THE client is a specialty food retailer who started operations in a commercial center two years ago. Five partners invested $50,000 each for a total of $250,000 for a food business that sells a specialty product that everyone likes to eat.
The problem with a business that’s based on a retail outlet in a commercial center is that the business lives or dies depending on the foot traffic of the commercial center. If the foot traffic is slow, there’s practically nothing the business can do to sell more. Indeed, if the foot traffic is slow, even if the business gives away the product for free, it will still be stuck with inventory. Every businessperson knows that when you go into business, you make money; break-even or you lose money. If the business is losing money, the owners will have to continue financing the loss by giving new money to cover the loss. There are no two ways about this. Some businesses make money from day one. I have a client who opened a specialty restaurant with a $100,000 investment, and in the first year, he made $500,000 of profit. The problem was that he had partners who decided to compete with him by opening their own.
On the other hand, there are businesses that never make money, no matter what the owners do to improve it. It’s just a money loser. In this case, the client had a good concept but made the mistake of opening the business in a commercial center that had slow foot traffic. How did the client end up in such a sorry commercial center? Apparently, there was some misrepresentation on the part of the commercial center owner who said that the foot traffic had doubled in the last 12 months, without stating any figures. When you say double, it does not really mean anything, does it? If the foot traffic was 20 people a month showing up in the place last year, and this year there are 40 people showing up monthly, the traffic doubled, but it’s still not enough to sustain a profitable business that relies on “good” foot traffic. The five partners checked out the center a couple of times for foot traffic before making the plunge, and for some reason, they must have seen “good” foot traffic. But when they actually started doing business, the center was almost a ghost town most of the time. The only good month was December when they made some money. The rest of the year, the partners had to cover a deficit of $3,000 monthly. This is not a big loss, but this becomes $36,000 a year, or $72,000 loss in two years. Including the initial investment of $250,000, the partners are staring at a $320,000 loss in two years.
The kicker is that the lease is for another four years at $5,000 a month. So, even if they stop the business, the business will still owe $240,000 on the commercial lease! Add that to the $320,000 of lifetime savings that already evaporated into thin air, the partners are looking at a potential loss of half a million dollars. Even good business may suffer serious setbacks initially.
Even, Walt Disney’s first venture into the famous mouse did not work, and Mr. Disney had to file for Chapter 7 for a fresh start. After bankruptcy, Disneyland opened in 1956 in Anaheim. Now, of course, Disney is a multibillion-dollar business with theme parks internationally now. Who knows, my clients may now file for Chapter 7 relief but their business may later on become successful beyond their wildest imaginations. This is America after all where capitalist dreams still come true. One may be bankrupt today but become a billionaire in the future. Just look at the failed business as a practice test that makes one better prepared to become successful later.
Another problem that surfaced is that each partner signed a personal guaranty for the commercial lease. So, each partner is on the hook for $250,000 each! Business people should never execute a personal guaranty for the debts of the business. It’s a good idea to incorporate the business so the business can assume its own liabilities. There is absolutely no sense that the shareholders should personally guaranty the debts of the business. If the business goes down, only the business files for bankruptcy. The investors keep their good credit and have no personal liability. If the landlord asks you to guaranty personally the proposed lease of the premises by your company business, just say no. You will not regret it. If the landlord will not lease the premises to the business without your personal guaranty just look for another place where you do not have to give a personal guaranty. I have had a client who was on the hook for $800,000 for unpaid commercial lease by way of personal guaranty when all he had to do to prevent this from happening was to not execute the personal guaranty. Think twice before you sign that personal guaranty.
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Disclaimer: The foregoing is an expression of opinion and is not meant to be legal advice to any reader. There is no attorney-client relationship established by this article with the reader. If you want to discuss your situation, you have to set an appointment to consult with the attorney. The first general consultation is free.
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Lawrence Bautista Yang specializes in bankruptcy, business, real estate and civil litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S. Fremont Ave, Mailstop 58, Building A-1 Suite 1125, Alhambra, CA 91803 or at 20274 Carrey Road, Walnut, CA 91789.