Managing a Small Business Case Study The Purchase Alternative

Answer questions and send responses

Nelson worked as chief installer for a small chain of floor-covering retailers, All Floors Inc. Most of the companys installers specialized in just carpet, or ceramics, or hardwood, but Nelson had experience in all types of installations and he was also skilled at measuring and costing installation jobs.

One day the owner of All Floors, Hugette, came to Nelson and explained that the company was going to stop doing its own installations and, in future, subcontract out that work. Nelson was immediately worried. Losing his job meant that he would not be able to pay the mortgage on his house. But Hugette went on to explain that All Floors would sell off its installation department, including its trucks and tools, as a separate company. This new separate company could get most of All Floorss installation work as well as work from other flooring retailers. She said it was a great opportunity to make money and that Nelson, with his broad experience, would be the ideal owner of the new company.

Hugette knew that Nelsons only major asset was his house, but she suggested that Nelson could borrow money against it. And if that wasnt enough to cover the cost of buying the installation department, Hugette might be willing to loan Nelson the difference, which he could repay out of his profits. She suggested that if he was interested, he should go to his bank and see how much he could borrow.

Nelson and his life partner, Morgan, discussed the situation, agreeing that it was a risk to go into business, but both were excited about the idea of owning their own company. The bank agreed to give Nelson a second mortgage on the house of $200,000, and he had another $20,000 that he could take out of his registered retirement savings plan.

When Nelson met with Hugette, he told her that he could arrange finance of up to $220,000. Hugette said that All Floors accountant had been working out a value for the installation department. She said the cost of buying used trucks and tools similar to what would be sold off would come to around $150,000. She also indicated that the installation department was already a going concern with trained employees, established systems, and customers. She said that this goodwill was worth another $150,000, for a total value of around $300,000. Hugette said that if Nelson wanted to buy the department as his own company, she would be willing to let him have it for $290,000, and she would loan him the $70,000 that he was short. Nelson quickly agreed to the deal and Hugette said she would have her lawyer draw up a contract.

Two years later, Nelson was bankrupt.

Nelson had renamed his spin-off company Nelson Floor Installations. And for the first few months, the new company was profitable, subcontracting from All Floors as well as two or three other carpet retailers. Nelson paid himself a small living allowance and gave the rest of the profit to Hugette in order to get that loan paid off as quickly as possible. During this time, two new installation companies started to compete with Nelson, and their business was growing rapidly as they were able to undercut Nelsons price by paying lower wages to their employees. Nelson believed that because all his installers were experienced, it would be difficult to pay them less than the rates established by All Floors.

During this time, three of the trucks that Nelson had purchased from All Floors turned out to need such extensive repairs that he decided to replace them with new vehicles. Also, over the next few months, one by one, the carpet companies Nelson was getting business from left him for his cheaper competitors, and he was unable to find new customers. The final blow came when Hugette regretfully informed Nelson that she, too, would be turning to cheaper installers. When Nelson reminded her that she had a contract with his firm, Hugette explained that their contract obligated Nelson to supply installation services at their previous rates, but did not obligate her to buy from Nelson.

Nelson managed to hang on for several more months, able to pay his employees, but with other unpaid bills piling up. Eventually he was forced into bankruptcy and a court-appointed trustee seized the assets of his company. The bank took Nelsons house, and all his remaining equity in it was used up by legal and administrative costs. Ironically, it was Hugette who purchased the assets of Nelsons business from the trustee for a sum of $75,000, including the new trucks Nelson had replaced her old ones with. Using those trucks and the other equipment, she re-opened her own installation department at All Floors, hiring new installers at cheaper rates than she had previously paid.

QUESTIONS

1. Suggest reasons why Hugette likely wanted to sell off the installation department. How could Nelson have investigated these reasons?
2. What mistakes did Nelson make? What were the likely reasons that he was not more diligent?
3. What advisors should Nelson have used before making the purchase? For what specific areas of advice?
4. How could Nelson have responded to the competition?
5. What is the most important lesson to be learned from Nelson?