Letters of Credit and Security Deposits – What Tenants Should Know

Ever wonder why some landlords ask for a security deposit while others insist on a letter of credit? It often feels arbitrary, but here are the fundamentals:

Key Principles

• Stronger credit = less security

• Larger deposits should have a burn-down tied to tenant performance or financial benchmarks

• Security should cover a portion of the landlord’s upfront capital or a few months’ rent—not the full lease obligation

• Landlords prefer letters of credit (LOCs) because they can access funds faster in a default. Cash deposits may get tied up in bankruptcy proceedings

Sample Scenario

• 10,000 SF lease

• Solid tenant: profitable, cash-rich, good financials

• Landlord invests $2.05M upfront

• Monthly rent: $60,000 | Term: 8 years

• Landlord proposes LOC = 8 months’ rent ($480K) → too high

• Fairer ask = 3 months’ rent ($180K) with burn-down to 1 month by year 4

For Startups

Riskier tenants are judged by burn rate:

If a company has $10M cash and burns $800K/month, it has ~12 months of runway.

High burn = high risk → expect larger LOC or even prepayment of rent.

One More Thing: Pass-Through Entities

Large companies often use shell entities to sign leases. These may hold no assets, which can concern landlords. Solutions:

• Parent guarantee (limited or full)

• Use an entity with tangible assets