At some stage most business owners will have to decide whether they should rent or buy their business premises. In a greater majority of cases it makes sense to rent premises, as many businesses cannot afford to tie up the capital required to buy land and buildings and require the flexibility for growth potential.
The practical question of fitting out the rented premises with the necessary equipment must then be considered. How this is done may make a difference to the business while it is trading – and a large difference to creditors if the business fails.
If premises are rented, then everything ‘fixed’ to that premises becomes part of the premises. Just because the landlord did not pay for it, it does not mean that they do not end up owning it.
This problem was highlighted in a recent liquidation managed by Worrells. The business leased vacant land on a long-term basis and constructed a processing plant and a retail outlet on that land. The major pieces of equipment (mainly freezers) were constructed as part of that processing building. Having spent hundreds of thousands of dollars on the processing plant, the business failed and we were appointed.
The major ‘asset’ of the business was the processing plant that it had built. However, in practical terms, it was no longer an asset of the business, it was now an asset of the landlord. The building could not be moved (it was literally a Besser Block building) and the many hundreds of thousands of dollars worth of expenditure was lost.
One of the reasons that the business failed was that the annual lease payments on the land increased substantially. The problem for the business was that it could not relocate to cheaper premises because the processing plant and retail building were all fixed to the land and could not be moved. They would have to walk away from (almost) every asset they had and start again.
There are a number of advantages to having equipment separate from the land and buildings (being Plant & Equipment as opposed to Fixtures & Fittings).
- Better depreciation rates for equipment;
- The flexibility to modify and replace equipment as required;
- The ability to relocate equipment within the premises or to another location if the business moves.
If the business is wound up, the equipment can be separated from the buildings and sold. This distinction is particularly important if equipment is leased or financed – and directors or other parties have guaranteed the facility. At least the equipment can be repossessed and sold to lessen the amount called under the guarantee. If it is part of the building, it is also lost to the financier.
In our case, it would have made some sense to install free-standing freezers in a building that could be disassembled. Even if a solid building had to be built, it should be made as basic as possible. Offices and retail outlets could be housed in demountable buildings. However, they were not and the creditors lost all rights to those assets.
The lesson: do not add substantial improvements to land, or if they are essential, negotiate some cost sharing arrangement with the landlord.