This can be one of the most contentious points in any lease negotiation… Just how much security deposit does the landlord want and what is the tenant willing to provide? This is an issue with almost any tenant I’ve worked with, from the small law firm all the way up to Fortune 100 companies.
It’s helpful to understand what the landlord wants to securitize. Because the landlord is amortizing a number of up-front costs into the lease term, he is most focused on those costs when he weights the amount of security deposit he requests. These initial costs include the tenant fit-out budget, any relocation allowances, rent concessions, and other deal expenses (like commissions and attorney fees.)
There are a few ways to handle the security deposit and I have helped tenants work through a number of them (and kept them away from others.)
Traditional Security in Escrow: This is probably the most common and simplest way to take care of a security deposit. A check for the agreed-upon amount is provided with the signed lease and placed in escrow for the term of the lease. Some tenants shy away from this because they don’t want to give up control of their cash or want it earning interest in their bank.
Letter of Credit: In this case, the tenant places the security deposit in a savings account with their bank and a legal document is provided that gives the landlord access to those funds if the tenant defaults. There is typically an annual fee from the bank for this service and some additional documents that must be attached to the lease.
Personal Guarantee: Essentially, the principal is personally guaranteeing the credit of his firm to avoid tying up cash like you would have to with one of the two above options. While it does avoid any up-front cash outlay, there is tremendous exposure. While I have seen these in leases I’ve reviewed, I’ve never had a client put forth a personal guarantee.
The next post will discuss how the security gets negotiated, creative ways to structure a security deposit, and ways to minimize the impact on available cash.