Lease Break Clauses Are They Good For Your Business Or Not?

04/02/2011 by info.

A break clause in a lease gives a business owner the automatic right to terminate the lease at one or more specified dates. An entreprenuer may want a break clause if they are unsure about how successful a business venture is going to be.

So they will negotiate a five year lease for example with a two year break clause, and if the venture is not working out they can then withdraw without any fear that the landlord will want the other three years rent.

The problem with these break clauses of course is that the owner only has a short period of time to decide whether a venture is working or not, and some break clauses require a long period of notice say six months.

The business may not even open for business for the first one or two months of the lease as they will be fitting the premises and stocking it, meaning that the business owner has effectively just over a year to decide whether to opt for the break.

Now most new businesses do not make a decent profit in the first year, most small businesses are sold for one to two times ongoing profitability, why, because that is the opportunity cost or starting a business. You either have the choice of buy a business with immediate profitability or start one and have minimal profitability for the first two years.

A lot of business owners also overestimate their profits in year one, and just because they are not meeting their unrealistic targets they often give up.

So what happens psychologically with a break clause?

The owner knows he has a fall back position and he has to make a decision after a year, is this business going to work? I have already shown that a year may not be enough time to assess whether a business is going to work, an owner therefore may give up just as he business is about to bear fruit.

In addition it stops the owner selling the business as, in year one no one would be interested, and he knows that the business is going to close in 6 months so there is no point in trying to sell it is there?

The problem with break clauses is that they are often used as a substitute for research and business planning. Ensuring that your business proposal has legs and ensuring it will be successful is replaced by a negotiating break clause.

Are lease break clauses leading to the closure of otherwise good businesses? The answer clearly is yes.

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