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Covenant strengths at odds with how small businesses run their finances.

21st August 2012

Covenant strengths at odds with how small businesses run their finances.

It is a difficult for small businesses to come to terms with, but when entering a lease negotiation for a new office space, the twists and turns used by accountants to minimise company taxes are often the very actions that compromise a company’s ability to avoid large commercial property deposits.

“I was dealing with an Oil and Gas consultancy recently who wanted to secure new Mayfair office space.  They were obviously successful but because they held their profits offshore, their UK accounts were not strong enough to avoid a large deposit.” says Tom Lax, an agent with Morgan Pryce.  “Despite our advice, the client simply could not grasp that a 6-12 month deposit was normal given their unwillingness to declare healthy UK accounts.  The uncompromising stance the client took in refusing to give the landlord the comfort they required ultimately led to them not securing the space they wanted, even though the rest of the deal was extremely advantageous.”

This is unfortunately not an unusual occurrence in the world of commercial property, especially when a tenant is not being advised correctly.  The strength of a company’s covenant, in effect the likelihood that they will be around to complete the full term of the lease, is determined by a combination of net assets and the net profits being generated by the business.  To avoid a deposit altogether a company would normally be expected to demonstrate balanced accounts that show a genuine net profit of three times the annual rental value.  This profitability should be demonstrable for a period of three years prior.  Anything less and a deposit is required and for West End office space, this often sits at a minimum of six months for companies that cannot pass the Landlords covenant tests and twelve months if the accounts are a cause for concern.

“It is unfortunate that companies tend not to think about deposits or why they are required until the last minute” says David Perrins, Managing Director of Morgan Pryce.  “The reality is that many tenants think they can get away with low deposits based on their anecdotal assessment of the weakness of today’s London office market.  They fail to see that in the current climate, Landlords are more risk averse, not less, and they would rather hold out for a better tenant unless they are adequately covered.”

For clients being represented by reputable acquisition agents, and who are prepared to listen to sound advice, these pitfalls can normally be avoided.  For those tenants attempting to navigate the minefield of commercial property unadvised, or those that simply refuse to listen to the advice they are given, the results can often be frustrating and painful.

Morgan Pryce is a tenant only Agency, specialising in locating, negotiating and securing new London office spaces for its clients.

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