Updated: Jan 12
This month we will be looking at a business directly impacted by the Covid-19 pandemic.
Our client, Leah, had purchased a café business with her three brothers in 2015. To fund the purchase, their mother, Nancy, agreed to allow a mortgage over her home to secure a loan for $350,000. Nancy allowed this as each of the children banked with different banks and had their own home loan arrangements. It was just too hard to utilise any equity in these properties for one loan for the business. Nancy had no interest in the business at all, which was owned and operated by Leah and her brothers.
The café traded reasonably well for a period of time, but at an annual review with their newly appointed accountant our clients realised that the rent on the business premises was very high and that this business cost was well outside of industry norms. This placed a limit on the profitability of the café, and as time went on, became an increasing burden. Before the pandemic the clients, like many people do, had put their head in the sand and intended to just continue trading in the hope they would just get by.
Then Covid-19 happened
Next minute – the pandemic. The café was reduced to take away service only. Surrounding office buildings emptied as businesses transitioned largely to a work-from-home basis. Foot traffic was seriously reduced and cashflow collapsed. In some ways, this gave the client time to review their entire operation. Was continuing the right thing to do?
Leah and her brothers were not under immediate pressure. Legislation gave them some protections from eviction from the café. The landlord would have to give them an opportunity to pay off any overdue rent over a reasonable term. They could potentially have applied for a 50 % Government guaranteed loan up to $250,000. Leah thought through all the options and discussed the matter with her accountant and her family.
Leah came to the conclusion that the underlying problem of above market rental was not going away. The rent was $200,000 per annum, and the lease had a further 3 years to run. The fundamentals of the business were unlikely to improve in the future. Any rent that accrued or loan they obtained would need to be repaid at some point.
Leah had been approached to take over a smaller site that had been vacant for some time at an attractive rental. The premises was fully fitted out and the landlord keen to secure a new tenant. Leah and her brothers had also developed a following for their catering services. They were confident they could be successful in the new site and be able to continue to service the debt on their mother’s home, largely due to the dramatically reduced rent.
Leah and her brothers made the decision to restructure the business. While Covid-19 may have been the catalyst, the real reason was that the business was just not sustainable in any event. The problem the client faced was that all four of the siblings had signed personal guarantees for the lease and were jointly and severally liable for the landlord’s loss, potentially over $600,000.
Some key points about the business were as follows:
The café had some minor pieces of equipment and furniture.
There was minimal stock or any other physical assets.
The business was up to date with all ATO payments.
Trade creditors were very modest, and all within agreed terms.
The landlord held a Bank Guarantee of $75,000 secured by a term deposit in the name of the business.
These physical assets were valued by a licensed valuer. The goodwill of the business was valued by a qualified accountant. The total valuation came in at $50,000. With a little more help from Nancy a related entity was able to purchase the business and its assets at full market value. After the sale, the business distributed the money it had available on priority and security positions, with employee entitlements having priority in this case and receiving the majority of the monies available.
The client’s issue then became the personal guarantees provided to the landlord. As part of the original agreement with their mother, in return for her allowing a mortgage on her property, each of the children agreed to grant Nancy a caveatable interest over property they held in their own names. The clients obtained independent legal advice and committed this agreement to paper, with caveats lodged on properties in the name of Leah and her brothers.
Negotiating with the landlord
After guiding the client through the restructure of the business and the distribution of funds available in the appropriate way, we entered into negotiations with the landlord for settlement of the debt owing under personal guarantees.
We demonstrated to the landlord that there was no equity in any property held in the name of the guarantors. After the respective mortgages and Nancy’s caveat, each property was actually in a negative equity position. The landlord effectively had the option of accepting a commercial settlement or pursuing a formal recovery action, potentially leading to the bankruptcy of the guarantors.
Our comprehensive financial review and careful project management showed the landlord that if he pursued the clients into bankruptcy not only would there not be a return, he would be even further out of pocket from the necessary legal fees involved. After some quite robust discussions and negotiations the landlord acted on his Bank Guarantee of $75,000 and accepted a reasonable, commercial settlement offer of $20,000.
Leah and her brothers were able to move on. They are no longer locked into a punishing rental commitment and working excessive hours just to break even. Instead of sitting back and waiting, Leah and her brothers took action and are now able to move on with their lives. So, Covid-19 did not necessarily cause their problems, but they knew the stimulus packages were not the answer either.
Should you have clients or associates that you know are struggling with financial issues or need assistance in reviewing their business affairs in preparation for what’s around the corner, our team of Strategists would be pleased to discuss options that are available on how to best design and implement insolvency strategies. Call us now on 1300 765 080.