Thinking Back, and Forth

"What if…," he said. "What if you do everything right in this new business and for reasons totally beyond your control, it goes bust? You've done the best job that anyone could do, but it's not enough. What then?"

Pat Liles, Professor of Entrepreneurship, was one of my mentors in those days. I had just finished telling him (1.) that I had just turned 40; (2.) that I had just purchased a new home with an 18% mortgage (early '80s); (3.) that Annie and I had just brought our fifth child into the world; and, therefore (4.) I had 20 years' worth of college term bills to look forward to. And — oh yeah — I was fully committed, with a partner, to starting a new business.

"For your family's sake, if not your own," he continued, "you can't afford to let that happen. You have to assess the downside and hedge your risk. You can't put all of your eggs in that single basket."

Pat was right. Despite my best efforts, the business did go bust, but not before I had responded to Pat's homework assignment and developed a back-up strategy which ultimately morphed into my now 25-year consulting practice. In retrospect, it all resulted from protecting my downside.

There have been a lot of downsides tested during the past year. A lot of basic assumptions have been questioned, leading managers much more frequently to say "What if…"

For example:

In a conference call twelve months ago, the financially-astute director of one of my client companies was telling the rest of the Board, and me, that having more than $100,000 on deposit in any bank was risky. It was hard to believe that big bank failures were imminent, but we pulled the $700,000 balance — seven months worth of venture funding — from our large Boston bank and invested it in a ladder of almost-zero-yield T-bills. Better safe than sorry. We all slept better during the next several months.

The management team of another client company in December 2008 decided that its record profits and substantial project backlog were evidence that its growth strategy was working. Consequently, the managers projected a 25% revenue increase for 2009, only to discover by the end of January that nothing more was coming in the door. Their Fortune 500-level clientele had put most of their 2009 initiatives on hold. Many painful decisions, involving salary reductions and furloughs, ultimately led to a new compensation structure with lower fixed salaries and strong incentives based on generating and closing qualified leads.

A third client of mine also had a record-breaking year in FY08, benefitting from the revenue and profitability growth which resulted from bringing a new manufacturing facility on line. Feeling quite secure after several years of steady pay hikes, the 100 employees on the shop floor were looking forward to a continuation of 30% overtime, which increased their weekly paychecks by an average of 45%. Surprise: 2009 brought a revenue drop of 10%; new equipment increased productivity by 10%, and for much of the year O.T. was zero. But everyone still had a job, and the company continues to make money.

From these and my other client experiences in 2009, five lessons for small business management are worth reiterating:

1. You absolutely have to consider the downside — the worst-case scenario. At some point in your historic growth, your revenues were 30% less than they are today. Just take the back of an envelope: what would it take to cut back to that level right now? If your fixed costs preclude it, you may want to reconsider your risk profile.

2. Most employees are resilient enough to handle salary reductions and furloughs IF (a.) they're not alone; (b.) it's fair; (c.) it's well-communicated; (d.) it's temporary; and (e.) the state's unemployment fund picks up some of the payroll shortfall. It also helps if it occurs during the summer.

3. The bigger the bank, the harder they fall — on you. But community bankers don't have delusions of grandeur. For the most part, they have come to terms with the traditional risk- reward profile of commercial banking. Long-term relationships pay off in tough times, and there hasn't been much turnover in the smaller banks — the person you started with five years ago likely is still involved in your account.

4. Cash is not only king, it's the only game in town when everyone else is struggling for credit. Positive cash comes from the President leaving no uncertain terms on credit and monitoring the collection process him/herself. Positive cash allows you to take discounts from your vendors, which added almost a percentage point of profit to client number two (above) this year.

5. The benefits of open-book management in contributing to a strong upside are well-documented. Even more significant, however, is the effect that shared financials have in mitigating the downside. "Here's where we are today," you say to your employees, "and here's where we'll be next quarter if everyone produces at 100%. We're in this together." You have to believe in them, for them to believe in you.

Financial Managers helps the managers of smaller companies and non-profit organizations develop reliable financial information for operational decisions.

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