An entrepreneur's guide to heads of terms for leases - Boodle Hatfield

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Article
19 Oct 2023

An entrepreneur’s guide to heads of terms for leases

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Katherine Worrall View profile
4 min read

When it comes to leasing your first commercial space for your business, or expanding as you scale up, head of terms can be a powerful tool to streamline the process and help you hit the ground running. In this short guide, we'll break down the fundamentals of heads of terms for leases and highlight key points for time-pressed entrepreneurs.

What are heads of terms?

Heads of terms are the agreed fundamental, commercial terms for the lease. They should be set out in a concise heads of terms document which will then be used as a roadmap for drafting and negotiating the lease documentation. Heads of terms set the stage and can be instrumental in avoiding misunderstandings later on.

Key points to remember when agreeing heads of terms:

  1. Parties, property and term: Ensure that you clearly state the parties involved, the property details and define the lease term, specifying the start and end dates.
  2. Rent and rent review: Lay out the rent amount (including whether VAT will be payable), payment frequency, any rent free periods and any rent review mechanisms.

Note that you might want a break option to counterbalance the risk of a rent hike on review, or to maximise your flexibility should the property be no longer suitable for your needs (see exit strategy below).

  1. Repair and maintenance: Clarify responsibilities for repair and maintenance. Typically, the landlord will be responsible for structural and external repair and maintenance (with the costs thereof recovered from you via the service charge), with you handling internal, non-structural repair and maintenance. If the property is in disrepair at the outset, consider whether a schedule of condition would be appropriate, limiting your repair obligation so that you do not need to return the property (at the end of the term) in any better state of repair or condition than that it was in at the start. 
  2. Rent deposit: Agree the amount and terms of any rent deposit. Landlords will generally require some security against the risk of you not paying the rent or complying with your other lease obligations. This is particularly the case where there is an SPV, or infancy stage, tenant. A combination of a rent deposit and a guarantee might be required by some landlords. 
  3. Permitted use: Specify the permitted use of the property. Ensure that aligns with your business activities, and future plans, and consider whether you might want the right to change the use in the future, how the breadth (or lack thereof) might impact any rent review, whether the use covers relevant ancillary uses and whether you require flexibility so that you can market the lease more easily if you need to assign it later.
  4. Alterations: Outline what alterations you will be able to make (ie: structural, non-structural, internal, external) and whether they will require landlord consent or not. This is crucial if you plan to customise the property to suit your needs either at the start of the term or as your business develops. Whilst you will typically want maximum flexibility, landlords will be concerned about how alterations could affect the residual value of the property. 
  5. Service charge: Service charge is the contribution you will pay towards the landlord's costs in maintaining and repairing common parts, providing communal facilities and so forth. It is particularly relevant if you are taking a lease of part of a building, or estate, rather than a lease of whole. Consider whether there should be any service charge exclusions, caps or limits on the use of reserve funds and ensure that items which are properly the landlord's responsibility (such as the cost of enforcing tenant covenants in other tenants' leases) are not recoverable.
  6. Insurance: Set out the insurance obligations, including who is responsible for what cover. Common practice is for the landlord to take out buildings insurance and for you to then reimburse it for a fair proportion of that cost (depending, if you are taking a lease of part, on the size/ value of the space you are taking compared with the wider building or estate).
  7. Exit strategy: Make sure you have a clear exit strategy in place. If things don't go as planned then you will want to be able to walk away. It is not standard for a lease to allow you to just terminate at any time and so you will need to make sure you agree the inclusion of an ability to assign (sell) the lease and/ or underlet the property alongside, if possible, a break clause.

Conclusion

As a time-poor entrepreneur, proper heads of terms are key to a smooth leasing process. By investing time and thought into them at the outset, you will set the stage for a faster, easier and more efficient process. Remember, the devil is in the detail, so be thorough and consult with legal experts as necessary.

It is important to remember that whilst heads of terms show intent, and have moral force, they are not binding and cannot be enforced between parties.

Once you have agreed heads of terms, what should you expect from the legal process? A helpful article on this topic can be found here. 

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