We previously discussed some of the issues regarding an office lease that need to be considered when buying an orthodontic practice and the selling doctor owns the office. In this article, we will discuss lease issues to be considered when the office is leased from a third party.
The first item to consider is when you can contact the landlord about lease terms once you purchase the practice. Quite often, the selling orthodontist wants the sale of the practice to remain confidential as long as possible. The seller may not want the landlord to know that he/she is selling the practice until many of the other sale and financing terms are agreed to by the buyer and seller. Thus, the buyer’s conversations with the landlord may not begin until later in the negotiation process.
Just like when the selling orthodontist owns the real estate, the lease terms must be considered. The buyer generally has to get at least a 5 year lease term, inclusive of renewal options, in order for a bank to provide financing for the transaction (the bank wants assurance that the buyer will have an office to treat patients and earn income for a reasonable amount of time in order to repay the purchase loan). The landlord generally prefers a longer lease term, and the buyer has to consider how long he/she plans to stay in the office and whether another office or location in the city is better for the practice. If the buyer’s plans are to relocate the practice soon, he/she should try to negotiate a shorter initial lease term with options to extend the lease for one year periods (to satisfy the lender’s requirement).
The lease rate also needs to be considered as we have seen some instances where the seller has been in a tenant in the office for a number of years without a rate increase, or without a formal lease agreement, and has a very good relationship with the landlord. When the seller is no longer the tenant, the landlord may see this as an opportunity to increase the rental rate to fair market rates, which has an impact on the practice’s profitability. Similar to when the seller owns the office and the fair market lease rates should be considered when the practice valuation is prepared, if it is fairly certain that the lease rate will be increased in the future, the practice valuation should take this into account and the buyer should be made aware of this early in the process.
Finally, one of the biggest issues we often face is the landlord’s reluctance to release the selling orthodontist from personal liability related to the lease (particularly when the lease is assigned to the buyer). The individual doctor often personally guarantees that his/her professional corporation will pay the lease. The selling doctor usually has been a tenant in the building for a number of years, is financially well established, and may have a great relationship with the landlord. With the sale of the practice, the buyer will be required to personally guarantee the lease payments, but the buyer usually doesn’t have substantial personal assets as does the seller. More than likely, the buyer has minimal liquid assets, a lot of student debt, and very little or no experience running a practice. Understandably, this makes the landlord nervous and the landlord may refuse to release the selling doctor from his/her personal guarantee of the lease. This is an issue for the seller, which may require additional negotiations with the Landlord as to how long the seller will remain a guarantor.
There are many items to consider when selling and transitioning an orthodontic practice, and the lease agreement is just one of those items. However, the lease can often turn in to a multi-faceted negotiation process that can take longer than the parties anticipate.