TENANCY

What is a tenancy?

Tenanted pubs are operated under a tenancy agreement. This agreement is offered by the owner of the property, (normally a brewery or pub company) to individuals wishing to become a pub tenant. The pub tenant runs the pub as their own business and is responsible for paying all the bills. They take on the pub by paying for fixtures and fittings, stock and a deposit. A rent is paid to the owners, and tenants have some obligations to decorate and repair their pub. Tenants may be ‘tied’ to buying certain drinks products direct from the brewery or a brewery nominated by the pub company. Agreements typically run for 3 or 5 years, with some having a guaranteed option to renew the agreement, subject to a rent review. Rents are reviewed on a specified basis; some rents are increased annually in line with inflation.

What’s good about a tenancy?

A tenancy allows you to acquire an established business for a relatively small outlay. It is the traditional agreement that has been offered by breweries for the last century and is a well-established way of operating. Many breweries and pub companies now offer excellent training courses that you will be required to attend before you take on your pub. Ongoing support and advice is provided and there will be regular visits from their representatives (known as Business Development Managers or Area Managers).

Agreements have protection under the Landlord & Tenant Act 1954, which means that your position as tenant is legally protected. You cannot be asked to leave the pub during the course of your tenancy unless you are in serious breach of your agreement or have accepted terms to leave for some other reason.

The tie

The agreement may ‘tie’ you to buying specified drinks directly from the brewery or a brewery nominated by the pub company. Drinks prices are displayed in the price list that should be issued to you at the early stages of any discussions to take on a tenancy. You may find that identical drinks can be purchased from other suppliers more cheaply than you can buy them from your tied supplier. This can be a frustration for many tenants. However, the rent for your pub has been calculated taking into account the prices of the products you are tied to buying. To buy from unauthorised suppliers is regarded as a major breach of your agreement and one that may result in legal action against you. If you want to take on a tenanted pub, the tie is something that you will have to accept and adhere to.

Ties will vary between different tenancies, some being full ties and others, part ties. A full tie is where you are fully tied to buying all drinks products from the agreed supplier. A part tie only ties you to buying certain drinks products, for example, a beer and lager only arrangement, where you are free to purchase wines, spirits and minerals from elsewhere.

Discounts

The brewery or pub company may offer discounts on drinks products purchased from them. Depending on the agreement, these discounts may only be available if you exceed certain targets or may be immediately applicable for certain products. Prior to offering a pub, the brewery or pub company estimates how much discount is likely to be earned from them, and take this into account when calculating rent. This estimate is based on what they expect you to sell. The more you sell, the more discounts you earn. Here are some general tips on discussing discounts with a brewery or pub company:

• ask how the discount scheme works;
• make sure you understand it;
• ask them to explain how any ‘anticipated discounts’ have been worked out;
• be realistic about how much discount you are likely to earn;
• seek advice from an accountant if necessary.

Amusement machines

It is normal practice for the brewery or pub company to take a share of income from any amusement machines you have on your premises. The tenancy agreement may also require you to only use machine suppliers that are recommended by the brewery or pub company. For more information, see Chapter 18, Amusement Machines.

Trading accounts

Most tenants are not required to disclose their trading accounts to the brewery or pub company. Nor are they obliged to show this information to anyone wanting to take on their pub when they are planning to leave. There is no purpose in disclosing this information as they are not selling on their business. It is the responsibility of the brewery or pub company to find a replacement tenant when an existing tenant decides to leave. This is one of the downsides to taking on a tenancy: a lack of trading accounts. Any decision has an added element of risk. This can be minimised by putting together your own financial forecasts. (See Chapter 3 for details.)

Rents

The setting of rents is generally based on turnover and profitability. In calculating a pub’s rent, the brewery or pub company will initially assess the pub’s turnover based on ‘fair maintainable trade’ (FMT), ie their prediction of the turnover that a competent hypothetical tenant or lessee could achieve whilst operating the pub. From this they prepare an estimated profit and loss forecast using industry standards as a guide to the pub’s operating costs. The rent is then based on this. It should be noted that the brewery or pub company profit and loss forecast is simply an estimate – although hopefully an accurate and professionally assessed one. However, if in the course of preparing your own financial forecasts, you can demonstrate that the rent appears unfair, then you may be able to renegotiate this. It is worth asking how the rent has been assessed and whether it reflects how the pub is currently trading. The forecasted fair maintainable trade may be higher than the present turnover of the pub. In such cases, you may be able to negotiate a ‘stepped rent’, ie one that starts low and increases in stages over a period of time, to give you time to build up the business.

How rents are calculated

Typical tenancy rents are based on:

• 8–12% of forecasted turnover;
• 40–50% of forecast net profit – excluding rent.

Forecasted turnover is a pub’s total sales revenue, including food sales, gaming machines and any other income earned, such as letting accommodation. All figures are calculated excluding VAT.

An example of a simplified rent calculation is given here (note all figures exclude VAT):

Total turnover	£200,000
Gross profit (calculated at 45% of turnover)	£90,000
Less: total expenses before rent applied	£50,000
	________
Net profit before rent is applied	£40,000

Rent calculation
1	Rent if calculated as 10% of turnover ie £ 200,000 × 10% = £ 20,000	£ 20,000
2	Rent if calculated as 50% of net profit before rent ie £ 40,000 × 50% = £ 20,000	£ 20,000

Either calculation results in an annual rent of £ 20,000 that leaves a net profit after rent has been applied of £ 20,000.

Net profit before rent is applied	£ 40,000
Less: annual rent	£ 20,000
	_______
Leaves: net profit	£ 20,000

Rent payment and reviews

VAT will be payable on your rent, but only applies to 90% of the total rent, this being assessed by Customs and Excise as the commercial element of your rent. They regard the remaining 10% as being your domestic portion and it will therefore not be subject to VAT.

Using the above example:

£ 20,000 × 90% (commercial element)	=	£ 18,000
(£ 18,000 of your rent will be subject to VAT)
£ 20,000 × 10% (domestic element)	=	£ 2,000
(£ 2,000 of your rent will not be subject to VAT)

Based on a rate of 17.5%, VAT of £ 3,150 will be added, resulting in a total rent payable of £ 23,150. Rents are normally charged in advance usually on a fortnightly or monthly basis.

Repairs

There is normally an obligation under the terms of your agreement to repair and decorate your pub. The extent of this obligation varies from agreement to agreement, and should be clearly understood prior to signing. Decorating the interior of the premises and undertaking minor repairs are normal tenancy terms, with the brewery or pub company being responsible for painting the exterior and dealing with any major repairs. Sometimes pubs can be left in a poor state of repair and decoration. It is worth inspecting the premises thoroughly prior to signing a tenancy to identify any major areas of concern. These issues should be raised with the brewery or pub company at an early opportunity, and written confirmation should be requested following any verbal promises made to attend to these.

Ingoing payments and expenses

Ingoing payments are made up of fixtures and fittings and stock, which are purchased from the outgoing tenant, and a deposit that is paid to the brewery or pub company. There are also fees relating to the transaction and a requirement for working capital. These are discussed in more detail in Chapter 4, Funding the Business.