• Landlord forms often include a right of the landlord to terminate the lease if it wishes to
redevelop a building. This is a right that should be excluded but if it is included, tenants
should at least be given a long notice period sufficient to find alternate premises, such
as 12-18 months, plus be reimbursed for any of tenant’s unamortized leasehold
improvements.
13

7. Transfers
• Typically drafted to be very landlord friendly. There are several
terms that tenants should negotiate:
a. Permitted transfers to affiliates and subsidiaries;
b. Permitted changes of control – can provide Landlord comfort by
stating that tenant will have equal greater Net Asset Value after
change of control. Landlords may not agree to this. Emerging
companies are often purchased within five years so this is especially
material for you;
c. Landlord to not unreasonably withhold consent; and
d. Landlord should not have any termination rights upon request for
consent
(a to d should all be described in the Offer to Lease)
14

7. Transfers (continued)
Tenants should ensure there are no rights in leases that are personal to
the Tenant entering into the lease that would cease to exist upon a
transfer taking place, such as the right to a tenant improvement
allowance, free rent period or right to extend the term of the lease
15

8. Insurance
• Leases will include a list of insurance requirements of tenants and tenants will
be required to pay for the premiums of the landlord’s insurance policies as an
Operating Cost.
• Tenants should always consult with an insurance advisor to ensure satisfactory
insurance can be obtained.
• All insurance policies should contain mutual waivers of subrogation so that the
insurance company that pays a claim cannot then sue the party that caused
the damage of injury. The intention is to have most risks insured by either the
Landlord’s insurance or the tenant’s insurance, and with no right of the insurer
to come after the Landlord or tenant for reimbursement. This is only fair
seeing as the tenant pays for its own insurance, and also pays the premiums of
the landlord’s insurance as an Operating Cost
• The parties should also indemnify each other for all costs associated with risks
for which they are required to be insured.
16

9. Events of Default
• Tenants should always be given written notice of default plus a reasonable
time to cure it
• For monetary defaults, a short cure period is standard (e.g. 5 days).
• For non-monetary defaults, the cure period should be longer (e.g. 20 days)
but provide that the cure period can be extended if such a breach cannot
reasonably be cured within such time frame, provided that the tenant is
diligently pursuing curing the default and it is eventually cured.
• Landlord’s remedies include terminating and suing for the present value of
rent for the balance of the Term; distraining against inventory/personal
property; suing on the covenant; suing every month
17

10. Term and Extensions
• Consider the appropriate length of term for your business. Are you
entering into a five year lease for space that will only be suitable for
the next year? Do you want the right to extend beyond 5 years?
• The typical commercial lease term is five years but a shorter or
longer term can be negotiated.
• Tenants often negotiate the right to extend the term for at least one
five year period.
18

10. Term and Extensions (continued)
• The extension right should only be conditional on there not
currently being a default beyond any applicable notice or cure
periods, and not conditional on there not having been a transfer or
no default having occurred in the past
• The extension should be on the same terms as the lease, except for
the base rent, which should either be specified in the lease or
should be the market rent, and to be determined by arbitration if
the parties cannot agree on the rent. This prevents the Landlord
from arguing that they could not come to an agreement on rent so
the clause is not enforceable and you cannot extend the term.
19

The future of commercial insurance

Main types of insurance
1. General Liability
2. Professional Liability
3. Cybersecurity
4. Management Liability
5. Auto
6. Crime
Nothing in this document should be taken as insurance advice or recommendations. This is purely an informational document. Please
visit Zensurance.com to get learn more, buy a policy and reach the state of Zen!

General Liability
Main Coverages Example claims What to watch out for
• Product Liability
• Premises and contents
• Libel/slander
• Non-owned auto
• Employer’s Liability
(“Workers Comp” for tech)
• The hardware device you
manufacture catches fire
and burns down a house
• You accidentally infringe
on someone’s copyright
• An employee drives to a
nearby deli in her own car
to buy lunch for the team
and gets into an accident
• Get flood and sewer-
backup – it is worth the
extra premium
• Property – know how
much you are covered for
fixed property vs.
electronics
• Sub-limits. Although you
may have a ”$2M limit”,
individual items may be
sub-limited

Professional Liability / Errors & Omissions (E&O)
• Professional Liability
• Third party cyber
security (if you are
getting a tech policy)
• Your accounting software
inaccurately calculates a tax
liability, and your customer is
fined by the CRA
• You fail to meet a contractual
deadline resulting in a
financial loss to your client
• Hackers leverage a weakness
in your software to hack your
customer’s systems
• If you are a software
company, make sure you
get a Tech E&O policy
with Privacy/Data
coverage
• Often customers ask for
big limits, but you can
negotiate down
individual items may be
sub-limited

Cybersecurity
• First Party (your own costs)
• Customer notification
• PR support
• Business interruption
• Fines/penalties
• Extortion/ransom
• Fraudulent instruction
• Third Party (others’ costs)
• Your servers are brought
down
• Customer data is leaked
to the public
• Your data is held for
ransom
• An employee accidentally
emails out sensitive
customer information
• Do you have both First and
Third party coverage?
• The specific coverages
included in your policy – this
varies a lot
• The allowable trigger events
• What is required in order for
your claim to be honored
individual items may be sub-
limited

Management Liability
• Directors & Officers
• Employment Practices (EPL)
• Fiduciary Liability
• Unfair termination or
harassment of an
employee
• Misuse of investor funds
• Bad investment or
business decisions
resulting in bankruptcy or
big financial losses
• Seed investors feeling
unfairly treated upon
Series A funding
• Are both D&O and
Employment practices
included? EPL is very
important
• Definition of insured
• Bankruptcy exclusion – make
sure it is not included
• Are you covered for
employees based outside of
Canada?
individual items may be sub-
limited

Auto
• Collision: accident with
another vehicle
• Comprehensive: colliding
with a fixed object
• Loss of Use
• Rental Vehicle coverage
• Your vehicle is vandalized
• You hit a deer while
driving north of the city
• You get into an accident
while driving for business
purposes
• You rent a vehicle for
business use and get into
an accident
• If you have 5 or more
vehicles, you may qualify for
a “Fleet” discount
• Getting a telematics device
could help reduce the
premium
• Don’t confuse this with Non
Owned Auto

Crime
• First party (theft of your
own property)
• Third party (theft of
someone else’s property)
• An employee skims 1 cent
off of every transaction
your platform processes
• An employee steals all the
monitors in the office
• Is electronic crime included?
• Does the coverage extend to
contractors?
• Often customers have a
requirement for crime by
default, but you generally
only need it of you deal with
physical cash or valuables

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