What to do when your landlord asks for a security deposit
You have 3 main options to secure your lease during office negotiations. Here’s how to tell if a security deposit, letter of credit or personal guaranty is best.
Believe it or not, finding a space that's attractive to talent and flexible enough to grow is often the easy part of your real estate search. It’s the negotiations and minutiae of making a deal that threaten to take the wind out of your sail, or even cause you to rethink your choice. Especially if you’re a startup or new to lease negotiations. But it doesn’t have to be that way. The best advice: Know your options. Understand what you should expect from a landlord and alternatively, what they’ll expect from you.
Where most small companies run into issues is negotiating how to secure their lease, or what the landlord will hold in case a tenant doesn’t hold up their end of the deal.
Many landlords spend tens of thousands, if not hundreds of thousands of dollars, to build out a space to attract a particular tenant. But they’re uncomfortable investing in startups that lack financial history and require some type of security up front. Here’s how to prove your company is a worthy investment.
Depending on your budget and landlord’s expectations, you might use a security deposit, a letter of credit or a personal guaranty to secure your office lease. Below, see the pros and cons of each.
This is the most common way to secure a lease and works much like a residential security deposit. Typically, a commercial security deposit is equal to one month of rent and is paid upfront when a tenant signs the lease. The landlord holds the security deposit throughout the lease term and returns it back to the tenant at the end, provided they adhered to all lease obligations.
The amount of security deposit can be higher, depending on what the landlord spends on tenant improvements. In some cases, a landlord will ask for up to 6-12 months of rent as security deposit. This is challenging for any company, let alone a startup.
Even if you’re willing and able to put up a larger security deposit, always negotiate incremental refunds in your lease. That way you can recoup a portion of that deposit on a regular basis, provided you’re in good standing with rent payments and other obligations. In no event should you let a landlord hold several months of rent for the entirety of the lease term.
Letter of credit
Some companies have a strong relationship with their bank and have built up an availability of credit. If that’s the case, you can put up a letter of credit in lieu of a large security deposit. This solves the challenge of paying cash up front, but can still significantly impact your access to capital.
Does a large line of credit make you nervous? Smart advice would have you spend investments only on the growth and sustainability of your company itself. However, that often hinges on having the right office space to attract talent and boost productivity, so the investment through credit could be worth it.
As with the security deposit, always negotiate that the amount held in a letter of credit is reduced over time and ultimately would go away as you stay current on rent and earn trust from your landlord.
In this arrangement, the owner of a company puts up their personal assets as collateral should something happen with the lease. This is highly uncommon scenario, but is still an option. However, it is viewed as an unorthodox solution that should not be taken lightly and requires a strong negotiating partner to lower your risk. In the event you find the absolute perfect office for your company, cash is tight and available credit is limited, a personal guaranty could be the right option.
To give you some context: In my nine years of representing tenants in these types of negotiations, I have only had one client sign a personal guaranty. He did so with the confidence that his company would succeed and he was not stretching himself too thin. It ultimately worked out and never became an issue, but we negotiated a low-risk scenario to ensure a good outcome.
Before you enter any lease negotiations, it’s important to know your options and what to expect. If you’re working with a real estate broker (and we suggest you do in this case), it’s important to have an up-front conversation about your comfort levels around security. Then when the issue arises in negotiations, you’ll have a plan that’s aligned with your future and financials.