To Head Lease or Not to Head Lease?
In the franchise industry, the franchisor or the franchisee could sign the “head lease” with the landlord. By doing so, either party becomes the “head tenant”. Whoever signs the head lease maintains more control but will, conversely, spend more time on management issues including paying rent directly to the landlord and complaining about leasing issues.
Much like driving a car, maintaining control is an important factor. Whoever is behind the wheel is in the best position to steer the vehicle to a desired destination in a safe manner. Carrying this analogy further, franchisees holding the head lease are better protected with their investment. Should a royalty payment or two be missed, the franchisor cannot threaten to take the space over. Often, the franchisor completely controls and dictates the site selection process; however, a franchisee signing the head lease has much more say in the location selection. Should a franchisee with a head lease wish to ever sell his/her franchised business, this is a far simpler process requiring a lease assignment.
As The Lease Coach, we know full-well how franchisors often carry more weight with landlords and can negotiate favorable amounts of landlord’s work, leasehold improvement allowance, free rent, no deposit and so on. Note that not all franchisors will pass these benefits on to the franchisee. With a franchisee signing the head lease, any such inducements made can be to the franchisee’s benefit. One scenario we remember as being specifically relevant.
In this case, The Lease Coach successfully negotiated eight months of free rent plus a substantial tenant allowance as part of the lease deal for a former franchisor client … obviously, this client was delighted! Following our association, however, the franchisor then, however, offered the space to the franchisee with the sublease agreement providing only three months of free rent and no tenant allowance. The franchisor pocketed the incentives and savings while the franchisee remained none the wiser.
Overall, the main reason that franchisors would have for being on the head lease would be to position themselves to re-open or resell that location and franchise if the existing franchisee closes. We have seen franchisors make a tremendous windfall by repackaging a failed franchisee location and reselling the entire space - including equipment and leasehold improvements - to another franchisee that is not aware of a previous franchisee’s history in that location.
It is not uncommon for the franchisor to require the franchisee to include in the lease agreement an exhibit or list of terms giving the franchisor limited rights in the event that franchisee defaults on the lease agreement.
As we speak at franchise shows across the country, we are meeting with and noticing that more franchisors are not committing to head leases. Some franchisors are trending toward less risk by insisting their franchisees sign the head lease.
With a franchisee signing the head lease, the franchisee can control the real estate. This article does not provide enough space to examine all of the pros and cons of head leases, subleases and franchisee direct leases but, at least, the topic is now on the table.
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Dale Willerton and Jeff Grandfield - The Lease Coach are Commercial Lease Consultants who work exclusively for tenants. Dale and Jeff are professional speakers and co-authors of Negotiating Commercial Leases & Renewals FOR DUMMIES (Wiley, 2013). Got a leasing question? Need help with your new lease or renewal? Call 1-800-738-9202, e-mail [email protected] or visit www.TheLeaseCoach.com.