We present this last article on yet another recently failed investment project as an epilogue to our three part series on Failed Investment Schemes (see our September, October and November 2007 newsletters). Whilst the project was not an investment scheme as defined in the Corporations Act, it does have many of the same characteristics which tend to support the conclusions in our three part series.
The details of the project are fairly straightforward. Four separate companies were set up to undertake four unrelated developments of residential units and townhouses. A fifth was set up as a management company. Each of the four development companies has less than 20 shareholders, and the companies were partially funded through share capital, with the balance obtained through a main-stream bank. None of the projects proed to be viable and significant losses were incurred. The problems included cost overruns in the developments, increased funding costs due to the delays in finalizing and selling the units, and lower than expected selling prices.
This ‘scheme’ has some of the 7 factors mentioned in our last newsletter as being common amongst failed investment schemes. Investigations have not been completed, but we can offer the following observations at this stage.
1. Offering High Returns. The project offered returns to investor shareholders of around 14%. The directors say that the risks were explained to the investors, but it is doubtful that many of them looked past the anticipated returns and did not really consider that they may lose their money.
2. Large Numbers of Smaller Investors. The four development companies had 42 investor shareholders between them, investing just over $5 million in share capital. Further money was borrowed to fund the actual development costs and was secured across the land. The investor’s funds were put in as share capital at an average of $120,000 – compared to the combined development costs of about $9 million. There was no one significant investor that could control or oversee the projects.
3. The projects were not viable. At least with the benefit of hindsight it is clear that for the venntures to be viable it was essential to have efficient project mangement, a proven sales team selling an ‘in demand’ product and alimited project time period. Arguably none of this was present.
4. Legislative Blank Spots. The companies all have less than 20 shareholders so that they are not classified as public companies under the Corporations Act and subject to the extra statutory requirements. The monies were received as share capital and not as secured loans so they were not classified as an ‘investment scheme’. Certainly there exists the argument that taken in aggregate the critical levels were exceeded – but the directors say they received legal advice on this issue.
5. An Appearance of Respectability. The shareholders were predominately clients of one finance broker who promoted the projects to his clients separately from the directors of the company. The directors, it seems, only had contact with the investors after the money had been paid to the broker.
We suspect that the result of this ‘scheme’ will be similar to the other schemes examined in this series of articles – large losses to the investors.