The Basics: Key Money Deals

There are about 24,000 food service establishments operating in New York City.  In such a highly competitive industry, it’s no wonder that the failure rate for these businesses is so high. With new openings and closures happening every day, the market for fully built-out restaurant spaces is abundant.

If you’re thinking about opening a restaurant in NYC, these turnkey options may be very attractive.  Think about it: most of the work has already been done.  The current tenant has already negotiated a lease, built out the space, purchased equipment, and may have obtained a liquor license.  For an operator, this may seem like a dream come true. However, there are many aspects of a “key money” deal that must be considered, lest your dream quickly become a nightmare. 

What the heck is key money anyway?  

Basically, key money is an amount paid to the existing tenant to buy them out of their lease.

In addition to getting the seller to assign over its lease, the amount paid will usually entitle the purchaser to all of the furniture, fixtures and equipment within the restaurant. 

A premium may be paid if the seller has a full liquor license, as the purchaser may be able to get a temporary permit to serve cocktails while its retail application is pending.

Is it a good deal?  

A key money deal will make sense when the existing lease terms are favorable.  However, if the terms are suboptimal, they will have to be renegotiated, which may negate some of the benefits that made the space so attractive in the first place. 

  • For instance, if there are only 3 years left on a 10 year lease at a below-market rent, does it make sense for you to take it?  You can ask the current tenant to renegotiate the lease, though you risk losing that favorable rate in the process. 
  • Can the lease even be assigned?  Most leases have provisions that require landlord approval for assignments and some contain outright prohibitions.

At the end of the day, the key money price is usually negotiable.  It’s important for both buyers and sellers to have experienced counsel help them understand the nature of these deals, the current market and the various values that affect the price.

Is it what you want?  

Usually, someone looking to open a restaurant will want to do it on their terms, installing their own concept and design.  Does the existing space fit with what you want to do or will you have to renovate?  Significant alterations, particularly those involving electrical or plumbing work, can be costly and require permits that take time to issue. 

While the lease and location may be beneficial, a delay in opening due to construction may eat into your budget and, consequently, any advantages of the deal.

Can I get you a drink?  

In some situations, a purchaser of an existing restaurant with a valid liquor license may be able to get a Temporary Retail Permit (TRP) to serve alcohol.  A TRP, contrary to popular belief, is not a transfer of the seller’s liquor license; it is a special permit issued by the SLA that allows a purchaser to serve alcohol while its retail application is pending.  

There is no guarantee that, having been issued a TRP, the purchaser will be granted a full liquor license.  The purchaser will have to go through the same application process as every other new applicant, including notification of the local community board, compliance with the 200 & 500 foot rules, and disclosure of financials.  In addition, the TRP will only permit the purchaser to operate the same way as the seller — if the seller’s license allows only beer & wine sales, the purchaser will not be able to serve liquor.

Make no mistake, a TRP can be very valuable to a purchaser: the business can execute its full concept and reap the high margins on liquor sales while the full application is pending.  That extra revenue can be crucial in the first few months of operation.  

What now?

There is a lot to think about when making the decision to open a restaurant.  A key money deal is one common avenue to acquiring a location, though it's certainly not the only way.  To ensure that you choose the best path to success in the industry, it is vital that you retain the advice and services of expert legal counsel to guide you through the process.

Of course, my door is always open to continue the discussion!