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HOW TO INCORPORATE

Case Study
 

His rock club was in ruins. His partnership was crumbling. Could Allan Fingerhut save his business and his friendship?
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The bill arrived early last year. According to the notice, Allan Fingerhut's Minneapolis nightclub, First Avenue, owed $170,000 in overdue real estate taxes. It wasn't the first indication of trouble at the club -- which Fingerhut had entrusted to his childhood friend Byron Frank after moving to California and starting a new business. And it wouldn't be the last. Staring at the notice, Fingerhut wondered whether mixing friendship and business had been such a great idea after all.

First Avenue had been a Minneapolis institution since the 1970s, helping launch the careers of artists such as Prince and the Replacements. But revenue at the club had been sliding since 2002. Fingerhut's relationship with Frank was suffering as well. Since moving west in 1988, Fingerhut had had little direct involvement with the nightclub. Though he reviewed quarterly financial results and wrote the occasional check, he no longer knew who was headlining on a Saturday night; he visited just once a year. For years, the arrangement had worked out fine. But Fingerhut had come to regret his hands-off approach. Was it too late to step in and save his business?

Doing so would not be easy. Fingerhut and Frank had been pals since they were 8. In 1969, at the age of 25, Fingerhut signed a lease on a former Greyhound bus station in downtown Minneapolis and transformed it into a live music venue, the Depot, which he later renamed First Avenue. Frank soon joined him. Though Fingerhut was the club's sole owner, the two ran the place like partners. Fingerhut focused on marketing and strategy, while Frank, a CPA, maintained the books. Nightclub veterans Steve McClellan and Jack Meyers handled day-to-day operations, from overseeing the bar staff to booking acts. Throughout the 1970s, the club was a critical and financial success.

In 1983, First Avenue was the setting for Prince's cult movie Purple Rain, which sent the club's fortunes soaring even higher. But the years of late nights and loud music were taking a toll, and Fingerhut was getting burnt out. In 1988, he and his wife, Rose, decided to focus on a more subdued business in a warmer climate. They moved to Marin County, Calif., where they established a fine-art publishing company in San Rafael and an art gallery in Sausalito. Fingerhut says he never had a doubt about leaving First Avenue in the hands of his buddies back home. "I knew these guys shared my objective to keep the arts alive in Minneapolis," he says. "I thought they would never do anything to risk losing it."

And First Avenue continued to prosper. In fact, Fingerhut was so pleased with the business that in 2000, along with Frank, McClellan, Meyers, and Fingerhut's brother, Ron, he formed a partnership that purchased the building that housed the club. Frank, for the first time, now had a financial stake in the business; indeed, he was the building's largest single shareholder, though Fingerhut remained sole owner of the club itself.

But two years later, things took a turn for the worse. "After 9/11, people didn't want to come out in big groups to see music," says Meyers. What's more, R&B and hip-hop had grown increasingly popular in the Twin Cities, making First Avenue's all-rock format seem outdated. Meanwhile, a slew of new bars and clubs were cutting into the club's customer base. In 2003, revenue plunged nearly 25%, to $3.1 million, Fingerhut says. He urged his associates to shift the club's strategy by scheduling more DJs and dance nights. But Frank disagreed, insisting that the club remain true to its rock 'n' roll roots. Now that his own money was on the line, he was in no mood to compromise -- and McClellan and Meyers agreed. "In this industry, you have to roll with it and hang on through the trends," McClellan says.

As First Avenue's financial problems mounted, the arguments increased in both frequency and ferocity. Fingerhut was horrified when Frank spent some $200,000 on renovations, which included a plush new VIP lounge. His trust in his old friend eroding, Fingerhut decided he had to make a drastic move. If he allowed his buddies to continue running First Avenue their way, he was convinced, the business was bound to go bankrupt. But if he returned to the club, things could get ugly. For Fingerhut, it was beginning to look like a no-win situation.

The Decision

In March 2003, shortly after getting the bill for back taxes, Fingerhut fired Frank from the club, sending the pink slip in the mail. Not long after, he boarded a plane for Minneapolis and fired Meyers and McClellan, who had grown increasingly bitter after Frank's departure. "Their loyalty went completely to Frank," Fingerhut says. "I had to take back control."

Commuting between Minneapolis and Marin, Fingerhut immediately added a Latin dance night and more Top 40 parties. He repainted the club's interior with silver stars to appeal to a trendier crowd, added bright fluorescent lights to the entrance, and even replaced the nondescript black T-shirts worn by staffers with flashy gold ones. At first, the new plan appeared to be working. Over the summer and fall of 2003, revenue jumped about 15%, Fingerhut says. But the overall financial picture remained grim. One problem was that Frank had green-lighted a number of raises and bonuses before Fingerhut arrived, increasing the club's operating expenses. Even worse, Frank, Meyers, and McClellan all filed wrongful termination suits against their former boss, leaving Fingerhut with mounting legal bills. By the end of the year, the club had just $400,000 in assets, against liabilities of $1.4 million.

Fingerhut consulted his attorneys, who advised him to cut his losses. Last October, he filed for Chapter 7 bankruptcy on behalf of First Avenue. Losing his club after more than 30 years was devastating, he says. But what happened next stung even more. Frank, McClellan, and Meyers formed a partnership and purchased the club's assets for a mere $200,000. They reopened First Avenue on November 20 -- without Fingerhut.

First Avenue has struggled to stay afloat since then. The club's full-time staff has been reduced from 30 to nine, and it's open only three nights a week. Frank, who now splits his time between Minneapolis and Florida, says his only involvement is as a landlord. And he has no regrets. "I can take credit for making sure that there still is music at First Avenue," he says. "I hope that Allan is able to be happy for what he has and leave it at that. I don't expect to be back in touch ever again." McClellan, for his part, still helps with the club's communications and strategy, while Meyers handles operations.

Back in California, Fingerhut is dealing with the implications of First Avenue's bankruptcy. The court says he still owes $50,000 to creditors -- a ruling Fingerhut is fighting. Yet slowly, the nightclub that consumed most of his adult life is receding into history. Instead, he's turned his attention back to his art business, which now includes three galleries and generated $5 million in sales last year. Still, he says, nothing can make up for the First Avenue debacle. "Losing that club was like losing a child," he says.

The Experts Weigh In

It sounds like Fingerhut wasn't watching his own backyard, so he lost his club. While he wasn't deeply involved in First Avenue on a daily basis, he was deeply invested in it financially. Obviously, his company's bylaws did not appropriately protect him from liability. A lawyer should have advised him that he was getting overextended."

Alex Andreas
Owner
Boom Boom Room
San Francisco

When you add legal and operating issues to poor strategic analysis, you have a doomed proposition. Changes in competition were the club's biggest problem. Why were other music venues becoming popular in the Twin Cities? Why was rock music declining in popularity? If the team had done an analysis of their competitors and their customers, they might have been able to agree on a way to reformulate the club."

Lawrence Hrebiniak
Professor of Management
Wharton Business School

Instead of simply trusting people he likes, Fingerhut needs to develop trust in people who perform. In business, we need to stay on top of things, even with our closest friends. That said, he made a good decision when he walked away from his business rather than fighting to the death. Lawsuits and disagreements chomp up a lot of your time and money. So it was wise of him to move on."

John L. Schwartz
Psychiatrist and CEO
Value Investing Congress
Los Angeles

Last updated: May 1, 2005




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