Tag Archives: Finance

What to Do When Financing Fails

Having been in business in the same town for almost twenty years, a Midwest company was accustomed to expansion and going after market opportunities. The owner had kept her business competitive by continuously improving product offerings and learning from the input of both customers and target customers. With a loyal, experienced operations team, she felt that she had the recipe for long-term success. However, when the recession of 2008 hit, she was unable to obtain a renewal of her line of credit by which she had historically been able to normalize cash flows.

The case study above illustrates a business principle–that we must always as business owners prepare for the unexpected and have the flexibility to adapt to changing market conditions. If we seem surprised when an action that we did not anticipate occurs, then it follows that either: 1.) our planning is incomplete, 2.) our systems and processes are too unresponsive to key indicators, or 3.) we have not established a feedback loop that provides us as small business executives with vital, timely information. Regardless the reason, it is poor management to not have a contingency strategy or tactic in mind for situations that may arise.

What should an executive team do when financing from lenders or investors falls through? First, the reason  for such a collapse in financing is normally attributable to one of the following:

  1. Partners or new regulations restricted the financing source from making (continuing) the deal.
  2. A more attractive alternative was available to the lender/investor from another source at the same time.
  3. The company failed to read the market conditions and adjust the financing request accordingly.

To stabilize the business in response to one of these situations, the owner and top finance executive should always seek new sources of funds–even if today’s source has been very reliable. If you have built relationships with other providers of financing, you may be able to reduce the risk any one player undertakes by spreading it among several. Alternately, you may find that some institutions have differing standards for new clients than for existing ones and may want the entire financing facility.  In either scenario, it is incumbent upon you and your team to perform due diligence. Find out how the bank (or alternate source) has shown commitment to other borrowers. In many cases, your accountant or attorney may be able to recommend new sources for you. Others in your trade group may have similar referrals to provide.

Being able to lay out both your best case scenario and a worst case one will show a new source your planning strengths and help to establish credibility. Ask questions about how credit facilities could be expanded as you hit milestones. Offer your plan for reporting your financial and operating performance. Discuss what the loan covenants may look like and have frank conversations about how your team will accommodate the request to demonstrate creditworthiness.

To avoid a recurring financing problem, owners should try to over-finance their operating needs whenever possible. It is extremely valuable to have credit available that is not being used–this cannot be overstated! Given that this funding source may dry up at any point, you never want to have to go back to the lender or investor because you failed to anticipate growth. 

The other recommendation is that you look at different types of credit. If you traditionally have only taken out installment loans, look for lines of credit–and vice versa. There are additional types of financing that may also be advantageous to consider–accounts receivable, factoring, purchase order financing, contract or project financing, asset based lending, leasing, etc. By using more than one type of funds from more than one source, you are diversifying your vulnerability to a credit restriction that could be deleterious to your business success.

Too Many Houses Are Us

Most businesses face unforeseen circumstances while in pursuit of their sales and other goals. The way these situations are handled will quite often determine the degree to which the company’s efforts are successful. A useful method to see what others have tried and what principles we can learn from their experience is the case study. When your business produces products, it creates inventory. When the inventory is too large for the demand, it becomes a problem. Let’s take a look:

A speculative home builder on the West Coast discovered to his chagrin that the market in his local area was inundated with homes very similar in style and price to those he was building in large numbers. There was both a general glut, and a specific one related to this company. As his lender began to point out, an inventory level that has escalated out of control presents severe cash flow problems among a variety of other concerns. The lender was also quick to point out that the builder was in jeopardy of defaulting on construction loan interest payments a couple of months down the road if he did not begin selling some of his inventory–and soon.

How could this builder (and others in a similar situation) end this problem of increasing inventory? First, the problem can normally be attributed to one or more of the following factors:

  • an overbuilt market in the builder’s product offering
  • incorrect, incomplete, or absent market research
  • an inability to revise product in terms of plans, elevations, and prices to meet buyer demands.

Once a builder has determined the existence of increasing inventory levels–and their cause–it is time to stabilize the situation. Selling off an old unit for every new unit constructed is a bare minimum requirement. It is not wise to continue building simply to try to fund aging inventory interest payments out of new construction loan draws. As older homes are sold, new construction can be considered. Due consideration includes understanding the problems that led to former inventory level increases well enough to avoid the same errors in the future.

In addition, an inventory reduction plan should be initiated immediately, making sure to target the oldest inventory with the worst gross margins first in any type of incentive offer. The use of incentives can be gradually lessened as the builder moves through the oldest inventory into newer inventory with better margins. Sales staff can be of great help in determining what may help to move homes. If qualified buyers are hard to come by, it may be advantageous to work with local mortgage lenders and offer a program for qualifying buyers at lower monthly payment levels in the early years of a home purchase. Also, it is always helpful to walk all inventory and make lists of all items that need to be repaired, replaced, or cleaned up.

Finally, a builder can prevent uncontrolled increases in inventory levels by performing more careful, thoughtful research, making revisions to product as soon as buyer tastes are known to have changed, and offering ongoing, automatic incentives for aging inventory to be sold. It is often helpful to “re-research” current projects to make sure that the original research findings remain valid and informative. Periodic product updates and revisions are necessary even in a stable, conservative market. Buyers are always looking for small things that make one home purchase better than another. By catering to buyers’ particular tastes and requests, a builder can offer a better home and still make money.

Even if you are not in the homebuilding business, but in some other business that has inventory, these principles are important to observe. Think through ways to reduce inventories–better yet how to prevent them from ever becoming a problem!

How to Handle Lenders

In dealing with lenders, it is important for executive teams to understand the background of those with whom they transact business. Bankers, for instance, are often conservative by nature, have little experience running their own business, and can be a part of a corporate system that is bureaucratic and slow moving. Realizing from the outset that the word “risk” is a four-letter word to these professionals can prepare you to have better conversations. Furthermore, you must accept that most front-line bankers are not empowered to question the standards they must enforce on behalf of their employer or the banking system as a whole. All of this is especially true after the recent mortgage industry troubles of the 2008 recession genre. By keeping in mind who is on the other side of the desk when a loan request is submitted, you as a management team member can position your request in a way that gives the banker the best ammunition to give you an affirmative response.

How Lenders Think

Understanding how lenders think helps the entrepreneur better understand why lending policies are pragmatic rather than opportunity-driven, standard rather than adaptable, and monitoring rather than recommending. While market opportunities drive the entrepreneur, lenders approach the very same data with caution. The same unpredicted cash shortage that merely surprises a business owner may send a lender into a panic. Lenders are not in the business of selling advice–in fact, they can be held liable if found to be doing so and the business goes under. They are in the business of making money on loans. Therefore, their loyalty is to company profits and a return on their monies borrowed–and noting else! Anyone who wishes to test the strength of this premise should try missing a few note payments.

Consistency is the hallmark of the lender, due in large part to the constraints of a corporate directive of standardization. The seemingly two-sided face that the entrepreneur sees the lender wear is real; the lending officer truly wants to help and has empathy, but is governed by institutional guidelines. Overidentification with the needs of the borrower can cause a lender to lose her job. 

Consequently, the face the business owner sees is not reality but rather a front depicting what the lending institution would like to see happen. Rarely does a borrower learn the true acceptable level of performance that a lender would be willing to accept. Since lenders control the purse strings to the resources that keep the borrower in business, these lenders are impossible to control. Knowing a lender’s true bottom line enables the borrower to influence lending policies that permit operation under the best possible conditions.

How Lenders Act

During tough economic times, lenders are expected to:

  • serve as a flexible yet profitable source of capital,
  • monitor the performance of borrowers in their book of business, and 
  • provide sound references to inquirers on behalf of their clients.

Lenders must be allowed to continue to make money on the loans they have extended, but the borrower may request modifications of the terms of repayment based on business financial performance. Principal payment deferrals, interest accruals, and other methods can be used to create cash within the business operation, but one is ill advised to single-handedly embark on such practices without securing the commitment of the lending institution in advance.

To the extent they are able, lenders should be encouraged to visit the places of business of their borrowers and check things out. Outside assessment of company execution of its plans by this important stakeholder group can prove valuable to the management of the company. Hopefully, an open dialogue creates an environment where the lender reference in credit applications is always a positive one and facilitates smooth operations in your company!

 

 

The Turnaround Adviser’s Responsibility

The ability to turn the company around quickly without getting it bogged down in the minor setbacks is a hallmark of a good turnaround adviser. Emphasizing a solution-oriented approach, the adviser can rise above circumstances and fight another day;  such determination distinguishes the true turnaround expert from the would-be practitioners of company revitalization. Rather than dwelling on problems and making too much of an ultimately inconsequential event, effective advisers confront each challenge ready to overcome the odds stacked against them.

For example, a company may become delinquent with creditors and be unable to pay them in full in the near future. Under those circumstances, a partial payment plan can be worked out, but only if all creditors agree. Non-compliant creditors should then be segregated and handled separately. Whether they are paid at all during the turnaround is an issue; it may be better to let them file liens, since the liens can be repaid according to a schedule that is devised later at the magistrate’s office or in a court of law.

Primary Responsibilities

It is the turnaround artist’s primary duty to critically assess the executive team’s vision for the company and create a recommended course of action for realization of a mutually agreeable vision. In light of this duty, the adviser has three primary responsibilities:

  1. analyzing problems,
  2. drafting a turnaround plan for marketing, operations, and finance, and
  3. implementing the plan.

Therefore, the adviser should not be confused with consultants who merely offer advice. he must necessarily preside over plan implementation and be prepared to modify it as changing conditions demand.

Analytical Responsibilties

The analytical role includes the gathering and analyzing of marketing, operations, and financial information. Both internally produced reports and externally researched intelligence should be scrutinized in creating the turnaround plan. Any errors and omissions in the compiled plan must be noted for further investigation. From this analysis, the adviser develops the road map–a basic critical path of action.

Critical Path of Action

First, crucial points of action within the critical path are prioritized, such as completing a project for billing or getting to a key milestone on another before a window of opportunity is missed on behalf of the client. Personnel are then assigned responsibilities based on the established priorities, which are time sensitive. The turnaround adviser conducts regular debriefing meetings to update all affected parties on turnaround progress and the focal areas for the upcoming time period. As problems surface, the managers responsible for prioritized critical points, rather than the top executive, conduct troubleshooting sessions. If the sessions require negotiations with third parties, the turnaround adviser initiates these negotiations. For example, if lenders turn up the heat, the turnaround adviser must assuage their fears. Clearly, it is the  adviser’s general job requirement to put out all fires or make sure that someone else does.

Education

The turnaround adviser’s final responsibility is to educate the top executive, her team and other managers in the principles of sound business judgment and practice. If the group can observe the adviser’s actions during the renewal process, its members will learn a great deal about management techniques and strategies. When the adviser leaves, he or she should feel that the existing team is capable of steering the company through any weather.

Finances, Debt & Analysis in the Turnaround

A company’s financial picture at any given time is vitally important to all stakeholders, and never more so than during a turnaround. Financial results are the yardstick by which the business is measured. Outside lenders, creditors, and buyers continually desire affirmation that the company is viable and will be able to continue to meet all of its obligations, including non-financial commitments. Additionally, management relies on this financial information to plan the strategies for the turnaround and future business growth.

Most financial information available has historically been of a reporting nature–it reports prior performance by means of accounting information. The assembly of reliable predictive information on a regular basis is an important step toward profitability; reports such as accounts receivable, accounts payable, cash flow projections, vendor analyses, equities, return on cash, and profits from sales must be generated.

The company’s cash position can be summed up as follows: the money in the bank plus anticipated revenues from sales and financing activities minus any expected payments for direct costs, indirect costs, and general and administrative expenses. The accounts payable portion of the cash position measures the company’s ability to pay current vendors and repay creditors for goods and services delivered. The accounts receivable position is a tabulation of expected sales and fees to be received during a given period. The difference between the two types of accounts is a quick, short-term indicator of the current financial condition of the company.

Complete listings of all bills owed and obligations accrued must be made prior to the release of monies from sales and financing activities. These bills are prioritized for payment–especially payroll, taxes, utilities, and subcontract labor. Secondary obligations are suppliers (unless sole sources), interest due lenders, retirement plan funding, leases, and equipment payments. Cash is only to be disbursed according to priority payment schedules; failure to abide by this rule, regardless of circumstances, will cause problems in restoring positive (or enhanced) cash flow and reduce the likelihood of successful implementation of the turnaround plan.

Debt Structure

A business’s debt structure dictates the profit necessary to amortize it. Accumulated debts to suppliers, lenders, and financing sources need to be determined and paid form the gross profit streams. Paying past-due accounts from loans leads to business failures. For this reason, the gross profit must be managed with extreme care. First, management must estimate the amount of money to:

  • repay creditors over a reasonable time (reasonable = 7 years for structured debt, biweekly for contract labor, monthly for suppliers, and quarterly for taxes),
  • pay creditors for the current portion (<45 days), and
  • pay past-due creditors while remaining current to maintain credibility.

Suppliers, 1099s, direct costs, and indirect costs should be paid from operating funds–not loans. General and administrative expenses should be paid from gross profits.

Creditors should be made a part of the turnaround plan. Analyze and prioritize all debts, contact them, and discuss the projected payment plan for the debt owed. Amortization schedules for their accounts need to be explained and agreed to. Input from other creditors can then be used to draft a scheduling document to complement the accounts payable plan. Taken as a whole, the schedule will aid management in disbursing funds.

Management Analysis

Accumulating data can be a time waste if not turned into timely, useful information. As marketing, operational, and financial numbers are compiled, it should form the basis of the management information system. The resulting analysis will test and challenge beliefs about the company’s competitive position. Critical assessment of trends, patterns, and tendencies can generate ideas to further one’s mission, goals, and objectives. 

Analysis and action should commence hand in hand as the return-to-growth process unfolds. Merely stabilizing is not a permanent solution, but rather a step in the process toward profitable growth. As analysis is performed, opportunities are generated by involving key personnel in problem-solving meetings on a regular basis–the team management concept. For example, a change in product quality to match buyer demand–such as reducing product size while adding features–may be an opportunity discussed in problem-solving meetings.