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Real estate lawyer David Tomek has negotiated two unusual leases this year — agreements calling for the tenant to give the landlord equity in return for rent concessions. When he started working on the first of those leases, Tomek, a partner in Vinson & Elkins in Austin, Texas, started asking around his firm and couldn’t find another real estate lawyer who had closed a deal with similar terms. Tomek expects that to change at Vinson & Elkins, which has 28 real estate lawyers, and at other firms where lawyers are helping startup companies lease space. New economy companies’ hunger for office space that’s wired for technology is spurring some growth and some new challenges in the real estate practice in Texas. “They seem to have a voracious appetite for leasing space,” says Tomek. “The technology companies, they all hope to hit the big homerun and grow far beyond the size they start with.” The real estate practice is so hot that some firms, such as Houston-based V&E and Thompson & Knight of Dallas, are beefing up and refocusing their real estate practice groups. And with the leases reflecting a 21st century flavor — landlords demanding equity interests in the startup client and tenants demanding space where they can operate their high-tech equipment — real estate lawyers are being forced to educate themselves on the needs of new economy companies. “Traditional real estate was residential, retail, office, warehouse, those kinds of things. Now the needs are different — the needs [are] to have real property rights for transmission towers, fiber-optic cables, places to put electronic transmissions equipment,” says Michael Boulden, co-head of V&E’s real estate section. “You’ve got to learn a new vocabulary, and you’ve got to learn something about your client’s business and learn the terminology that they use and learn their special needs — and they’ve got a lot of them,” says Austin solo practitioner Glenn Hall. But technology and the equity component in leases aren’t the only remarkable factors in leases for dot-coms — executives at the startups often demand quirks such as volleyball courts, full kitchens, picnic areas, and boat docks and even the right to serve alcohol at happy hours on Friday afternoons. Those wilder lease terms are influencing the selection of properties, says Paul Tobias, the partner heading Wilson Sonsini Goodrich & Rosati’s office in Austin. “It’s not nearly as big of a deal as, ‘Can we get enough space or are the terms good?’ but I think they are focusing on the quality-of-life issues as a function of recruiting,” Tobias says. NEW DEALS IN THE NEW ECONOMY Equity is a new item on the table in lease negotiations. Some veteran real estate lawyers say they haven’t yet had their fingers in a deal where equity is a bargaining tool. “I’ve been doing commercial landlord/tenant law for 33 years and I haven’t heard of that,” says Robert Bliss, a partner in Glast, Phillips & Murray in Dallas. Bliss isn’t sure it’s a good idea. He says it sounds a lot like a practice back in the early 1980s when the deregulated savings-and-loan industry began to take equity “kickers” as a part of a loan payment. “It got a lot of those S&Ls in a real lot of trouble. If landlords are starting to do this, that’s a bad sign,” Bliss suggests. “Most landlords that I talk to are not interested in that. They can go and invest in the stock market; they don’t need to use their buildings to invest,” says James Wallenstein, a shareholder in Jenkens & Gilchrist who heads the firm’s real estate practice. But equity is currency for start-up companies, and it doesn’t seem much of a reach for Texas landlords to follow Silicon Valley’s lead and try to cash in on the potential riches of dot-com companies. Even some large Texas firms are beginning to take equity interests in their clients, either through investment funds or by accepting equity in lieu of fees. Tomek says adding the equity interest complicates the lease negotiations and often requires the real estate lawyer to call in a corporate lawyer to go over the details of the warrants. Thomas McCaffrey, a partner in Dow, Cogburn & Friedman of Houston, says adding stock options to the mix also changes the dynamics between a landlord and a tenant by providing the landlord with a stake in the success of its tenant. In the first equity-rent deal he did, Tomek says the tenant, his client, wanted to move into a particular office building in the telecom corridor in Richardson because of its location. He says the landlord was motivated to take equity in exchange for reduced rent because she owns some multifamily units where the startup’s technology could be useful. “It’s not every landlord that would want to do this. Obviously when you reduce the cash flow off the property, obviously it reduces the amount of money you can raise off the property,” he says. “It’s not really as simple as a landlord saying, ‘Ah, this tenant is somebody where there might be a tremendous upside.’ “ In the Richardson deal, and the second one he negotiated in Austin, Tomek says the companies are startups that have venture-capital funding, but are pre-initial public offering. The lease agreement for Tomek’s client in Austin, Locale Systems, gives the landlord the right to invest up to a specified amount in any future private capital financing rounds over the next three years, says Greg Herring, Locale Systems’ vice president and chief financial officer. The landlord put the equity component on the table during lease negotiations, Herring says. “It’s a fairly limited amount that they can invest, so it was not disruptive to the company at all,” he says. Customers of Local Systems pay a monthly fee for a total computing system, Herring says. Like Tomek, other real estate lawyers say they have negotiated deals providing landlords with an equity sweetener. Terry Schpok, a partner in Akin, Gump, Strauss, Hauer & Feld in Dallas, says he’s worked deals where landlords, and even leasing brokers, are seeking compensation in the form of equity. In more than one case, Schpok says, he has represented start-up companies that negotiated leases in which they gave a landlord warrants in lieu of another form of collateral for the lease. Schpok, a corporate lawyer who heads Akin, Gump’s technology practice in Texas, says he can’t say whether startup companies should give up equity in exchange for favorable lease terms. It’s case specific, he says. But he suggests once a company can put up adequate financial security to meet a landlord’s lease requirement, it’s probably not wise to give landlords an equity interest. “It depends on circumstances,” says Tobias, the Wilson Sonsini lawyer. “I wouldn’t discourage it. If my clients asked for my opinion on that, I would tell them that when you issue equity, you have to make sure you are getting value for that equity.” The new economy is transforming another aspect of the real estate practice — a change in the buildings where startups and high-tech companies are anxious to locate. The vast and specific technical needs of those companies have led to the development of office space in “Internet hotels,” which cater to technology clients because they are wired for it. Robert Converse, a partner in Fulbright & Jaworski in Austin, says the tech companies don’t have a lot of infrastructure and don’t need a lot of space for people or space for data processing and files. But the dot-coms and telecom companies do need space for equipment. “The transactions are sometimes complicated because you have tenants who have the same type of equipment, the same kind of receiving and transmitting equipment,” says Boulden, the V&E partner in Dallas. “In a typical office building, the landlord would try to allocate expansion space. Now landlords are allocating perhaps roof space for transmission equipment.” NEW TIMES Wallenstein, a real estate lawyer for 30 years, says a whole new genre of roof leases has developed recently. “With some buildings the difference between profit and loss is just the roof,” he says. Real estate work produced by new economy companies goes beyond office-space leases. Boulden says the high-tech companies need leases for high-tech equipment, means of transmission, easements and rights of way. Lawyers from V&E, for instance, are helping Enron Corp. subsidiary Enron Broadband obtain the real property rights it needs throughout the Midwest for its fiber-optic cable transmissions. Executives of some dot-coms are challenging tradition when deciding what’s key to a lease, says Diane Senterfitt, a partner in Akin, Gump in Austin who says about 40 percent of her clients are startups. In more than one case, she has negotiated space where employees of her client can park their bicycles. She also worked on one lease that gave employees of one client the right to do “free art” on a wall. Although landlords in Texas are getting accustomed to unusual requests from tenants, Senterfitt says most clients have not been able to negotiate leases that would allow employees to bring dogs to work.

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