Sunday, June 27, 2010

Growth is Not Always a Good Thing

“Slow buds the pink dawn like a rose from out night’s gray and cloudy sheath; softly and still it grows and grows, petal by petal, leaf by leaf…”

~Susan Coolidge, “The Morning Comes Before the Sun”

We were helping a young entrepreneur who started a business four years ago with $10,000. Through hard work and smart decisions, she has grown the business to $8 million.

Her goal each year has been to grow sales by at least 30 percent, and even in a difficult economy, she has been able to meet or exceed this goal every year. Now she wants to continue this growth path.

She financed her business and growth with internal or retained earnings, and doing so has left her with very low equity. Now, she has financed 99 percent of her assets, and debt financing is her only means of obtaining the capital necessary to continue growing.

She came to us for help because, with her debt ratio so far out of whack, banks would no longer lend to her. She was at a loss as to how she was going to finance this year’s growth. She knew something was not right, but she just could not articulate or diagnose the problem.

This entrepreneur suffered from what I call “Growth At Any Cost Syndrome.” She thought that if she did not grow, her business would fail.

The problem with growth is that even though sales are up, cash flow needs can easily reach double the sales amount. To support increased sales, you must be able to finance additional receivables and larger inventories on top of a multitude of other costs.

If a firm has too much debt and is trying to grow, they have only two options. First, they can try to raise additional equity capital. The problem here is that so many small businesses cannot attract minority shareholders. This is because there is no control with minority equity interest in a small business. In addition, minority shareholders will not have any liquidity. The bottom line is that acquiring new equity capital from outsiders is very difficult – if not impossible – for most small businesses.

With option one ruled nearly impossible for a small business, only one alternative remains: to slow the growth down – even stop it altogether – and allow equity to build up through retained earnings. This is a very slow process, but it is the only dependable way of setting the stage for future financing. Growth sucks up cash, and slowing its progression is the only way to allow your cash stores to replenish.

Our advice for this entrepreneur was to slow her growth rate. While resistant at first, she quickly realized that this was the only way she could get where she wanted to be.

Increasing sales is not always the best strategy because it normally does not allow you to build up the infrastructure you need to grow your company. If you find yourself in a position like this entrepreneur, slowing your growth to allow cash and profits to build up is a very viable alternative.

Now go out and make sure that you have a growth plan in place, and that the plan ensures you are not taxing your resources.

You can do this!

Sunday, June 20, 2010

You can deal with problem employees

“The tougher the job, the greater the reward.” ~George Allen

Problem employees are the bane of every manager’s existence. By “problem employee” I mean an individual whose behavior negatively affects the morale and operations of the entire business in a significant way. For some reason, every organization seems to have at least one of these. Examples of some problem behaviors I commonly see are as follows:

1. An employee just does not do what he or she is asked even after repeated requests.
2. An employee’s temper causes everyone to tip-toe around them in fear of inciting their anger.
3. An employee is habitually late.
4. An employee’s extreme negativity detracts from the business’ mission.

Whatever the problem behavior, there are two ways of dealing with it. One is to do nothing, and the other is to take action. However, in about 99 percent of cases, ignoring the problem only makes it worse. Why does this happen? In my opinion, it is because doing nothing and pretending the problem will go away on its own is tantamount to encouraging – even rewarding – the undesirable behavior.

You must also consider that allowing one employee’s bad behavior to persist destroys your credibility as a manager. Whether you acknowledge it or not, your entire staff knows that there is a problem, and when you do nothing, your staff wonders why you do not act. In the end, your inaction dilutes your effectiveness as a manager.

One firm that I was assisting had an employee that was habitually 15 to 30 minutes late. Sometimes the manager took corrective action, and sometimes he ignored the problem. When dealing with these less severe kinds of behavioral issues, consistency is critical. If employees perceive you or your policies to be inconsistent, your credibility will be non-existent, and problem behaviors will escalate.

Where more serious problems are concerned, you must address the issue no matter how important or valuable the employee is. No employee should become so valuable that you cannot do without him or her. The minute an employee becomes invaluable, you allow that employee to take you hostage. The goals and mission of the department must be given a higher priority than the welfare of one problem employee.

One effective way to approach a problem employee is to ascertain the real issue, then address it in a meeting. The sooner this meeting takes place, the more quickly the problem can be resolved.

Without exception, when a problem employee is removed, the morale of the entire business improves dramatically. While terminating employees is not a pleasant experience, the price is much higher when you allow a problem behavior to continue. Additionally, in so many cases, termination was exactly what that employee really wanted. They just did not have the courage to quit.

Problem employees affect every single staff member, and I guarantee you that your staff would rather work harder and longer than put up with bad behavior. They will all be willing to pitch in if it means their working environment will be improved.

Problem employees can have devastating affects on the morale of your entire department. By dealing quickly and fairly with these employees, you ensure that your business remains a wonderful place to work.

You can do this!

Monday, June 14, 2010

Getting a Loan: The Rules Have Changed

“If you don’t like something, change it. If you can’t change it, change your attitude.” ~Maya Angelou

So many of the entrepreneurs we help at the Jim Moran Institute are expressing frustration with financial institutions and their new lending processes. In the past, entrepreneurs could get bank loans without too much hassle. However, because of the recent credit crunch, these financial institutions have adopted much stricter loan requirements.

Financial institutions have a gross margin of less than five percent. That is, the differential between the rates they lend and the rates they pay depositors is very low. Under normal circumstances, financial institutions have to make 20 good loans to make up for one bad loan.

Because of the collapse of the real estate and construction industries, many financial institutions have experienced large losses. As a result, their ability to take on risk has been significantly diminished. In general, bad loans reduce income, which in turn, reduces a bank’s equity. Once the bank’s equity goes down, their ability to lend decreases dramatically.

While financial institutions would like to give more loans, they are simply unable to do so. If banks or credit unions are making commercial loans at all right now, they are requiring so much more in an effort to minimize their risk. For example, they now want great business plans backed up by documented facts, not projections.

Many entrepreneurs are taking these heightened requirements personally. However, things have changed, and entrepreneurs just need to understand the new rules.

First, if you are going in for a loan, you just need to expect it to be a much more exhaustive process than previously. Just about all financial institutions are now requiring some form of collateral to cover the loan. While this might seem onerous, it is just a precaution these financial institutions are taking to ensure they do not lose any more money. The more collateral you offer, the higher your likelihood of getting a loan.

Additionally, financial institutions are carefully evaluating a borrower’s ability to repay the loan. We are working with a business that is looking to secure a loan for the property they are using. In this case, the financial institutions are requiring personal guarantees (which is normal), but they also want documentation showing the business’ past financial performance. They want to ensure the business is going to be able to make rent payments back to the owners, thereby minimizing their probability of loss.

If you are currently in the market for a loan, you just have to realize that the rules have changed drastically. Getting a loan is much tougher, but understanding the new rules and being able to anticipate what financial institutions are now looking for will make the process far less frustrating.

You can do this!

Monday, June 7, 2010

Economics of Green Alternatives

"Civilization and profits go hand in hand." ~Calvin Coolidge

Lately, I have seen more and more businesses adopting new technologies to save energy and garner applicable tax incentives. While saving energy and other natural resources is critical to our earth, these decisions must be made within an economic framework.

Before my inbox is flooded with emails from environmentalists, let me just tell you that I have been driving a Prius for the last four years, and I am a staunch believer in the responsible stewardship of our natural resources. However, in business, green technologies must always be evaluated within the economics of reality. The question entrepreneurs must ask is not how many natural resources will be saved, but whether or not saving these resources is economically viable.

From geo-thermal to solar, new green technologies are very expensive right now, and the amount a business can end up spending on them is unlimited. The technology is also changing rapidly, which normally means falling prices. Additionally, over time, existing technology will need repairs, and those repairs could become very expensive as new technologies emerge.

As with any investment, you must look at the rate of return. I frequently hear people talking about a 10-year or longer payback, which refers to the number of years required to recover the initial project cost out of the annual savings. For example, if a new technology costs $100,000, and the additional annual savings are $10,000, the payback is 10 years.

The problem with payback is that it ignores the time value or opportunity cost of money. A better way to evaluate these green investments is by the project’s real rate of return.

Going back to the example of the $100,000 investment, we see that they recover enough through savings to pay back the cost of the project in 10 years. While this sounds okay, it does not consider rate of return, which most businesses should be using. In this case, when we take the time value of money into account, we see that the annual return on this investment is only eight percent.

After establishing the ROI, every entrepreneur should determine their opportunity cost. That is, if a firm could earn a higher rate of return by investing elsewhere, from an economic point of view, this would not be a sound decision. However, if a higher rate of return was not available, the firm should feel confident in this investment.

While investing in new environmental technologies feels great, this is not an adequate basis for making prudent business decisions.

Now go out and make sure you have processes and procedures in place to help you make rational decisions when evaluating green – or any other – technologies.

You can do this!