The Security Deposit is a critical factor in office lease negotiations. For start-ups, the amount required can often make an otherwise attractive lease transaction impractical.
From the landlords’ perspective, a lease to a start-up is often a risky proposition. The “standard” one-month of rent equivalent security deposit generally goes out the window. The typical start-up has a short operating history and usually, has yet to turn a profit. So to mitigate risk when leasing space to a start-up company, most sophisticated Landlords will require a security deposit that will cover their out of pocket costs for the transaction and some amount of vacancy.
Transaction costs can include: Tenant Improvements (build-out of the office), free rent, attorney fees, brokerage commissions, and often, a few months’ cash equivalent of monthly rent for vacancy. These line items can quickly add up. In some cases, I have seen Landlords require a security deposit equivalent to 10-12 months of rent from start-up tenants.
For a start-up business, underwriting a large security deposit for the duration of their lease is unacceptable. In response, I have negotiated creative solutions and structured the securitization of a lease to meet both tenant and landlord needs. For example: Rather than a cash deposit, Landlord’s will often accept, and in some cases prefer, a Letter of Credit (LC). Additionally, I have successfully negotiated a “burn down” of this LC over time for a tenant in good standing. This means that so long as the Tenant is not in default, after a certain period of time, a portion of the Security Deposit is reduced or credited towards monthly rent.
The security deposit is often overlooked or not addressed during initial negations. I always push to flush out the security deposit as soon as possible, because in some situations, a substantial security deposit can be a deal killer.