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Franchise Tutorial 20: Intro to Leasehold Improvements

Leasehold improvements are fixtures or improvements that are attached to the retail or commercial space and installed by the franchisee when setting up a new location. Upon expiration of the lease, these improvements remain with the space and become the property of the landlord. Examples of such improvements include:

walls
doors
cabinets
light fixtures
floor coverings
machinery and equipment if bolted down to the floor

These improvements are required to make the space work for the needs of the business. As a franchisee, you are typically responsible for all the costs associated with constructing the space and leasehold improvements, as well as ensuring that this is done according to the franchisor's specifications and standards. The franchisor is responsible for the integrity of the brand and will usually provide standard prototype plans and drawings. An architect would then be required to create new plans that are specific to your space and that comply with local bylaws and city requirements, while still meeting the franchisor's standards. Some franchisors have design services as part of the franchise support or as an added fee. The franchisor will require that plans be approved by them before construction starts.

Depending upon condition of the space and the business model, the required leasehold improvements can be extensive. If you are dealing with a brand new building with a "shell" space (bare cement walls and floor) and are constructing a restaurant, you will require plumbing, HVAC, heating and electrical, in addition to the typical improvements. Costs can range from $100,000 to well in excess of $700,000, depending upon the type of business, size and condition of the space. These costs can sometimes be reduced by the landlord through a leasehold improvement allowance or a lump-sum payment upon completion of the space.

In some cases, you may acquire a space that has pre-existing leasehold improvements. This could reduce the costs, but not necessarily. In some cases, few improvements can be salvaged for your use. This means you are paying for demolition of the old as well as new construction to bring the space to the franchisor's specifications. Many times there are costs associated with bringing the old improvements up to standard building codes, such as having extra washrooms and proper kitchen electrical, gas, plumbing and ventilation. Don't assume there are savings by dealing with existing improvements. Work with the franchisor to have a thorough site assessment done.

Depending upon the franchise, you may be required to build out the location through the hiring of a general contractor. Ask the franchisor to recommend a general contractor who has built out stores for the franchise in the past. You want to select someone who is reputable and can get the job done on time, on budget and within the franchisor's specifications. Check references and visit locations that this contractor has built in the past.

Whether it is through a general contractor or the franchisor, be sure to get specific quotes as to what the build out of the location will cost and get it in writing. There will often be unforeseen costs and delays. Address beforehand what happens if costs exceed, say, a 10 percent variance. You may be able to negotiate that such overruns are the general contractor's responsibility or that there is some compensation to you for delays. In reviewing the costs for a store build out a franchisee will often comment that the costs seem high. Avoid the desire to negotiate the improvements and reduce costs. Quality construction is expensive but typically necessary. You will always be able to find a cheaper piece of equipment or specification of carpet, but usually at the expense of quality or warranty service. The cheaper kitchen equipment may have a tendency to break down. How much will this cost you in lost revenues when your restaurant is closed for equipment repairs? How does it affect your business when the carpet is frayed and worn in high traffic areas after only a year, and in need of replacement?

Throughout the entire process, the franchisor will be overseeing the plans and construction to ensure the finished location conforms to franchise concept specifications. The franchisor will typically make regular site inspections during construction to ensure that the brand is consistent and that the location has the same look and feel as all the locations of the brand. You may be able to provide input but it will be the franchisor that will make the final decisions. Recognize that they have the experience and that often there is a strategy behind the design. You may feel that the kitchen is too small and want to make it bigger, yet the franchisor recognizes, through experience, that a smaller, well-designed kitchen creates greater work efficiencies and permits more front of house space, thus allowing more tables and greater revenues. If you object and fail to comply with the standards, you may risk being in breach of your franchise agreement and incur costs to redo certain parts of the build out in order to conform to franchise standards.

Leasehold improvements and store build outs can be overwhelming. There are a lot of details and it is a large investment. Make sure that you select the right contractor and have the build out monitored closely by the franchisor. Ask questions so that you understand the decisions being made but rely on the experience of the franchisor. That is part of the value of a franchise.

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Posted Date: January 2011