By Jesse
Fragale (Toronto)
A few months ago, the Rotman School of
Business in Toronto, in partnership with the Urban Land Institute, hosted an
event entitled Is Toronto’s Real Estate
Environment Healthy For Entrepreneurs? On the panel was an array of
experienced individuals, including the CEO of a growing fin-tech
company, the director of operations of a popular incubator and the head of a
major office REIT. The event was packed – an indication of how relevant the
question has become.
As a commercial real estate (CRE) broker
in Toronto who specializes in office leasing, I am well aware of the challenges
that startups have in acquiring the right office space in their early years. Conversely,
from working with clients on the landlord side, I can appreciate the hesitation
to lease space to these types of companies.
The Challenges
1. 1. Uncertain growth trajectory
Companies that are at the first few
rounds of financing in their new venture, or at earlier stages, have an
incredibly difficult time estimating a growth pattern with any sort of
precision. Their growth is certainly not perfectly linear, and this factor poses
a challenge for brokers in finding not only the right space, but the right
space for now. Companies at this
point in their evolution are just not in a position to make
commitments of five years or more without being exposed to some significant financial
risk. Abstractly, we can think of these companies’ growth as a curved or
exponential line on a graph, and office needs as a line that looks like a
staircase – once the company is too big for the space, the firm hits a wall and
needs to expand (a new step). We need to place this set of stairs over top of
this growth line as precisely as possible.
2 2. Covenant
When tasked with making a commitment to
office space, landlords expect that they will be able to hedge their risk with
a solid covenant from the tenant. When market conditions dictate that landlords
have more bargaining power, they will be less likely to gamble on new ventures that
have more potential to “go sideways.” As a result, startups can find it
difficult to secure an office location without having a track record. This
track record will typically mean a minimum of a few years of profitable
operating history.
3. Disconnect from the commercial real estate community
I believe that this point is the most
controversial of the three challenges, but I believe it is real and should not
be overlooked. The majority of these companies are being run by millennials and
hiring millennials. Although the CRE industry is becoming more and more
innovative, we are still behind in our engagement with millennials today – there
is a lack of presence and engagement on social media platforms that they use
every day (Snapchat, Instagram, YouTube, etc.)
What’s a startup to do?
Subleases, shared
office, collaboration, oh my
Five- and 10-year deals are just not
going to be an option for many startup companies. Potentially discounted
subleases can lower upfront capital expenditures and shorten time commitments
to make these companies more nimble. Shared offices and collaborative work
environments are other good options, provided the clients are amenable to these
arrangements and do not require exclusivity/use clauses (i.e. a clause whereby the
landlord agrees not to rent space to another tenant that directly competes with
the company that has said exclusivity.) Shared
space has become an attractive option over the past few years as we see more
co-working groups on the scene in major cities.
No easy way out
Creativity might not cut it here as landlords
– in lieu of an operating history – may ask for letters of credit, personal
indemnification or upfront rent to compensate their risk. As a broker, the
worst thing you can do in this regard is not have an upfront discussion of these
potential requirements right out of the gate. The last thing you want to do
after negotiating an offer or letter of intent is not be able to waive
financing conditions at the 11th hour because you were ill prepared.
Engage, engage,
engage!
Furthermore, startup clients should focus
on retaining representation from brokerages that make an effort to communicate
and engage with them – brokerages that understand their challenges and offer
solutions. Staying relevant and using all the resources you have available to
you is crucial. Beyond that, brokerage firms should reach out to incubators,
accelerators, business schools and like minded landlords who target startups or
other dynamic tenant groups (for example TAMI tenants; technology, advertising,
media, information). Engaging and spending time prospecting startups is not
without risk. Many of these companies fail before they get their feet off the
ground. A proficient broker will evaluate new-venture clients more intensely
and take a venture capitalist approach when targeting these companies. Does the
business make sense? Are the principals committed? What have they accomplished
to date? Ultimately, engagement must be a calculated endeavour and as efficient
as possible.
The bottom line
A mentor and founding partner at Avison
Young once said to me, “Jesse, think
of two rotating gears when working with any company. The large gear is human resources
and the little gear is real estate. The large gear costs the company much more
than the little gear and looks more important – but if you screw up on the
little gear, the large gear will grind to a halt.”
Startups should be focused on their
business and not get bogged down in acquiring new office space. Brokers who
represent these types of tenants need to ensure that they provide solutions
that position clients in an optimal place for future growth and success.
(Jesse Fragale is an
office leasing advisor who specializes in tenant representation focusing on
startup and tech firms. Based in Avison Young’s Toronto office, he focuses on
the Downtown and Midtown markets. Fragale holds a Master of
Business Administration (M.B.A.) degree in Finance and Strategy from Wilfrid
Laurier’s Lazaridis School of Business.
He holds a Bachelor of Arts degree in economics. He has also completed a
joint program on negotiation through Harvard University and the Massachusetts
Institute of Technology (MIT).
