CLIENT is a specialty food retailer that started operations in a commercial center two years ago. Five partners invested $50K each for a total of $250K 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 $100K investment, and in the first year, he made $500K 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, client had a good concept but made the mistake of opening the business in a commercial center that had slow foot traffic. How did 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 doesn’t 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’s 40 people showing up monthly, the traffic doubled, but its 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 $3K monthly. This is not a big loss, but this becomes $36K a year, or $72K loss in two years. Including the initial investment of $250K, the partners are staring at a $320K loss in two years.
The kicker is that the lease is for another 4 years at $5K a month. So, even if they stop the business, the business will still owe $240K on the commercial lease! Add that to the $320K 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 set backs 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 multi billion-dollar business with another theme park opening in Shanghai this year. Who knows, my clients may now file for Chapter 7 relief but their business may later on become successful beyond their wildest imagination. 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 $250K 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 $800K 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.
“Trust in Him at all times, o people; pour out your hearts to Him, for God is our refuge.” — Psalm 62:8
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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.
