By Jeff Manley, Senior Managing Director & Board Member, Taylor Wood, Senior Managing Director, and Tony DeFrancis, Managing Director, Savills Studley
With more than 1,700 start-up companies and counting, Orange County is a magnet for young, Southern California tech companies, many of which are sidestepping the pricier Santa Monica, Venice, and other Silicon Beach locations. One of the fastest-growing tech hubs in the U.S., Orange County ranks second in the nation in the number of high-tech clusters, and 14 OC-based companies rank among the Deloitte Tech 500’s fastest growing tech companies.
The influx of start-ups into Orange County, along with the exponential growth of many maturing tech companies, makes it increasingly challenging for these businesses to acquire space in one of the most vibrant commercial real estate markets in the nation. This challenge is exacerbated by the responsibility of managing need vs. want. Companies need to preserve the capital that is critical for the growth of the business, while securing the facilities and top talent that support forward momentum. So, how can OC start-ups effectively address their real estate requirements as they develop and expand?
Attracting and Retaining Top Talent (and the Associated Cost)
Jobs at tech companies are the top choices for talent, as the industry offers wide-open opportunities and values of innovation and growth. It can be a challenge to provide a space where youthful talent will want to come and stay. The common wisdom is that the “cool” factor makes all the difference in building a talented team of young, disruptive, smart, and creative people. The conundrum is that it costs money to create innovative environments, and new start-up companies don’t have the money to spend—although today’s open plans free of dividing walls or cubicles generally cost 20 percent less than higher-density space. You will need to understand and manage the gap between the average tenant improvement allowance in your lease—the amount a landlord is willing to spend so that the tenant can retrofit or renovate the office space, generally around $50 per square foot—and the $190 per square foot average cost of a creative build-out, including hard and soft surfaces, furniture and technology.
Managing Cash and Maintaining Flexibility through Effective Negotiation
Much of the conversation about tech workspaces orbits around the “cool factor,” but you will undoubtedly spend more time addressing your company’s more pragmatic issues. Principal among these is negotiating and securing a real estate opportunity that is as economically favorable and organizationally flexible as possible. The commercial real estate rule of thumb is to, whenever possible, prevent unwanted surprises. This is particularly true for new and growing companies that must be able to adapt to unpredictably changing circumstances.
Negotiating option rights to make your lease and lease terms more fluid, e.g., by implementing meaningful expansion, contraction and extension rights, is one way to address operational fluctuations.
It’s important to understand how to manage cash through effective negotiation for space that is appropriate to your company’s cash position. For example, your advisor might help you to:
- Approach your prospective landlord in the most persuasive way possible, including validating how you will meet your lease obligation. Establishing financial intelligence and demonstrating why an owner should take the risk of leasing to a young company may mitigate having to pay an overly burdensome security deposit.
- Defer some cost by agreeing to “must-take” space, which is an option for a predetermined space for expansion that you will exercise at some agreed-on point in the lease term; or
- Postpone part of your payment by negotiating a deferred rent concession where you make fewer or lower payments at the beginning of your lease, with the understanding that additional rent to compensate for the deferral will be due in future periods of the lease; or
- Reduce your outlay on a security deposit by using a letter of credit (LC) to preserve cash in your company’s bank account. The landlord may prefer an LC to cash, which is subject to bankruptcy protection, to have the ability to draw on the LC.
- Reduce your security deposit amount by, for example, committing to timely rent payments; demonstrating that your company will receive subsequent rounds of funding; demonstrating your profitability metrics; and showing expected inflows from impending product, software, or service releases.
- Consider sublease opportunities where capital has already been spent and avoid the negative cash burn required by the construction of tenant improvements. Due to the rapid growth and need for frequent moves in the technology industry, more companies are subletting their leased office spaces, providing an opportunity to make shorter-term commitments and take advantage of fully built-out and furnished workspace. Sometimes piggybacking on second-generation space is the smart move.
Why grow in Orange County?
Although rents in Orange County in the current strong market remain high, with gross asking rent in Irvine averaging $3.10 per square foot, you will still enjoy a cost-saving advantage when you locate your headquarters in Orange County. A glance at the average rents in Orange County and how they compare with other U.S. markets will give you an idea of what to expect when you enter negotiations for your lease.
Source: Irvine Company Office Properties
Tustin, Santa Ana, and parts of Irvine are less expensive, as well as outlying areas acceptable to start-ups that want to dodge the $3.00-$4.00 per square foot rents that are becoming the norm in the John Wayne Airport and Irvine Spectrum areas. Another key advantage for start-ups is that Orange County doesn’t levy any city taxes on the gross receipts/revenues of a company, unlike much of greater Los Angeles.
The success of your start-up will depend on your business plan, the market you are entering, and your own talents and capabilities. Amid the many urgent priorities competing for your time and attention, it can be easy to overlook the importance of your company’s commercial real estate choices. Keep in mind, however, that your rent and the provisions that govern your lease are significant financial factors that can support—or slow—your company’s growth. Working with an experienced real estate advisor will make your real estate learning curve a lot shorter. You can rely on your representative’s knowledge to guide you through the careful planning, good timing, and skillful lease negotiations that will secure optimal cost savings for your start-up’s headquarters.
Savills Studley is a leader in analyzing space needs for businesses to help set goals and expectations, create solutions, and smartly manage and deploy resources in securing office, R&D, and industrial spaces. For more information, please visit www.savills-studley.com.
Real Estate Strategies for the Stages of a Start-Up’s Growth
When venture capitalists fund a new venture, they provide private equity capital to see a start-up through seed, early stage, growth, and mezzanine in exchange for equity. Every stage generates different, unique real estate needs for a company.
- Seed and Development
Before the start-up is officially a business, it needs a period of time to develop its business idea, assess its viability, explore the market it wants to enter, and figure out how to finance a launch. Typically, this stage starts in a living room or a garage—a space with no infrastructure costs.
This is a risky stage where a company will need to conserve resources and not spend investors’ money unnecessarily. For a company of two to 10 employees, a month-to-month lease in a co-working space such as WeWork, Regus, or Serviced Office Space, is a low-cost solution. Companies that want to protect proprietary information may prefer not to share space and systems. In the initial stage of a company’s lifecycle, however, the rule of thumb is to spend as little money as possible on space. Consider live/work alternatives—your office should be basic, functional and shared.
Companies in their initial stages may believe that a “cool,” standalone office is a key to success in attracting tech talent. Don’t overpay for the cool factor in your space. At this stage containing costs is the wiser course.
- Establishment and Growth
When the company begins to generate consistent income and is expanding its customer base, improved cash flow will be available to cover expenses. It’s time for a first move. For a company of 11-20 employees, a good solution is a 12-month lease on a customizable, fully furnished “spec suite,” a pre-built office suite, usually about 1,500-4,000 square feet in size. A sublease can be another way to obtain a furnished space at minimal out-of-pocket cost, but you may not have the option to remain in the space at the end of your lease.
The start-up has attained a secure place in the industry, with rising revenue levels and an expanding workforce of 21-49 employees. At this stage, a company can look at its growth forecast, assess its needs for the next three to five years, and lease a space where it has an opportunity to build out and create its own, unique workspace environment that is congenial to employees and optimized for further growth.
Having successfully expanded its business, the company is seeing stable profits from year to year. With 50 or more employees, it may still be growing at a fairly fast clip. It’s time to lease a generously sized space the company can “build-to-suit” for further expansion, or even build its own facility based on careful analysis and forecasting.