ASSIGNMENT #3 – Individual Assignment
We would like you to submit a two-page memo, single-spaced, 11-font, that describes your recommendation, the alternatives considered and a summary of the rationale supporting your recommendation. Any detailed supporting analysis should be included in abriefappendix.
Fact Scenario:
Cliff, a good friend of your group who is 60 years old, is thinking about purchasing an existing restaurant and has approached a bank to provide him with financing. The bank, uncharacteristically, is willing to finance the venture as there is a large real estate component to the business (banks are usually loathe to finance restaurants as 9 out of 10 go out of business in the first year, also restaurants generally have no real assets over which banks can take security). The bank is looking for Cliff to pay at least 30% of the purchase price from his own resources or by finding other investors to invest in the business. In evaluating the down payment Cliff will be providing, the bank has looked at Cliff’s personal credit situation and informed Cliff that they will not allow Cliff to borrow any additional amounts against his principal residence for the purposes of a down payment for the business. Cliff had been relying on his ability to tap into the equity of his home in order to pursue the business opportunity. The bank will also not allow Cliff to increase the debt/equity ratio of the deal beyond the 70% financing being provided by the bank (i.e. Cliff cannot borrow the additional funds from another source and put the money into the company as debt). Cliff’s family has no money at this time to lend him. Many of Cliff’s friends are reluctant to lend him money to operate a restaurant as he has no experience in the restaurant business.
Cliff now finds himself in the following situation:
Purchase Price for the Business: $450,000
Cash available for the down payment: $ 50,000
Shortfall for down payment: $ 85,000
Additional Facts:
The restaurant has in the past been open 9 months of the year as the restaurant is located in a tourist town. The restaurant has many local customers but the current owners prefer to go to warmer climates in the off-season. The restaurant generates approximately $600,000/year in revenue. The restaurant has typically paid the owners about $100,000 per year after covering all costs (the current owners paid off all of their loans many years ago). The appraisal on the building cliff will be purchasing as part of the business is estimated to be $450,000. The Bank will charge Cliff 8% interest per annum on the amount they are willing to lend as they see this as a risky investment, notwithstanding the value of the land that forms part of the assets of the business. From the Bank’s perspective, the main risks are that Cliff has never run a business of any kind and has no additional sources of income to make loan payments should the restaurant fail. The bank has given Cliff the option to pay interest only on the loan for the first 2 years as they know that the business will need some cash flow in order to succeed. Interest expenses will total approximately $26,000 per year for the first two years. Cliff has informed your group that he will also need to renovate the building and incur some additional expenses totaling about $75,000 in the first year in order to set the tone that he has in mind for the restaurant. Cliff’s lack of any additional sources of income means that he will need to draw some sort of salary from the restaurant in order to live and pay the mortgage on his home. Cliff thought about selling his home and moving into the restaurant (sleeping in the store room on a cot) but was told by his insurance company that doing so was against municipal code and would invalidate his insurance policy with respect to both the building and the restaurant. Cliff, after doing some back of the envelope calculations, feels that he can increase sales with an overhaul of the current operations. Cliff realizes that he will have to take a lower salary than the previous owners but has calculated (again back of the envelope) that he can draw enough to live on for several years and still have enough cash to make the business successful.
The current owners of the business have no interest in taking a vendor take back mortgage so that avenue for financing is closed to Cliff.
Cliff is purchasing the assets of the corporation owned by the vendors so he has a clean slate to work with in structuring the new venture.
Cliff wants to build the business and leave a legacy for his 3 children and 5 (so far) grandchildren. Cliff is not married.
Potential Investors:
Cliff has found several potential investors who are willing to lend him money.
The first wants to take a 63% stake in the business for the 63% down payment they are willing to provide. This investor will let Cliff run the business unless something goes wrong and then, as they have explicitly stated, they will step in and take over the business. The investor also wants every decision regarding the business to be unanimously approved by all of the owners of the business before being implemented. This investor has a strong track record of entrepreneurial success having started and grown several different businesses. The investor has never been involved in a restaurant business but is excited about the potential of the venture.
The second investor wants a 10% annual return on their money and is not really interested in getting involved in the business as the investor knows nothing about restaurants except that they are very risky but have great food and lots of booze. This investor likes to eat at restaurants and has told Cliff that he eats out every night of the week. This investor owns several successful businesses. One of the businesses that the investor owns has a cult like following and the investor holds regular gatherings for the customers throughout the region in which the restaurant is located. This investor wants to be paid back in full in no more than 5 years.
Cliff has 4 dear friends whom he has known for over 30 years. His friends are each willing to put $20,000 in to the business. Cliff can probably, by cashing his minimum RRSP holdings, come up with the balance of the purchase price. Some of Cliff’s friends are quite pushy and know-it-alls but then so is Cliff. Two of his friends are married and one marriage has been somewhat rocky for the past couple of years. All of the friends are very close to each other. One of Cliff’s friends was the manager for a very successful nightclub for 15 years. This friend is well connected in the food and beverage industry and his spouse is a rep for a liquor company.
Your group has been approached by Cliff to help him decide which of the potential investors he should enter into business with. The investors are mutually exclusive – you cannot mix the investors therefore you must choose only one of the potential investors. He would like you to help him to structure the business (i.e. what business entity should he use). In advising Cliff you need to figure out what you perceive are the real interests that each investor (or group of investors) has in getting involved with the business. You also must provide Cliff with the rationale for structuring the business in the manner you have chosen and how the structure will address the investor’s interests and Cliff’s interests. You also need to address how you will ensure that Cliff’s interests are going to be protected in the business.
Cliff has asked that you write a memo that is no longer than 2 pages (double spaced) which outlines your advice to Cliff and answers the questions outlined above. Attach any documents that you feel are relevant for Cliff to understand your recommendations as appendices and, if you are using any material from the course, you may simply reference the material as Cliff can get access to all of your course materials and precedents that you have received.
Please note: This is not an accounting exercise so please do not carry out extensive financial analysis. Any Individual that provides a spreadsheet with more than 1 sheet of calculations will have 10% deducted from their final mark for the assignment. We are looking for you to be creative, but “real” in your set of solutions.
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