Written by Condon Associates on 25 March 2012
ADMINISTRATION – FAMILY BREAKDOWN – FRANCHISING – POOR BUSINESS SELECTION – LACK OF CONTROL – INADEQUATE BUSINESS PREPARATION AND INVESTIGATION – POOR STRUCTURING
Company Four had been formed by its owners to operate a number of franchised food outlets from two different franchises operated by the one Franchisor Group. Two of the stores were core businesses (C-MD and C-P) and one was not (NC-RH). The Company was structured as a corporate trustee with two separate discretionary trusts which operated the three stores that were located in western and north-western areas of Sydney. One trust having two stores and the other trust having the remaining store. The last acquisition was the Non-Core business which was acquired with the “support” of the Franchisor.
To fund the acquisition and operations of the Group the Company had an arrangement with one of the Australian major banks (the Secured Creditor) which sought to obtain all of the relevant securities and guarantees, including the personal assets of the Directors.
The Businesses (shops) were classic examples of the modern franchise model which includes the following:
- Franchisor directed and costed fit-out,
- Commercial property leases in the name of the Franchisor,
- Common requirements for the purchase of stock and the payment of royalties and franchise fees,
- Franchisor direction in relation to location, placement and size of premises, including negotiation of all lease arrangements, and
- The provision of relevant training and support services by the Franchisor.
Unfortunately over the period of the Company’s operation trade never reached the anticipated levels of turnover, particularly in the most recently acquired store. As it often does, this in turn lead to stress within the family relationship and ultimately its demise placing further financial strain on the owners. Ultimately pressure grew beyond controllable and bearable limits and the Owners/Directors were referred to Condon Associates.
Our assessment immediately confirmed that the businesses could not continue to operate under current circumstances with the Directors becoming increasingly exposed for Trading Whilst Insolvent. This then lead to the Company being placed into Voluntary Administration, due to the following underlying specific causes:-
- The NC-RH store placed a significant cash flow drain on the Company. The primary underlying cause for this cash flow loss was the level of rent which was required to be paid for the premises.
- The NC-RH store was a new store in a new shopping centre. The actual level of sales being achieved was significantly less than originally forecast. Attempts had been made to negotiate a revised rent but all efforts were to no avail.
- As a result of the low profitability of the NC-RH store, the Directors were required to invest more time and effort into this store which diverted their attentions away from their regular involvement at the Core stores.
- The cash flow drain drew funds required to sustain the Core stores which lead to an increasing decline in performance of these stores.
- Ultimately a notice was issued by the Secured Creditor questioning the continuance of the Banking Facilities to the Company.
- This notice and pressure from other Creditors resulted in the Directors seeking advice from their accountant and ultimately ourselves.
Once appointed we sought to continue to trade each of the three businesses in order to preserve the value of the Company\\\’s assets by seeking to sell the three businesses as going concerns.
Unfortunately a formal insolvency appointment will not of itself reverse or change underlying significant business errors. This quickly became obvious with the NC-RH operation where continuing levels of turnover could not sustain any potential improvement in the overall value of those relevant assets. Consequently with the landlord unwilling to vary the rent, the timeframe required for the Franchisor to accept and train up any independent purchaser, the Franchisors unwillingness to acquire the store, and no other Franchisees willing to acquire the business at any cost the decision was made to close its operations and dispose of the assets as a job lot. Had this business never been acquired then it is most likely that an appointment would ever have been required.
The future of the Core shops was now fortunately more positive. We were able to continue trading C-MD and C-P as their trading performance had now not only begun to steady but slowly improve thus ensuring a modest and improving profit being generated. Unfortunately however, the level of cash generated was not sufficient to allow a strategy that would enable the overall company structure to survive; it had been too substantively damaged.
Given the requirements of the Franchisor as to acceptability of owner, need for financial advice and substantiation, operational training and certain other criteria, we formed the view that the strongest possible avenue for a successful sale of the businesses would be from one of the existing Franchisors. To enhance our prospects we sought the assistance of a broker known to the group who regularly marketed existing franchises that came up for sale from time to time, this enhanced the comfort level of the potential purchasers.
One of the two Core businesses, C-P quickly generated a fair degree of interest however this business relied on the existence of another franchise to support it with the provision of baked goods, consequently we were required to keep both operations running until effective sales could be achieved. The possibility of obtaining goods from another Franchisee was considered but the prices at which goods were available removed any possibility of our operation to generate a profit.
Ultimately an acceptable offer was received however now both the Franchisor and the Secured Creditor laid claim to the funds based upon the now conflicting documents that the Company had entered into. After much debate and delay a new position was negotiated and the C-P store sold. The remaining store now became uncommercial on its own as it had relied on suppling to the other store to remain profitable consequently the business was closed and the remaining assets were sold at open tender to a bidder identified by one of the Directors.
In the end a reasonable result was achieved from a very diabolical position. The complexities imposed by the combination of fixed and high leasing costs, Franchisor constraints and the impact of a Secured Creditor combined to significantly reduce the future potential value of the overall business.
People looking to go into franchise operations must ensure they do the necessary investigation before commencing and ensure that their structure adequately deals with the risks associated with the specific circumstances of their investment and that they have a full working understanding of the interrelationships between the assets they hold. They must also adequately deal with protecting themselves and their Creditors in the event that pressures are applied to the business. In this case one failing store ultimately brought about the demise of the whole Group and the loss of significant value by a number of parties.
Better planning and cooperation could easily have prevented the level of financial damage that ultimately occurred.