Growing companies often face a dilemma when a landlord requires a 3-5 year lease. Lease only the space they need today and risk not having the space they need as they grow. Or lease more space than they need now betting on the growth that then doesn't occur.
So what to do? The best way to handle this dilemma is to sign a lease for the space they actually need now to take care of the immediate need and include an expansion provision. Expansion provisions come in a variety of forms:
Rights of First Refusal (ROFR)
Right of First Offer (ROFO)
An expansion option means that the landlord holds space off the market for some period of time until a date on which the tenant has the exclusive right to lease the space. Landlords hate this because it means there is little to no chance they are going to get revenue from that space during that time.
A right of first refusal (ROFR) entitles the tenant the right to accept or reject an offer on expansion space on which the landlord has received a third-party offer it is willing to accept. This is especially advantageous for tenants who are expecting growth and would like to control an adjacent space. Granting the ROFR to a growing tenant can be advantageous to a landlord because of the existing relationship and the far-reaching financial benefits of having a long-term, stable tenant in place.
ROFRs can be structured many different ways, but often require that the terms of the third-party offer be matched. Those terms may not fit the tenant’s situation..or the landlord’s for that matter. Additionally, the control of an available space as a result of the ROFR jeopardizes the landlord's ability to market it.
Rights of First Offer (ROFO) clauses are similar in that they grant an existing tenant the right to negotiate for a space being pursued by an interested tenant. A ROFO grants a tenant the opportunity to negotiate for the subject space when it first becomes available…not simply agree or disagree to terms already negotiated by another party.
Receiving a ROFO in a lease often satisfies a tenant's desire for growth while significantly reducing the landlord's obligations and improving its ability to market space. Thus, many transactions pass over the ROFR in favor of the ROFO.
For both the ROFR and ROFO, a tenant should ask that the space be re-offered if a competing negotiation fails or if the terms of the current offer improve significantly in the favor of the third party.
Finally, the Must-Take is a mechanism whereby the additional space that a tenant is going to need for growth automatically becomes part of the leased premises on an agreed date. If the tenant leases 5,000 square feet (SF) initially, it might also commit to lease an additional 1,000 SF which automatically becomes a part of their space after 6 or 12 months.
Any construction required is done at the same time as the initial premises in most cases. That way the space is guaranteed to be ready when the tenant needs it. The only risk is that the tenant’s growth doesn’t occur on the schedule expected and they may then be obligated to an additional expense before they need it.
But let’s face it. Dealing with space needs for a growing company is a far better problem to have then excess space for a shrinking one.