Putting it all on the line
If you're getting involved in taking a lease over a property, you'll likely hear reference to the term ‘covenant’.
The word covenant has roots from the Latin ‘convenire’ – meaning ‘to meet’ or ‘to agree’ and latterly from the French ‘covenant’ meaning ‘agreement, pact or promise’.
Yep, you didn’t think you’d signed up for a lesson in, not one, but two languages but here you are.
In property terms, a company’s covenant relates to the strength of the entity that a tenant offers as security against the lease.
At one extreme, Tesco Stores Limited holds every Tesco store lease. So, the chances of that going bust are considered very, very low. From a landlord's perspective, Tesco are therefore a very safe tenant, which landlords find advantageous, naturally.
On the other hand, a new company that's just been formed today may have no assets, no money and no trading history – so landlords naturally consider this more high risk.
The consideration for operators is that the choice of whether to accumulate a growing store portfolio under one company or to operate each site from a series of new companies, known as Special Purpose Vehicles (SPVs), is a contentious and strategic decision.
Each side of the coin has pros and cons, so it’s worth taking specialist advice from accountants, lawyers and property advisors before getting stuck into to a lease that might leave you, err, stuck, in the future.
The key benefit of holding all leases in one company is that a profitable company can reduce the need for rent deposits on new sites, whilst increasing landlord confidence to offer you a cash contribution towards your fit-outs, and can even lead to lower rents – freeing up cashflow for quicker expansion. The flipside is that, if one of your stores is not performing, it can be difficult to extricate yourself from that lease, threatening the whole company. Naturally, the landlords are also not spared this risk, as the landlord of a strongly performing site could be affected by the failure of another site elsewhere, with the losses sending the tenant into a company restructure.
For these reasons, some operators will insist that they don't want to offer their main company for each new site that they open. The upside is protecting one part of the business from another, by ‘ring-fencing’ each operation, but that comes at a cost. Landlords are likely to insist on rent deposits, and without much security to rely on, may be more reticent about handing over substantial capital contribution incentives, lest the newly-formed tenant pocket the money and disappear to the Bahamas (tempting though it is…).
It is slightly perverse that the operators who likely have the most money to expand tend to get the best deals, and the younger operators starting up tend to be seen as too high risk despite finding cash in more short supply, but that is the nature of the market.
Before you set off on your journey to dominate the hospitality sector, you need to give some consideration to what structure you’re going to build your empire on. But don’t do it alone, find the experts who can guide you through the big property decisions.
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