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Case Study: This new client looks shaky – how to take them on with confidence

February 21, 2019

 

 



We recently met a client who was referred by his brand new accountant. In fact, the accountant was not sure he wanted to take them on as his client. The management accounts were a mess, and the client had no idea where their cashflow was going. They had a company that operated two fast food outlets in major shopping centres, and were behind on rent and other creditor payments. The accountant was concerned the business was not viable and sent the husband and wife director team to our firm for an obligation free meeting.

 

What the client THOUGHT was happening


When we met with the client they spoke of their aspirations to eventually franchise or license the business. They offered a unique type of cuisine and hoped to continue to expand their brand. They explained to us how Store A was good and Store B was bad. Store A was a busy outlet and had much higher sales. 

We talked through the financials with the client and identified that previous creditor payments from a past operation were being accounted as cost of goods sold. This was distorting all the numbers and making it hard to benchmark the business to identify the underlying cause of the problem. Everything we raised as a potential issue was explained by the owners, who had a good grasp of operational matters. 

We spoke to the accountant again and recommended new management information systems be put in place. The clients were confident everything was just an accounting issue and that their previous bookkeeper had just made a mess of things. With the old creditors from the previous operation just about paid off everything would be fine.

 
 

What was REALLY happening
 

Now, fast forward a little and the accountant called. Turns out it wasn’t just an accounting issue after all and the business continued to struggle after the creditors from the old operation were settled. The client received a Notice 7 to vacate the premises at Store A due to overdue rent. New management systems identified that Store A was not good at all. The rent included a repayment of landlord contributions to fitout. When correctly accounted this showed that while Store A had higher sales, it was actually bleeding cash. On the other hand, Store B was performing reasonably well.  


The default under the lease for Store A triggered a large liability for the company. The company had already incurred significant creditors and statutory liabilities that it now could not pay. The client was passionate about the business and wanted the opportunity to trade on. The major issues were as follows:

  • Rent on the Store A was $60,000 in arrears.

  • The business was unable to remedy the breach. The landlord proposed an up-front payment of $35,000 followed by payments of $8,000 per week. The business could simply not meet these payments. 

  • The monthly rent was $25,000 and the lease had four years left to run. This included the repayment of the landlord’s fitout contribution. 

  • The potential liability under the lease for the Store A alone was over $1m. 

  • The business had statutory liabilities of over $100,000. 

  • The fitout, which was a major component of the rent payment, was not saleable.

  • There were minimal physical assets, mainly comprising minor items of kitchen equipment.


Strategy

 

Our strategy was to have Store B sold to a new entity for fair commercial consideration and to cease trading Store A. This required valuations of plant & equipment, goodwill and intellectual property. Given the minimal physical assets and the trading performance of the store these valuations were quite modest at $48,000. The clients were able to arrange a loan from a family member to the new company to facilitate this transaction. 

As part of our project management we arranged for the lease on Store B to be assigned to the new entity on existing terms. We ensured that the loan to the new company was secured appropriately on the PPSR to protect the family member by making them a secured creditor. We then assisted the directors in distributing the sales proceeds based on security and priority positions. This maximised the payment of employee entitlements and superannuation. Store A ceased to trade and we assisted the director in appointing a liquidator to the company.

 


Outcome

The liquidator reviewed the sales transaction and found it to be commercial. No claims were made against our clients by the liquidator. 

While personally guaranteed creditors (specifically the landlord of Store A) had the ability to pursue the debt and potentially bankrupt the directors, we were able to demonstrate that there was no value in doing this based on their individual financial circumstances. We have well defined systems and processes and were able to clearly demonstrate to creditors what their return would be should they bankrupt the directors. When presented with a compelling case it is often possible to negotiate settlements on a commercial basis that is relevant to the director’s financial position. In this case we were able to settle these claims for a small amount.

 

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