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Distribute remaining capital and debt between business members

You are Chris and Pat Smith, entrepreneurs with five years of experience investing in small businesses. Eighteen months ago you decided to invest in a catering venture with two chefs, J. P. Martin and L. L. Miller, who have culinary science degrees and five years of work experience, which includes winning a prestigious prize in a gourmet food competition. Following some extended discussions, the four of you decided to set up a business catering to parties and weddings under the name of At Your Service.

The arrangement between you was quite informal. Essentially you put up $25,000 and the chefs put up $10,000 in capital to get the operation started. You were to manage the advertising, and the bookkeeping. The chefs' contribution was to set up the kitchen and menus, cook, hire staff, and be on site to supervise all catering jobs. The agreement between you was that the profits would be split 50-50 after clearing fixed expenses.

Although the first few months were difficult and At Your Service had to use some of the investment reserves to cover monthly expenses, a good newspaper review produced a spurt of business in the third month when the company not only covered fixed costs, but distributed a profit of $250 to each owner. Throughout the first year, you continued to make a little money, or lose a little every month, but the company has been steadily losing money in the second year and has had to use reserves in order to keep in business.

You think the problem is that the chefs do not know how to manage a business. As soon as the business seemed to be breaking even last year, you noticed that they changed menus, offering more elaborate dishes with more expensive ingredients without increasing prices. These dishes cost too much and take too much time to prepare, limiting their availability to take on more jobs.

The lack of profits forced you to take a more active role in the management of the company. Although you told the chefs to raise prices, they approved the new seasonal menus with the same elaborate dishes and the same low prices. You found out before the menus were printed and raised the prices by 10%. You have also put them on a strict ingredients budget.

Of course, all of this has not pleased them, but the $35,000 investment is rapidly disappearing. You are down to $15,000 in working capital, and you and your partner have no more money to put into the business. You are quite sure that Martin and Miller have no more money either.

Last week, you all briefly discussed dissolving the business. You are very interested in doing so; you find it hard to believe you had such bad business judgment to form a partnership with two chefs. It is possible that with higher prices and more discipline on their part profitability will improve, although you doubt that your relationship will. Alternatively, profitability may not improve and you will have to use the last of the reserves to terminate the leases on the space, the van, and the kitchen equipment.

The issues that have to be resolved are as follows:

How you will split the $15,000 left in the investment.
How to handle the lease on the kitchen space, which has 18 months more to run.
How to handle the lease on the van, which has 18 months more to run.
How to handle the lease on the kitchen equipment, which as six months more to run.

There are a variety of options for distributing the remaining capital. You take the remaining capital giving the chefs nothing; you take $12,000 leaving $3,000 for the chefs; you take $10,000 and they take $5,000; you split the capital evenly; you take $5,000 and they take $10,000, you take $3,000 and they take $12,000; you leave all the remaining capital for them. You need to recoup as much as your investment possible to open an alternative venture. You recently began to look at the possibility of opening a flower shop, although you have not yet done extensive planning for it. To do so you need capital. You also do not think that the chefs deserve the capital because they caused the business to fail.

You also need to rent space for this new venture, and you were thinking that you might take over the lease on the store front space that you rented for the catering business. The only problem is the kitchen, which you really do not need and don't want to have to pay a premium price for. Your options are to promise the chefs that you will make the storefront lease payments; to have the lease amended to be in your names only (which would cost about $500); terminate the lease and pay the $1,000 penalty; have the lease amended to remove your names (same $500 cost); accept the chefs' promise to pay the lease. All in all, you think it is better to leave the lease alone and just promise the chefs that you pay it rather than pay the fee for changing the names on the lease, terminating it, or paying the fee to assign it to them. You are concerned that if they took over the lease and then later could not make payments, you would still be responsible.

You could certainly use the van leased for the catering service for flower deliveries. Your options for the van are similar to those for the storefront space. You could promise the chefs that you will make the van payments, have the van lease amended to be in your names only (which would cost about $500); terminate the lease and pay the $1,000 penalty, have the lease amended to remove your names (same $500 cost); accept the chefs' promise to pay the van lease. You are concerned that if the chefs took over the lease and then later could not make the payments you would be liable. Your first preference is to promise the chefs that you will make the payments. If necessary, you are willing to make the $500 payment to take their names off the lease. You have the same concern about the van lease as you do with the storefront lease, if you turn it over to the chefs before the end of the term of the lease, you will still be responsible for payments they do not make. Your preference is to take the van's lease over yourselves.

You have no use for the high quality cooking equipment that was leased for the catering business. You have a similar set of options for the kitchen equipment as you have for the storefront and van. You assume the chefs will continue in the cooking business and can use the equipment. It would be all right with you if they took over the lease. You understand there is no charge to remove your names from the lease agreement. However, you think the best all around solution is to terminate the lease for the kitchen equipment.

Your Role/Assignment

You are to meet with the chefs for 30 minutes to try to dissolve the partnership. The table on the next page summarizes your preferences on the options for each issue in terms of points. Your goal is to negotiate an agreement worth as many points as possible. To reach an agreement with the chefs, you must gain at least 100 points.

Issue Option Value to the Entrepreneurs
Type $15,000 the entrepreneurs $ 0 the chefs 85
$12,000 the entrepreneurs $ 3,000 the chefs 75
$10,000 the entrepreneurs $ 5,000 the chefs 45
$ 7,500 the entrepreneurs $ 7,500 the chefs 20
$ 5,000 the entrepreneurs $10,000 the chefs 15
$ 3,000 the entrepreneurs $12,000 the chefs 10
$ 0 the entrepreneurs $15,000 the chefs 5

Space The chefs promise to pay lease 15
The chefs take over lease 20
Terminate lease 25
The entrepreneurs take over lease 55
The entrepreneurs promise to pay lease 65

Van The chefs promise to pay lease 15
The chefs take over lease 20
Terminate lease 25
The entrepreneurs take over lease 65
The entrepreneurs promise to pay lease 75

Equipment The chefs promise to pay lease 10
The chefs take over lease 15
Terminate lease 25
The entrepreneurs take over lease 10
The entrepreneurs promise to pay lease 5

Solution Preview

Please see the attached Excel file.

The Award Phase - You Decide:
Chris and Pat Smith's Investment Decision

When Chris and Pat Smith go to the meeting with J.P. Martin and L.L. Miller to finalize the decision for At Your Service, Chris and Pat have to consider the following objectives and put them at the top of their minds:

1. Need for capital to be able to fund the new business venture
2. Need for space for the new venture
3. Leaving any lease to the chefs will save a few hundreds of dollars now, but might eventually result to expensive legal problems in the future
4. Need for a van for the new venture
5. No need for high quality equipment
6. Total value for the agreement of at least 100 points

Given this, the following final options are suggested for Chris and Pat

Issue Option Value
Investment $15,000 the entrepreneurs $0 the chefs 85
Space The entrepreneurs promise to pay lease ...

Solution Summary

The expert distributes the remaining capital and debt between business members.

$2.19