How I Closed My Small Business - A Personal Closing Experience - Part 3: The Lease and Selling Assets

If you've been following the series, you'll note the store is looking pretty empty!
If you've been following the series, you'll note the store is looking pretty empty!

Summary

This article is the third in an on going series on how my wife and I went about closing our small business. It based on our research and experience and is intended to show what we faced and how we handled the hundreds of decisions along the way. It is not intended to provide legal or tax advice, and you should always consult your own professionals. By sharing what we experienced, we hope our experience can make this part of owning a small business easier for others . We hope to share both the factual and emotional ups and downs along the way. This is the third article in a planned four article series.

The Lease

As we mentioned in the previous article, the most difficult liability was our lease, which we personally guaranteed. Even if we went through bankruptcy for the business, we would not eliminate the biggest obligation and personal bankruptcy was only an option of last resort for us. Again, every one's case is different so please get good financial and legal advisers.

We had a double whammy facing us, not only was our lease personally guaranteed but we had signed up for a TEN YEAR lease! Ouch! We were given advice to match the lease term and our franchise term, but in in hindsight this did not consider the potential risk we could close.  We were naive when we open our business (this was the first real business we ever opened) and in future endeavors would minimize the length of any lease commitment.

So facing a huge personal obligation and not want to pay the $2900.00 a month for our space through the term of the lease we considered our options.

1. We could sublease

2. We could try to work out an arrangement with our landlord and buyout the terms of the lease

3. We could ignore it, stop paying our lease payments and wait for the legal paper work.

Obviously, the last one was not a serious option given we were trying to avoid personal bankruptcy.

Option 1 was not ideal for us. We did not want to become landlords plus given the current market we figured it would take some time to lease the space and we would have to discount the lease rate to attract a tenant. This would be our backup option we would fall back on but our personal preference was to close the business and settle all our open obligations.

So, the question is how to approach your landlord and what is the right offer? For us we did our homework, consulted our legal counsel, and ran some what if spread sheets.

Calculating a Buyout Offer

So we needed to figure out what would be a reasonable buyout offer for our landlord. This is a quick summary of the factors we considered before starting negotiations with our landlord.

Step 1 : What is "break even" compared to subleasing- In order to baseline what would be a "break even" for us compared to what we felt it would cost to sublease we created a spreadsheet to calculate various scenarios. We consider several factors including how long we would have to carry the space before leasing and what % discount we would be giving. We then applied a discount rate since this would not be all paid out day one. In our scenario, we decided a reasonable break even would be based on 12 month period to lease the space with a 20% discount to the space at a 10% discount rate to calculate the Net Present Value (NPV). For us this figure worked out to about $65,000.00. There were risks it could cost more but also upside it could be less expensive. This was going to be our maximum to use in any buyout considerations.

Step 2 - We calculated what the NPV was for the remaining term of the lease. This is what we expected our landlord would initially ask for since it would make him 100% whole on the agreement and give him a huge opportunity to release the space. In our case this was about $200k (full remaining term was about $270k). We would never pay the full amount but we figured this would be the stating point for the landlord.

Step 3 - Since we originally planned to sign up for a 5 year lease, we thought paying out the remaining term of this would be another useful data point. In our case, we did not get any discount in the 1st five years of the lease term it was only in the 6-10 years we did realize a discount over a 5+5 lease. Again we were very naïve here in retrospect and at the time closing was not a serious consideration. For our situation, we would have about 28 months left on a 5 year term which discounted at 10% would be about 75k. Higher than our sublease "break even" but another data point.

Step 4 - What would the landlord expect in a full business bankruptcy? Every state is different here and our personal obligation was also an extenuating factor. In general terms based on some advice we received, if the business went bankrupt with assets, the landlord would typically be entitled to either 12 months rent or 15% of the remaining lease. Our state does not require the landlord to "mitigate damages" for a lease, but in the event of a bankruptcy this would tend to bound the minimum we expected the landlord would accept. Each state is different but this could serve as guidance. In our case, 12 months of full lease payments would be about $35k.

Step 5- What could we afford? In our case we had a decent tax return thanks to all the losses in the business and a decent steady income from a real job. We also had some assets. In general we thought we could come up with $35k in cash and assets and could stretch and borrow $25k from my work retirement plan (note: in bankruptcy, retire assets are typically not at risk). For us, going into a little more debt to clear this long term obligation was worth the cost. Every one's case is different and there are no hard fast rules here.

So we had some numbers in mind when we began the process of negotiation. Remember, the landlord has all the cards. He has a legally binding contract and does not have to negotiate. He is also a business man and will want to try to recover as much as possible. Also, I would expect generally they do not want to have it decided in a bankruptcy court if they can work a deal. Its likely not going to be less than he thinks he could get out of a bankruptcy.

Some other notes (again confirm anything here with your own legal counsel) with respect to bankruptcy - If you have less than 50K equity in your home it should not be considered an asset in bankruptcy. Also 401k's are protected and IRA though not specifically protected are typically treated like 401k's and not considered assets. If your closing your business like in our case, there is probably not much else except some personal property and the business assets.

Making the Offer

Once you have your offered bound by what you think the minimum the landlord would take and what the maximum you can afford and are willing to pay you can sit down with your landlord.

Since the lease obligation was the biggest single item we needed to deal with we felt we needed to tackle this first. Before we finalized plans for closing we needed to understand how this would work out. Once we made the decision to close and did some of the above research we called our landlord to set up a meeting to discuss our options. At the first meeting we did not have the full research above done but had a basic idea of what we wanted. Our first meeting was tough but our landlord was understanding. We had not talked with a bankruptcy attorney yet and did not have a good feel for the lower bound, so made a verbal offer of $25k to buy out the lease. The landlord countered as we expected at the full lease value less the discount rate (of course we use a 10% and he uses a 6% rate). We left the meeting unsettled, but the door was open. We both agreed to go back and review further and meet again.

The good news was our landlord was willing to work with us and entertain additional discussions. Our landlord happens to be a decent person but he is also a business man. He was not necessarily doing this out of the goodness of his heart since he has a business to run. I have heard stories where their landlord was not so willing to discuss options, at the end of the day if you can reach mutually agreeable terms everyone will make out. No one wants to see you close your business including your landlord, but they also understand these things happen especially for small start up businesses.

We met with our lawyers next including our bankruptcy attorney. After this meeting we finalized the above numbers and had a better understanding of what our next offer should be. We decided this time to present a written offer and settled on a figure of $50k. We arrived at this figure based on the minimum expected in bankruptcy (if enough assets existed) plus 50% as an incentive to close the deal. We then scheduled a second meeting and presented the offer. Our landlord also calculated what he was looking for and his number was about $70k (He calculated this based on the CAM for the term of the lease discounted to present value). Since we were close we both agreed to meet halfway, which turns out to be about what we felt we could afford and slightly less than our sub-lease break even number. Ideally we would have settled for less, but we were happy to reach an agreement we both could live with. In general, given how much outlay we had monthly to operate the business, we would be ahead in less than twelve months.

As condition of the buyout, we agreed we would both sign a mutual release freeing both parties of any further obligation. We settled on a closing date that gave us enough time to close our operations and clean up the store to hand back to the landlord. In our case this was about 8 weeks, which should be reduced to 6 once we are finished. We agreed to pay our lease payments during the period we remained open and then a one time final payment when we turned over the store.

I can't say how much a relief this was for my wife and I. We would need to take out a little more debt, but we now had hope and a sense of a huge weight lifted from our shoulders.

Some suggestions when approaching your landlord is not to directly threaten bankruptcy, but it can be suggested in conversation that it is an option you are considering but you are trying to avoid this and would only be a last resort. No one likes to be threatened, and if they have to your landlord will take you to court. We all want to avoid this. Also, don't lay all your cards on the table right away, this is a negotiation and your already in a weak position, work up to your maximum number since there will be some give and take during the negotiation. You can use some of the guidelines we followed above to help reach your targets. At the end, there are no hard rules in this. In our case, we came to terms that both our landlord and we could accept.

Selling the Assets

The next challenge we faced was turning all our business assets into cash. When we opened our business as part of our franchise agreement we had to purchase a large amount of refrigeration equipment. All this had to be new, so we had a decent base of assets to try to turn into income. Since our store is a food based business there seems to always be a market for this type of equipment. The good news is if you have time to market these items yourself you will be better off than trying to contract with someone else to sell. Our original estimate was our assets were worth about $15k, as of today we believe we will earn over $23k which helps in reducing some of our debts. Of course we paid much more, but in some cases were were able to make back 75% of what we paid for some items. In the end, we think we will end up a little more than 50% of what we paid.

We considered several options to sell our equipment when we decided to sell. I'll summarize these below.

1) Contacted local equipment suppliers - This proved to be the least beneficial. In most cases, these business do not have the cash to buy your equipment out right. We have a few offers once we finally close to give us a bid on all remaining items but have not gotten to the point yet

2) Customers - We were surprised at how many items our customer purchased directly. We also had customers pass on our information to other businesses. Our email database was very useful. We basically sold pictures and fixtures right off the walls!

3) Auctions - We entertained using a service call Fast Track Auction based in Cincinnati, OH. We had heard good things from other franchises that used their service. In general, after paying their commission most stores earned about 35% of the new value of their equipment. If we had to close fast, we would have seriously considered this option. Our original plan was to sell things direct, than as of June 1st go under contract with the auction house. The good news is we had the majority of our larger assets sold (or committed to) by this time and choose not to use the auction.

4) Craig's List - This really worked well for us! We listed several times on Craig's list our equipment for sale and got a very good response. I listed our equipment at between 50-75% of the new value based on what we saw the returns where from some other online auctions and what we saw used items for sale on eBay. Our equipment was really in great condition so we had little trouble getting people interested. On some pieces we did have to negotiate a little, but in many cases we got our full list price. In most cases, I think we realized about double the sale price compared to what we saw on similar auctions (after commission). You do have to do a little work, but it did seem to pay off.

Tips for Using Craig's List

  • Always have real pictures. For individual equipment listings we added the pictures right on the ad and for our store closing listing we added a link to Google's Picassa picture website were we posted all our store pictures.
  • Include as much of the equipment spec's you have. A link to a data sheet is also good. At a minimum try to include the vendor and model #. Dimensions also help.
  • Your selling this stuff, so talk it up. Since we had commercial equipment used in an atypical kitchen environment, we talked up the great condition of our equipment and the light use it had seen. Especially our sandwich prep stations, since these were mostly used by customers, they were in like new condition.
  • In general, I found the more details the better. I also listed a Business Closing listing, then a listing for each item separately. Once listed I did not have to try to re-list multiple times but I did update as equipment was sold.
  • Being able to have your business open and people can come in and see the equipment running also was a plus. We had some items we could let go right away and others we took deposits to hold items till we closed. Most people were understanding and did not have an issue with this.

In the end, we will end up closing one or two weeks ahead of schedule since we sold out of most of our remaing food items and have the majoirty of our large assets sold. We will hold a final week of sales and have a final "yard sale" day were we will try to sell any remaining items. A few people mentioned they would make an offer on any remaining large assets which we may have one or two pieces left.

One other key benefit we saw by having an orderly closeout, is our last month we saw a big increase in sales as we gave our customers one last month to order food. We were busier than we had been in the last twelve months. That little extra income also helped.

We have one more article that will cover how things finally turned out and summarize any additional lessons learned we think might be useful for others.

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Comments 8 comments

ripplemaker profile image

ripplemaker 7 years ago from Cebu, Philippines

Hi pschmitt, your experiences cleary taught you a lot about closing a small business. I operate a small business too and I hope I won't close it anytime soon. 

By the way, did you know you have nominated for the Hubnuggets this week? Yup, you are a Hubnugget Wannabe!  This link will take you to Patty's hub and see the surprise you have in store for you. http://hubpages.com/hub/Nuggets-of-the-Green-Corn-...

I hope you could find the time to participate and get your friends and family to vote for you. Good luck!


Jerilee Wei profile image

Jerilee Wei 7 years ago from United States

I think this series is very timely and much needed. Best of luck to you.


Pearldiver profile image

Pearldiver 7 years ago from Tomorrow - In Words & NZ Time.

Well written and a very hard subject, while living it .. Good Luck in HubNuggets.


ripplemaker profile image

ripplemaker 7 years ago from Cebu, Philippines

Congratulations for being part of the top 5 winners! Have you read the Hubpages newsletter already? I hope you did. Great job!


pschmitt profile image

pschmitt 7 years ago from Rochester, NY Author

Thanks for all the votes in the hubnugget contest!


alekhouse profile image

alekhouse 7 years ago from Louisville, Kentucky

Don't have a lot of time right now, but skimmed your hub and will be coming back to slow down and read it carefully. I'm on the cusp of closing my small business and I want to see if I can glean something useful here. Thanks.


jbgnet profile image

jbgnet 7 years ago

I really enjoyed your content. I'm a small business owner as well and I've been looking for information on this particular topic for awhile. Thanks very much,

Jake


Frank 6 years ago

Thank you for your honesty. Your story is one that many small business owners are experiencing right now. Hopefully they can use your experiences as an example of the right way to close down their business.

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