Protecting the business
Most entrepreneurs, when starting to model their business operations using a spreadsheet, start with expected revenue by month. Then they calculate cost of sales, and then project their expenses, to find the bottom line profit or loss each projected month.
There is a rarely-used twist that makes lots of sense. Add a new row at the bottom of the spreadsheet. Project your revenues and costs as in the original exercise. Then consider that an operating entity should be able to generate a ten percent operating profit based upon revenues, and add a row to your spreadsheet immediately below “operating profit” that calculates 10% profit from sales each month. Compare that with the operating profit as calculated, which surely will be
lower, probably negative, for months or even years. The difference is something new – a target for reduction of expenses or addition to revenue for each month in which the calculated number is lower than 10% of revenues.
[Email readers, continue here...] We are not taught to think this way, but rather to find the month in which we break even in our plan, then calculate the accumulated losses to that point, add all the cash needed for investment in fixed assets, and end up with the amount needed to finance the business to breakeven through equity or debt financing. This new tool gives you that number plus the amount needed to make the business a viable entity with a chance of long term survival. The longer the time it takes to break even, the higher the number of dollars needed. Sometimes, the difference is a reminder to consider a reduction of expenses, if revenues cannot be raised from projected levels.
And sometimes, it is just a reminder that we are all in business to make money, not to break even. Just like assuring that your own at-market salary is included in a forecast even if not drawn in cash during the earliest periods, the 10% target reminds us all that the target must be higher than merely breaking even, even if that means reassessing all expenses until the target is met or exceeded.
With help from JJ Richa
The next logical step in our analysis of financing tools is to analyze asset-based lending, in which you pledge or assign your short term assets, such as accounts receivable or inventory, to the lender. Often, the lender then tracks the pledged assets until money is received or inventory sold, expecting repayment from the proceeds of sale.
Asset-based financing is a specialized method of providing structured working capital and term loans that are secured by accounts receivable, inventory, machinery, equipment and/or real estate. This type of funding is great for startup companies, refinancing existing loans, and financing for growth, mergers and acquisitions.
[Email readers, continue here...] One example of asset-based finance would be purchase order financing. This may be attractive to a company that has stretched its credit limits with vendors and has reached its lending capacity at the bank – or a for possibly a startup company without adequate financing. The inability to finance raw
materials to fill all orders would leave a company operating under capacity. An asset-based lender finances the purchase of the raw material. The purchase orders are then assigned to the lender. After the orders are filled, payment is made directly to the lender by the customer, and the lender then deducts its cost and fees and remits the balance to the company. The disadvantage of this type of financing, however, is the high interest typically charged.
Handling the reporting for such loans often require some amount of dedicated time. Many lenders require that a transaction report be generated along with a batch of purchase orders or invoices pledged as collateral for the loan. The lender has the right to reject any individual pledged item, and then calculates a percentage of the value as the amount to loan. Ranging from 50% to 80%, you can request an “advance” up to your credit limit, beyond which no more is available, and you must rely entirely upon your own devices to finance further transactions.
Each transaction report also contains a list of money received against pledged items, so that the calculation of available credit remains fresh, and based upon remaining invoices that are not yet overdue. Government invoices are usually not accepted, and any new invoices from accounts that have outstanding invoices more than 60 days overdue are usually also exempted, as are invoices to concentrated customers who account for a significant percentage of the company’s business.
Asset-based financing is not cheap. Lenders often tack on charges for management of your account, for a “float” of cash to account for the number of days to clear payments received, and for a periodic audit of the company’ accounts. Adding all of these often adds an additional 3-8% to the stated interest rate of the line of credit, sometimes making it one of the more expensive methods of finance.
Finally, some asset-based lenders are “factors” who actually purchase your invoices, hold back a portion of the proceeds to protect against future bad debts, then deduct their fees before remittance and remit a net amount, with the final amount to be remitted upon collection of the money owed by the customer to the factor. Factors redirect your customer’s payment to the factor’s postal lock box. You never see the cash collected, since the invoice is owned by the factor, no longer by you.
There are many other forms of financing a small business. Let’s explore some of them.
By JJ Richa
Dave’s note: Our guest insight this week is from JJ Richa. JJ is a successful entrepreneur and technologist giving back to the entrepreneurial
community in many ways, including his weekly Internet TV program on entrepreneurism, and participation in several mentoring programs.
Business partnerships have their advantages and disadvantages. Taking on a business partner is like a entering into a marriage. In general, partnerships are easy to get into and difficult to get out of. Certain guidelines should be taken into consideration along with a path to follow – from dating to prenup to marriage – all of which can be applied to a business partnership.
Taking on a business partner can be an excellent strategic decision in helping move the business forward. It should be well thought out for all parties involved. The relationship needs to be synergistic financially, emotionally, and operationally. All parties need to perform due diligence to ensure that the assumptions are correct, that neither partner has financial issues which could affect the partnership, and that the opposite partner has the skills to contribute to the partnership.
[Email readers, continue here...] Most of the important benefits for partnering include:
- Combining of complimentary skill sets
- Access to new markets
- Addition of new services or product lines
- Addition of essential expertise and knowledge to propel the business forward
- Open doors to new distribution channels
- Access to new technologies
- Access to capital unavailable to either partner singly
Certain steps should be taken before entering into a partnership.
1. Personal assessment and getting to know one another:
- Work together on 2-3 projects before an agreement is consummated
- Determine the commitment of the potential partners. Is the potential partner in for the long haul?
- Identify each of the partner’s unique contribution. Does the potential partner bring specialized knowledge, skills, leadership, or experience that compliments others?
- Understand each person’s personal goals. Are each set of goals consistent with the other’s including for example personal wealth, business success, and autonomy?
- Determine trust and Values. Is there trust between the parties? Do the proposed partners share a set of common values? Core values are none negotiable. Be ready to walk away when others are willing to negotiate their own values or try to negotiate others.
2. Determine personal and business goals:
- Contribution: What will the new partner contribute? Example: cash, assets, equipment, connections… Regardless of what it is, a partner’s contribution needs to increase the value of the business.
- Compensation: What are compensation expectations? Example: salary, equity, joint venture, etc… Can the business afford it?
- Control: What type of control is the new partner looking for? Example: percent of ownership, officer/operational, director/board member… What are the parties willing to give up in return for the prospect of business success?
- Brand and Success: Is the new partner dedicated to ensuring brand continuity and contribute to the success, or just to ride on what has been established by the other?
3. Create roles and guidelines in the potential partnership:
- What role and responsibility will each of the partners have including operation, financial, sales, marketing, etc..?
- How will decisions be made and by whom? Is it by committee?
- Will each have certain level of decision making authority? Will the new process impair quick decision making?
- Will authority limits be defined, and processes and procedures put in place?
- What is the understanding if one of the partners wants out or wants more? What is the understanding if things go downhill/uphill?
4. Perform preliminary due diligence:
- Review the business plan including marketing, sales strategies and financial needs
- Review long term company debt, goals, objectives and financial projections
- Review financial statements – up to 3 years if available
- Review tax returns – up to 3 years if available
- Research and talk to existing and past customers
5. Create partnership agreement basic terms:
- Define Key Performance Indicators (KPIs.) How will the success of the business be measured?
- Clarify decision making and dispute resolution processes
- Define each partner’s title and position
- Define management responsibilities and job descriptions
- Detail authority limits for each partner
- Clarify operation responsibilities and metrics used to measure performance
- Define vacations and time off policies such as with partners vacationing at the same time
- Determine compensation for each partner
- Exit strategy planning, including determining what happens when one partner leaves, if closing the business, if selling the business, creating a mutual buy/sell agreement, and more.
Depending on the legal structure of the business, different types of formal agreements may be required.
Partnership agreement should never be 50/50 regardless of the perception of compatibility at the time of execution. There must be some method of resolving a tie that is predetermined in the agreement.
Potential partners should follow and apply these guidelines independently. This should be followed by a joint meeting to determine commonalities, synergies, and conflicts. If necessary, this is the time to bring in an impartial third party to facilitate any possible conflicts and resolutions.
It is highly recommended that legal document are created and/or reviewed by a business transaction attorney. All agreements should be in writing and signed by all parties involved. Regardless of what method is taken to reach an agreement among partners, avoid some of the common mistakes. These include premature rejection of ideas by the other partner, prematurely judging others, one-sided financial consideration, and not sticking to core values.
Assuming first that a corporate whistle-blower is not tooting about you individually, such a class of people have been granted protections under the law and serve a function that needs to be acknowledged.
First, the assumption is that such a person is not making his or her gesture for personal profit, but to give proper notice that there is something illegal going on within the company that the person cannot accept and must tell someone about. Note that I use the word “illegal” to differentiate the tell-tale from the legitimate whistle-blower. A tell-tale almost always has a motive based upon political or personal gain, with the exception of when there is a perception or the reality of any form of sexual interference or bullying being reported. That’s a subject for a separate discussion, and there are civil penalties as recourse for such proven behavior.
Whistle-blowers, on the other hand, if not motivated by a personal reward, are often brave beyond need, risking job and reputation to call attention to an illegal act or acts. If the person comes to you with evidence of such acts, you must act immediately to address the issue, often including reporting the incident to the authorities along with the whistle-blower. That’s particularly tough if the consequence is going to be severe against the company itself. But, if we have learned anything at all from the last several decades of such incidents reported from within highly visible companies, covering up the problem results in amplifying it beyond anyone’s wildest imagination. Quickly dealing with it and the consequences always is the lesser of numerous alternatives.
[Email readers, continue here...] And of course, the whistle-blower is protected by law and cannot be punished in any way for the deed of reporting a wrongdoing that breaks the law, whether later proved true or false.
Some agencies offer cash rewards for whistle-blowers that are in proportion to the amount recaptured by a taxing authority or penalties assessed. Such rewards blur the heroic act into one where personal gain can easily be assumed to be more of a motive for a good deed than brave action. And there are raging arguments from company offices to the halls of Congress about whether a whistle-blower should or must first approach senior management within the company before reporting to authorities. But, no matter what the outcome or how high the reward, that does not change the protection the whistle-blower has under the law.
Much of work place safety is common sense. But there is a natural tension between economy of operation and provision for safety for employees, and the resulting risk to the enterprise must be carefully weighed.
Good boards of directors have a committee of the board to deal with “audit” issues, which should include analysis and recommendations to management about workplace safety as a part of a broader issue of risk management. After all, the board and management together are responsible for keeping the company alive, protecting the corporate asset on behalf of all stakeholders – including shareholders, employees, and customers.
Especially in a manufacturing environment, there are laws created by those who have experienced the result of accidents by others that impose upon all companies the hard-earned lessons from the past. Many of us groan when reading or hearing of these detailed, burdensome rules and laws. Yet workplace accidents are harmful to health and safety for all, to morale, and they ultimately cause financial hardships upon the company, whether in the form of lost productivity, increased insurance cost, or debilitating lawsuits that inevitably follow.
[Email readers, continue here...] No company, even the smallest, is immune to safety issues. In this computer keyboard-driven office world, programmers, accounting and office personnel, and many others are exposed to carpel tunnel, back, and leg and neck problems, just by sitting in place. The risk of injury, worker compensation insurance claim, lost productivity, and lawsuit are only slightly less in the office than on the factory floor.
And how do you protect your employees who travel when on the road? Are you and they aware of the procedures for informing insurance companies, their managers and others in the event of an accident while on the road? How do you and they respond when out of the country? To whom do they turn when in unsafe environments, let alone after an accident, when isolated from their local infrastructure?
None of us likes to think of these issues which detract from the focus upon growth and customer service. But these very issues can derail the best of organizations at the worst of times. At the very least, management and its board should discuss the exposures to safety risks and how they might be mitigated in advance.
Have you ever lost all of your data on your smartphone, laptop, or desktop PC? If not, it is probably only a matter of time until you do. Those of us who have experienced this heart-stopping event now regularly back up our data and many of us create images of our entire hard drives often, ready this time to address an effective recovery.
But what about the shock of a fire, a major natural disaster, or even the loss of an important company top executive? Are you or your board prepared to immediately jump into a pre-planned recovery? From experience on more than forty boards over the years, I can state that few have even considered the possibilities. All of us have a phone listing of our employees and associates. But very few have a phone tree for simultaneous contact of larger numbers of people to marshal a recovery from any type of disaster.
Boards of directors for companies of all sizes should have a person or better yet a committee dedicated to considering the preparations for disaster recovery. Often, we consolidate this task into the audit committee of a board; and often we expand the subject to ‘risk management’ which includes examination of all forms of risk, from insurance coverage to OSHA compliance and more.
[Email readers, continue here...] When a company is very small and the company’s assets reasonably replaceable with existing or easily borrowed funds, the event is less likely to threaten the existence of the organization. As a company grows in size and complexity, more stakeholders depend upon the wisdom of the CEO and the board to think in advance of these unpleasant things, and to attempt to insulate the company’s dependents from a disaster.
How about yourself? Have you been open in sharing your knowledge and talent with a backup, or even a potential successor? It is prudent and certainly a sign that you take this responsibility personally as a leader among your peers and subordinates.
I have three unfortunate examples in my past of founder-CEOs dying suddenly at their prime. The shock to each organization was a threat to the very core in all three instances. Yet as we will discuss in detail in a future insight, in one, the board stepped in immediately to reassure the stakeholders, elect a new CEO from within the board, and reach out to the community with a plan for succession that allowed the business to continue with minimal interruption. In another, the creditors threatened to close the company, and the board was completely unprepared to respond. The contrast was quite a lesson to me – one that I would never want to repeat as a board member or senior manager.
What if? How about dedicating at least a half hour of your next executive or board meeting to the subject, and creating a checklist and assignments for covering at least the greatest three risks identified? It is yet another sign of your growth and growing wisdom as a leader.
So you’ve been at this for years through thick and thin, great days and days in which you’ve had better times. Much of your job has become routine. But it feels good to see your “baby” grow and others buy into your vision.
It is human nature for you and every entrepreneur to fall into a routine of taking care of day to day issues, meetings, communicating with customers and shareholders. But you remember the thrilling days when everything was newer, each decision an event, each milestone something to be celebrated. If you think about it, you also remember that you spent much more of your time on strategic issues and thinking about the business and its growth, as opposed to thinking within the business about its process issues.
Your value as a CEO or executive is inherent in creating the vision, providing the drive, and forcing focus upon successful implementation of the vision that you bring to the enterprise. It is where the fun is.
[Email readers, continue here...] So, how do you regain that enthusiasm for what is best for you and for the company? There are a number of things you can and should do, and soon.
Take a day – a full day – off to walk, sit, and think of where you want this company and your role in it to be in the future. Don’t let interruptions from emails, phone calls and people at the door interfere with this focused effort.
Then call a strategic planning session, off site, for you, your board, your advisors, and direct reports. If needed, hire a facilitator. And provide for someone to take notes. Lay out your vision to those present as a starting point. Ask for comments, challenges, and additions. Then spend the rest of the day developing strategies and tactics to get you there. Finish the process by refining the resulting document, passing it through the same group for comments. Then call an all-company meeting to focus everyone on the vision, goal, strategies and tactics. Stand back and watch for the reaction. Most everyone wants direction and to buy into a vision that makes their jobs have meaning.
Starting the very next day, begin monitoring progress toward the goal or goals, raising your job to one of strategic implementation and guidance, not of day-to-day process.
Your value will increase in the minds of your board, and you will feel much more enthusiastic about your contributions to the success of your enterprise.
It’s your move.
Here is a simple economic truth. Fixed overhead continues to eat into your cash month after month. It doesn’t differentiate facile, efficient businesses from slow, disorganized, quality-challenged ones.
If it takes eighteen months to get a new product out the door and into the market, and if a product’s gross margin is ten dollars but the corporate overhead is a million a month, it will take the sale of 67,000 more units to break even than if it were to take only six months to market. If the total annual potential is 100,000 units, the slower cycle to market just cost the company two thirds of a year in the product’s profits. With today’s rapid obsolescence, that could be the entire life cycle of the product itself, lost because of being slow to market.
And profits from the sale of the product create cash for development of the next product. If the time to market is slowed by inefficient development, the risk of a competitive product overtaking yours increases dramatically.
[Email readers, continue here...] So the truth of the statement is self-evident. Because fixed overhead burns cash, extended development cycles burn more cash, preventing earlier sale of product, to create even more cash. Efficiency in development pays off in less cost and earlier competitive products, often producing greater market share in the process.
Have you considered how to make your operation more efficient as an important way to increase cash flow? Most of us are quick to worry over cutting costs. Some of us worry over how to greatly increase revenues. Few of us worry over how to squeeze more efficiency out of the development cycle or from the organization itself.
That’s your challenge for the day, week, and month.
Surely you’ve heard the buggy whip analogy. A business making those necessary items ignored the signs of progress and found itself without a market. Perhaps that happened to sword smiths upon the invention of the rifle, and certainly to the makers of cassette tapes upon the dawn of the CD.
I found myself in the middle of such a slow-rolling change twice in my career. First, in the late 1960’s (yes, I know, a long time ago), there were 31 phonograph record manufacturing plants in Southern California alone. By 1975, there were only two. That is sudden change, brought about by the fast acceptance of the cassette, which in turn gave way to the next technology, CDs, after a rather short lifecycle. Record plants were noisy, dirty places, using chemicals I can only imagine now rest somewhere in the ocean, to electroplate the “stampers” and press the records. Cassettes, in contrast, could be manufactured in small rooms with much less expensive equipment and no damage to the environment.
The second time I learned the buggy whip lesson was at the dawn of the personal computer age, and this time we guided our firm without a hitch from minicomputers to networked PCs, even growing the business as we gave up the lucrative $100,000 hardware sales in return for service fees to network our customers’ systems, install our database, and migrate to customer-purchased desktop and servers.
[Email readers, continue here...] Here it is, not so many years later, and the signs are more subtle yet, but the speed of obsolescence is much faster. Take for example, the public’s quick acceptance of Facebook, Zinga, Mixi, and other social networking portals, leaving early leader MySpace wondering what happened to their comfortable lead and large fan base. With rapid sharing of information and recommendations, a fickle public can change its mass preferences seemingly in an instant.
How do you spot the buggy whip trap and differentiate it from a simple business cycle slump? The answer is simple, but somehow out of reach for most senior executives and entrepreneurs. Micro trends may seem to be a whisper, as mini-trends follow with leading adopters making a bit of noise. It is those leading adopters who take the chance on new technologies, new companies, new styles, and new idioms. That is why so many larger companies pay specialty marketing firms to find, court, and listen to those individuals who lead the pack in taste and action.
For those of us who don’t have the resources to hire these expensive market trend-watching firms, there are more simple yet effective opportunities. Usually, technology and style trends begin with those aged between 15 and 23. And which of us doesn’t have at least one close relative or child at or near these ages? Have you ever asked for an hour of such a relative’s time to discuss what’s “cool” or “coming” or “must have” in their lives?
It is human nature to protect one’s investment of money, time and brand in an enterprise. That leads naturally to a resistance to change and inability to willingly move to replace your own product with something new that will kill its revenues.
But we all know that if we do not do it when offered the evidence of obsolescence, someone else will. So, are you investing in your own form of buggy whip product or service today?
Great executives and managers seem to intuitively know what they don’t know. But it is not at all uncommon to not even know what questions to ask.
How do you avoid being sideswiped by the new product you never saw coming, or by the “black swan” event no-one ever thought of – that might threaten your business?
Speaking with a roundtable group of fellow associates, most all of them CEOs, we addressed this question and spent an hour brainstorming how to protect against just such a lack of forward vision.
One CEO stated that she engages regularly in scenario planning with her executives, asking “what if” questions to explore the edges of the group’s thinking about everything from disruptions of supply to changes in customer taste to acts of God such as floods or earthquake. The group agreed that this is an excellent process, engaging the entire team and members’ experience to explore the unknown.
But what if no one in the group thinks to ask the pertinent question that leads to the most impactful unknown? What if that threat is outside of the experience of anyone in the room? What if no one knows what to ask?
[Email readers, continue here...] Another CEO chimed in with an answer that made us all think. Most every technology advance has been predicted in works of fiction years before the fact, he stated. Why not look to fiction for clues? From devastating events like tsunamis to future user interfaces predicted in such films as Star Trek or Minority Report, there are liberating clues within the experiences of most of us. Think of Flash Gordon or Dick Tracy, characters from many decades ago with communication devices that have not only come to life but have been far surpassed in reality. Tom Cruise’s virtual handling of graphics by hand movements came true only a few years later, even popularized as a game with Microsoft’s Kinect system driven by body movement alone.
Our frame of reference must be as broad as possible when asking “what if” questions to protect our future. Read more science fiction if you are involved in technology. Read more disaster novels to expand your thinking to the very edge, even if only for a minute as you examine what and how to react to the unknowns that are sure to someday challenge us.