June, 2012

It probably should happen more often, but occasionally — usually on a Saturday — Annie and I will head out for the day without a particular destination in mind, just to see what turns up. Because I’ve always been a Point A to Point B type of traveler and she’s always contended that the journey is more significant than the destination, these single-day excursions play to her experience, so I’m happy to let her take the lead. We call it “oozin’ on down the line” — no phone calls, no checking email, no looking at the clock.

So it was, that a couple of weekends ago we found ourselves heading for “Sand Bash 2012” on Fort Myers Beach in Florida. (Full disclosure: not so far down the line — it was less than 15 miles from our winter condo.) I had visions of discovering some elaborate sand castles from which I might extract ideas — and maybe even some techniques — with which to impress the grandkids this summer on the beaches of New England.

Under a huge tent which housed 200 tons of sand, a dozen artists — master sand sculptors! — had created competitive works of art interpreting the theme of “The Movies, Sculpted in Sand.” From Cinderella to The African Queen, and from Forrest Gump to Cars, the images were remarkable in their clarity and detail. Painstakingly created and on display for a week to thousands of beachgoers, the art by Monday morning was to be reduced to plain ol’ beach sand.

I asked apprentice sand sculptor Sandi Adams (real name — I’m not making this up), how she and her fellow sand artists dealt with the transitory nature of their creativity. “Well,” she said, “for the masters, turning sand into gold [doing commissionable work for sponsors] is sort of like alchemy. For the rest of us, it’s kind of a Zen thing. Unless the planets come into alignment for you, you really have to be satisfied being in the moment.”

As Annie and I took the fast track (non-stop air) back to New England this past week, Sandi’s reference stuck with me. I’m frequently struck by how much of small business ends up being “kind of a Zen thing.” Millions of entrepreneurs pursue their dreams of creating a unique and valuable product or service and then cashing in for a big return, but only a few thousand do so each year. The rest are, at best, rewarded by creating income for themselves and (in some cases) for employees; by developing and (in most cases) selling a useful product or service; and (in comparatively few cases) seeing their businesses survive them.

Unlike sand sculptors, however, they do keep looking for planetary alignment, often in the form of a receptive economic environment. They remember the fat years, pre-2007, as providing something for everyone, until the receding tides swept much of it away.

For many small business owners, waiting for the perfect economy is like waiting for the planets to align. It’s not going to happen any time soon. At the same time, you can’t take a couple of quarters of mediocre sales as evidence of a double-dip recession, causing you to hunker down again. More often than not, the big winners in the small business race are the swift, the bold, the innovative, the risk-seeking. You have to keep moving.

Consider the following moves among Financial Managers’ current client base:

• A health and wellness software company took on its first 7-figure contract in 2010-11 with a big offshore company and incurred a significant loss on the project when a co-venturing partner failed to deliver as promised. But the resulting lessons-learned, applied to the next two $1MM+ opportunities, resulted in disproportionate gains, establishing the company as a national leader in an emerging field.

• A 25-year-old boutique executive development consulting firm converted its home-grown client-supporting software into a stand-alone SaaS (Software as a Service) package, entered into a joint venture agreement with a strong marketing organization, and is about to spin off the new company with an established sales base of $1MM in mostly recurring revenue.

• A young specialty retail group, having successfully carved out a niche with four stores in Greater Boston, has refused to be intimidated by the Web. By investing heavily in product knowledge and training of its sales staff, the company has retained its competitive edge even as it tests a modified bricks-and-mortar concept in a fifth store which opened in November.

• A Naples, Florida-based construction company, targeting an upscale home remodeling market, has recently initiated a public relations campaign emphasizing print media to announce its new “concierge builder” concept. Why print? A significant portion of the target market of Naples-area retirees still turns to newspapers and magazines as its primary source of information.

• A long-time player in the crafting and scrapbooking business emerged from bankruptcy a year ago with its client base still intact and its legacy untarnished. Addressing its management deficiencies, the company upgraded its level of professionalism by hiring new senior managers in finance, operations, and design and is projecting its most profitable year in a decade.

You got into your own business by being action-oriented. You moved ahead by planning and making aggressive moves. (Okay — maybe in the early days it was less planning and more making). You’ve passed the survival tests, so what’s your next goal, and the ultimate one? Are you now so busy protecting your sculpture from the wind and the tide that you’re missing opportunities to create something permanent? Perhaps you need a time out for some strategic planning. Otherwise, it will be hard to establish a Point B, much less to get there, if you’re just oozin’ on down the line.

May, 2012

Living Will? Durable Power of Attorney? Life insurance policies? List of all credit cards?

I’m sure it was Beth who asked first. She’s the oldest. She long ago got her personal affairs all in line, making good use of her time during another long winter in northern Vermont. She’s the one who introduced me to I.C.E. (In Case of Emergency) to identify my personal first responder on my cell phone.

She’s also the one who mobilized the other four kids to join her in “encouraging” me to get my own ducks in order: Where are the car registrations? How do we access your bank accounts? The investment accounts? Where are the tax returns? I hadn’t anticipated that our extended Christmas gathering would include quite such an inquisition, but Beth had been doing some reading and deep thinking (another product of Vermont winters) and wanted to broaden the I.C.E. concept. Not hard to figure how Vermonters get ice on the mind, especially in December.

Of course, I knew where it all was. But no one else did. And that was just the point. So 2012 became the Year of Documentation. I committed to write it all down and make it accessible (see the “I.C.E.” file in My Dropbox, guys), and they and Annie committed to hold me accountable from time to time. With persistence, and a few rainy weekends, I may actually get the project done this spring.

“Ah, stop!” you say. “I’ve heard this before. Last September’s issue of Howe’s Bayou gave me all the info I need about Due Diligence. I know all about the financial history that the bankers and prospective investors need when I go looking for funding.”

Well, thank you for reading, and remembering. But there’s another whole side to the due diligence process that relates to your corporate organization. Briefly stated, your investors want to know that their money is going into a legally-constituted entity, that the corporate structure is well-established, and that, insofar as possible, the risks are fully disclosed, well-defined and well-described. They want to know who’s who in the established management hierarchy, what person or group has ultimate decision-making authority, what rights the various equity groups may possess, and what “membership fee” the other equity holders paid.

In most small companies, the responsibility for maintaining this record falls to the Controller or to the Director of Finance and Administration. But the Source, the usual repository of basic corporate information, is the lawyer or firm who filed the original documents to establish your company. At the earliest possible date thereafter, that information should migrate to your internal files to provide flexibility down the road should your needs for legal representation change.

This, then, is the minimum corporate documentation that should be on premises and no more than a couple of clicks away:

1. Certificate of Incorporation — Issued by the state and attesting to your legal existence in return for filing your Articles of Incorporation, which provides essential data about your corporate name, organizational (and stock) structure, your officers and directors, and your address.

2. Bylaws — Usually drafted by counsel and adopted by the Board to establish the rights and powers of the shareholders, the directors, and the officers and to describe the process for selection of the latter two groups.

3. Shareholders’ Agreement — Establishes the rights of the respective owners of the entity, especially when there is more than one class of stock, and specifies the process by which shares may be bought, sold, or transferred.

4. Stock Option Plan — Defines the basis by which persons or entities (usually those affiliated with the corporation) may be granted the right to purchase stock at a later time and/or under certain restricted conditions.

5. Stock Register — Records the issuance (and redemption) of stock by certificate number, by name and address of stockholder, by number of shares, and by purchase date.

6. Stock Option Register — Records the names and addresses of all option holders and the terms of their option grants, including the exercise prices and the effective dates and expiration dates of such grants.

7. Corporate Record Book — Includes signed minutes of all meetings of shareholders and of directors together with copies of documents distributed to attendees and referenced in the minutes.

8. Foreign Corporation Certificate — Attests to the company’s registration for the right to do business in a state other than the state of incorporation.

9. Corporate Ventures — Agreements relating to ownership of or investments in any business or enterprise, including investments in joint ventures and minority equity investments.

10. Cap Table — Presents in a single summary sheet your capitalization history, recording and tracking the ownership of the company including stock transactions, convertible debt, option conversions, and operating results (profit/loss) and the resulting effect on the value of the outstanding shares of stock.

After spending some time this week trying to reconstruct the Corporate File with the new Director of Finance of a still-young client company, I asked the CEO if he could help us to fill in the gaps. Of course, he knew where it all was. But no one else did. And that was just the point. Until he had a stable, full-time, permanent senior manager in charge, he wasn’t going to delegate the responsibility.

And neither am I.

April, 2012

In case you didn’t know it, I’m going to share a secret: I once dreamt of going to Harvard. This was a long time ago, and in a different college admissions era, but I thought that I was pretty hot stuff in high school as a class officer, newspaper editor, high scorer in the “morning activities” (grades and SAT scores) if not in the “afternoon events” (varsity letterman, but far from a star). Like several thousand other aspirants, I filled out my application, sent it in, and held my breath — which wasn’t easy to do from December until April.

I thought of this a couple of weeks ago as grandson Noah, a talented high school junior, spent a night with me while embarking on his first college tour during his winter break. Unlike his grandfather decades ago, but like most of his 2012 peers, Noah knows something about the admissions game. Where I applied to just two colleges (an early admission to Bowdoin relieved the pressure), Noah is developing his hierarchy of possibilities, hedging his bets, trying to appear committed in his conversations with admissions officers and college soccer coaches while remaining non-committal in his head.

His dream is to go to a college at which he can be both an athlete and a scholar, without being typecast as either one. In coming months, he’ll expand his list as well as his criteria while no doubt increasing his focus on the few schools that he considers to be the best match for his interests. And then he’ll start to dream, especially after his applications go in the mail: “Here I am at Princeton [or Middlebury, or Tufts, to mention a few early contenders]. The world is my oyster. How can I maximize the return on my four-year investment here?”

Coincidentally, I’ve heard the same question from three of my small business owner clients in recent months, each of them in various stages of trying to actualize their returns on many more than four years of investment. Each in their businesses has created an asset of value, but they’re approaching the far end of the timeline of personal return that starts in college or earlier. They have revenues, they have profits, and they have strong competitive positions in their respective markets.

As well, they’ve heard of various rules of thumb in determining value, from basic net worth to multiples of revenue to multiples of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) to rumors of the price commanded by other companies in the industry. In most cases, even a casual conversation on this topic has been enough to wake them up to pay attention.

But what they have found in seeking admission to the merger and acquisition market place is that there are some additional considerations in the process of value maximization for successful small businesses. Among them are the following:

• A continuing revenue stream: Major valuation benefits accrue to the firms that have a high persistency of customers/clients vs. those that start from zero each year.

• You can’t escape history: What you’ve done in the past few years is the best predictor of what you’re going to do in the future. Absent unique factors, your 5-10% historical growth rate isn’t going to morph into 15-20% overnight.

• You make it happen — and then you’ll get paid out. If a significant part of your company’s value is future-based, your post-sale proceeds similarly will be future-based.

• The financial acquirer may pay a multiple of your current profit or EBITDA, balanced against his/her risk. The less certain your future earnings, viewed in the context of your historical results, the lower the multiple.

• On the other hand, the strategic buyer may be willing to overlook your spotty financial history if parts of your business can add value to his/her current operations. But the other parts, including you and your senior staff, may not survive the deal.

• If your “special sauce” — the ingredient that makes your company stand out in the marketplace — isn’t bottled and sealed with non-compete agreements and/or intellectual property rights, you may have nothing to sell.

• Your buyer may dream of adding significantly to the company’s profitability by changing its culture: A new emphasis on productivity could be a nightmare for your loyal staff, on which your long-term payout depends.

In pursuing his or her dreams of a brilliant exit, the entrepreneur needs an occasional stock-taking to make sure that the package that he or she is creating fits not only with the general conditions described above, but also with the peculiarities of the industry. Better to spend a little time along the way with an investment banker (i.e., dream analyst) for a reality check than to be awakened (rudely) by offers well below your expectations.

So what happened to my dreams about Harvard, you ask? Well, even if you don’t ask, just let me tell you that when I received the fat envelope from Cambridge on that happy April morning sometime in the last century, the subsequent rude awakening was all Bowdoin’s.

March, 2012

The Super Bowl clock ticked down last Sunday with my home team, the New England Patriots, nursing a 17-15 lead over the New York Giants. Forced to punt with less than four minutes left in the game, the Patriots turned it over to their defense to pass their final and most important test of the year — to get the ball back to the offense without letting the Giants score.

Maligned all season long for their shortcomings, particularly in pass defense, the Patriots’ defensive players had a chance to redeem themselves, to prove to the world (after all, the whole world was watching, wasn’t it?) that the Patriots were more than the single dimension of Tom Brady. On the first play of the series, the defense failed the test. The fact that the Giants’ Eli Manning made a perfect pass and Mario Manningham a miraculous catch was less significant to this Pats’ fan than the defensive line’s inability to pressure Manning and the defensive backs’ failure to cover Manningham adequately.

After that, it was only a matter of time. It was clear that the Giants would take the lead. Patriots’ coach Bill Belichick hung the defense’s failing grade out for all to see by conceding the Giants’ go-ahead touchdown in favor of saving the clock. The final question was whether or not the Patriots’ offense could pass their test before the clock wound down to zero.

Brady passed on the first two plays from scrimmage — two catchable balls which fell incomplete — and absent the momentum that those plays might have provided, the rest was largely desperation. The offense, too, had failed.

So it is with your accounting team. During the regular season — the first eleven months of the fiscal year — your team keeps the score and reports it every month, your company’s wins and losses. If you, the owner or senior manager, have a sharp eye for numbers, you may spot some incompletions along the way. But the fumbles, those potential game-changers, often don’t show up until the CPA arrives to administer the ultimate test: the tax return, the review, or the audit. The result is frequently a year-end score that’s different from what your team has been reporting at each checkpoint. Like the referee who’s only going by the book, the auditor’s job is to throw a flag, which more often than not results in a penalty to your bottom line.

For your team to pass the test, it has to minimize the CPA’s dreaded “adjusting journal entries (AJEs),” which seemingly result from the application of accounting arcana to your day-to-day bookkeeping. Except that most of it is not really arcane. Most of it is just basic, straight-forward accounting that anyone with a degree in accounting or five years of progressive learning in the field of accounting should know.

If you, as the small business owner, are going to get off the sidelines and into the game to impact not only the final score, but the tally at each monthly milepost, here are nine accounting issues that should concern you before the CPA comes on the field of play:

1. Revenue recognition: You can record it only as fast as you actually earn it. Avoid the temptation to book in Month One all of the income from a service that you’re providing over the full year. And definitely don’t book as revenue any of your favorite customer’s advance deposit until you have delivered, at least in part, against it.

2. Inventory: Beyond accurately counting it in and counting it out, the trick is accounting for it while it’s still work-in-process (WIP). Whether it’s a product or a service, if you started working on it before the end of the accounting period, you’re creating additional value which should be capitalized on your balance sheet if it’s not out the door by month-end.

3. Payroll: Accrual-basis accounting requires that you recognize your labor expense as it’s incurred. You may have issued payroll on January 6th for the week ending December 31st, but the expense relates to December, not January.

4. Depreciation: There’s no need to wait for the outside accountant to determine this number. Your team can ask for the standard GAAP guidelines, calculate the monthly charge on new equipment, and add it to the rolling write-off on your asset-tracking spreadsheet.

5. Receivables: In the absence of special factors (e.g. retainage or other unique terms), you should take an uncollectible reserve for any invoices more than 120 days old. Better to be realistic and do it as you go along than have to package it all in a year-end surprise.

6. Payables: Get those invoices in! Outside contractors, in particular, are notorious for sloppy billing, as are some of your employees with their late expense reports. In the absence of a physical bill, book an accrual for the estimated expense to reduce the bad news that the accountant uncovers.

7. Unapplied credits: Look for negative numbers on your accounts payable aging statement. They’re often an indication that your team made a duplicate payment on a vendor invoice.

8. Misclassification: You and your CPA should agree from the start about the types of expenses that get charged to each account, and you should be rigorously consistent. An inordinate number of AJEs result from the simple reclassification of expenses.

9. Reconciliations: Most of us learned how to do math proofs back in middle school (remember?). Reconciling your balance sheet is nothing more than that, yet a lot of valuable CPA time (and your money) is spent on tying out the general ledger balance sheet accounts to the appropriate back-up ledgers for bank and credit card balances, debt and equity, receivables and payables.

The Patriots had a terrific regular season, which had a lot of their True Believers (yours truly included) willing to overlook some fundamental flaws to a point at which they expected the best during the playoffs. So it is with your financial statements. Lack of rigor in closing the books during the first eleven months can lead to a better won-loss record on your bottom line than you have actually earned. When the truth comes out in the twelfth month, don’t blame the auditors. Like the Giants, they’re only exposing your weaknesses in their drive for the final score.

February, 2012

The Syndicate was ready for action. Six neighbors and I assembled in the “Gathering Room” of the condo complex before the first of the NFL playoff games last Saturday to consider our collective wagers on the four contests. To varying degrees we had researched the subject — seasonal wins and losses, injuries, rushing and passing records — and we had ready access to the Web for the more arcane stats that would provide the definitive Eureka insight. We were primed.

The issue, of course, was not just which team might win or lose but how to deal with the Spread, the determination by the Las Vegas betting house of the number of handicap points the perceived underdog would need in order to equalize the betting interest between the two teams. Without the Spread, there’s no action: the favorites do win the majority of the games. In fact, the higher-seeded team won all four times last weekend (though higher-seeded Denver was not the favorite versus Pittsburgh). But the Syndicate likes to think that the collective wisdom of its members will more often than not beat the Spread. With relatively little debate we reached consensus and, brimming with confidence, placed our bets. [Results below.]

So it is with financial analysts. Usually right, but never in doubt. However, while reliance on the numbers is fine for citing history, it’s much less certain for predictions or projections. I thought of the parallel as I read through the last three years of annual financial reports of a new client company which I signed up last week. The bound statements were the product of a CPA’s review and were supplemented by a spreadsheet which arrayed the three years of income statements and balance sheets side by side for ease of analysis. Not exactly bedtime reading, even for a numbers guy, but useful background, especially for a numbers guy.

However, having discussed the Company’s recent history for a couple of hours with the Owner, my goal in analyzing the statements was to determine not only if his story was confirmed, but if it was well-represented by the numbers. In a quick overview, I was looking for the following:

• The Opinion: Were there any concerns expressed by the CPA in the cover letter which related to the integrity of the presentation?

• The Content: Beyond the income statement, balance sheet, and statement of cash flow, was there a capitalization table reflecting investors’ interests? Were there notes explaining accounting policies, status of loans and leases, and unusual financial events?

• The Format: Was the expense detail simply arrayed alphabetically by account, or was the analysis at a more sophisticated level, perhaps with the expenses grouped by type (e.g., Cost of Goods Sold, R & D, Sales and Marketing, General and Administrative)?

• The Trends: What was the three-year Revenue history — up or down, by what percentage? To what extent did other income statement line items reflect the same percentage change? Was annual overhead expense increasing at the same rate as sales (usually not a good sign)?

• Balance Sheet Trends: How has the cash position changed compared with short-term debt balances? Did accounts receivable and inventory balances track the changes in revenue? Are payables and accrued expenses showing disproportionate increases?

• Cash Flow Insights: What’s been the source of the Company’s funding — internally from Operating Income, or from Debt or Equity infusions, or from Asset Sales? Has there been adequate renewal of the plant and equipment via Capital Asset purchases? What does a quick calculation of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) as a percentage of revenue reveal?

• Additional Analysis: What does the calculator on my Smartphone (the 21st-century equivalent of the back of the envelope) provide in the way of a Current Ratio (current assets over current liabilities), a Debt-Equity Ratio, and a Debt Service Coverage Ratio (total annual debt service divided by EBITDA), and how do these compare with nominal industry standards? What does the interest rate being charged on the bank loans indicate about the company’s creditworthiness?

Fortunately, the Owner’s story was fully confirmed by the financial reports. The Company, a significant player in the local construction industry, has taken some heavy hits in recent years but has managed its retrenchment well with the continuing support of its financing sources. It is set to ride out the downturn and to come back strongly with lessons learned about effective management in the face of adversity.

Unfortunately, effective management in the face of adversity is now the challenge for the Syndicate. Had we been wagering on credit last weekend, we’d have been underwater. Despite a collective experience of 50+ years of professional football history and a full appreciation of the need to read between the lines (a/k/a the Spread) in understanding the story before placing our bets, we came out on the short end all four times. We were left wondering what kind of odds we might have been quoted on that happening (?!).

January, 2012

(Jingle, jingle, jingle) – “You better watch out, you better not cry, better not pout, I’m tellin’ you why – Santa Claus is coming to town.”

Man, did we get mileage out of that when our five kids were little! From Thanksgiving right through Christmas Eve, if they weren’t always angels, they usually tried. Even when they got into their teens, they retained some sense that their behavior could impact the quality or the quantity of their Christmas experience.

Beth, Dave, Katie, Will, and Chuck, now that most of you are parents, let me share a secret with you – it didn’t make any difference! But it sure improved the four-week, pre-Christmas experience for your mother and me, just as it likely has for generations of parents. In fact, if I were to go back far enough (!), that jingle probably represents my first conscious experience with behavior modification (mine!).

I thought of this last week in an extended conversation with the senior managers of one of my clients around the subject of a Christmas (year-end) bonus. For the first time in a decade, last year (2010) the company recorded a loss in the face of a tough year for the industry. Everyone knew it, so there was no sense trying to paper it over with even a token gift while people (a few) were being laid off.

This year was better than last – modestly profitable, but not exciting. The management team agreed that most of the employees hadn’t really been challenged, nor had they challenged themselves. Thus, any kind of after-the-fact, incremental compensation would have rewarded behavior that needs to change if the company is to achieve its higher 2012 goals.

But what of the employees’ expectations? “I’ve done everything they’ve asked of me and never given them any trouble,” one might say. “Wouldn’t you think they could at least show some appreciation?”

In fact, the management team decided that in addition to the holiday party, some recognition was appropriate, in this case a gift certificate. However, in responding this way, the managers agreed as well that they were not making a statement about company incentives or rewards. It was simply a nice gesture to avoid Scrooge-like references.

In planning for 2012, on the other hand, they decided to take a new approach. In an economic environment of persistently high unemployment, they recognized that a primary concern for many employees is job security. And the counter to insecurity is job training and education within the company’s day-to-day operations. For next year, in addition to requiring that everyone develop personal goals that are meaningful, measureable, specific, realistic, and achievable, the managers also mandated that the staff members each come up with a set of objectives for individual learning. This professional development will include internal and external training, project team work, job shadowing across functions, and agreed-on enhancement of job skills.

With an empowered work force expected to exercise independent judgment and initiative, my client has determined that it no longer seems appropriate to tell employees day after day what to do. In fact, the greater challenge for both managers and staff is to encourage people to manage themselves and to expand their individual skills and knowledge, acquiring marketable talents even after multiple years on the job.

Wrapping this new approach around the company’s revised and purposeful vision statement going into the New Year, it was thus resolved by the management team:

1. To incorporate individual goal-setting in the performance appraisal process and to provide for self-reporting of progress by each employee.

2. To eliminate the flat, across-the-board pay raise in favor of budgeting for increased compensation based on the Company’s profitability, with allocations based on individual achievement of goals.

3. To provide multiple opportunities for employees to acquire new skills and to cross-train in other functional specialties.

4. To communicate the new strategy before the old year is out, setting expectations that personal output and attitude will make a financial difference, to the company and the individual.

In the meantime, I don’t have to rummage for that original Bing Crosby on 78 rpm, or even the Supremes on 33s, in order to pass the “Better not shout…” lesson on to our next generation of Andrew, Noah, Jack, Emma, Abby, and Brooke. Turns out that the latest to record it is Justin Bieber, and I’ll bet you kids didn’t think that I even knew the name!

November, 2011

“If I was him,” the taller guy was saying, “I might be doin’ the same thing.” He leaned over the tailgate of his pick-up, the one with the Maine plates, “…especially for a million bucks.”

As I approached the Bailey Island General Store in pursuit of my newspapers last Sunday (reading the Sunday papers on-line is an idea whose time has not yet come for me), I picked up the conversation. I knew what the two Islanders were talking about.

“Yup,” said the other. “Read it in the Anchor. He’s puttin’ the place up for sale.”

I had read the same article in the local newspaper. Charles Abrahamson, whose shorefront property includes the only sandy beach for miles around, had closed off access to the beach at the middle of last summer for the only time in anyone’s memory, raising temperatures all over the Island. In return for a permanent easement through the edge of his property down to the beach, he had asked the Town (pop: 5,300) for $950,000 and been turned down. Now, fourteen months later, his motivation was clear to all — selling his property with an easement (by contract or by common law) might conceivably reduce the value by that amount.

After years of facilitating access to the beach, Abrahamson was cast as a greedy Highlander (summer resident) by many native Islanders and by other summer folk. In a broader, more generous context, he and his wife Sally are essentially trying to monetize their real estate asset at its highest value, which includes either providing their successor with a private sandy beach in perpetuity (at a premium price) or being compensated for allowing it to “go public.”

I have no interest in buying the property or even helping to fund the easement to a beach which we have enjoyed access to for more than 40 years with kids, grandkids, and others, just a 10-minute stroll down the road from our summer house. But as I walked back from B.I.G.S. last Sunday, I began to think about how a bank loan officer would value something as intangible as private access in considering a mortgage application from a prospective purchaser of the Abrahamson property. That, in turn, got me thinking about how anyone assigns value to any kind of collateral in lending money. And, even though it was Sunday, and even though it was just a short walk back from the Store to my sunny deck chair, that got me thinking about a question that one of my clients had posed to me a couple of days earlier: “Is there a way to consolidate all [our] term debt into one note at a better interest rate? Do banks entertain that?”

Not only do they entertain it, they do it all the time, I responded. It’s called “blend and extend.” Of course, they’re generally not enthusiastic about renegotiating a long-term loan agreement simply to lower the interest rate that you have contracted to pay, but unless there’s a prepayment penalty, they have to respond to the market. In particular, if you are expanding your borrowing base (e.g., by purchasing more equipment) and at the same time trying to improve your cash flow by stretching out the payment period, you may have a good case for refinancing. Here’s how it works:

1. The Matching Principle — Banks and other lenders typically want to match the loan to the collateral that supports it: revolving loans are for revolving assets like inventory and accounts receivable (“working capital” loans); term loans are for long-term assets like machinery and equipment. Real estate has its own category.

2. The Easier Way to Valuation — In most cases, what you pay for a piece of equipment establishes its market value, so borrow as you purchase, most conveniently by opening an equipment line which may include all equipment acquired during a 12- to 18-month period. Banks will usually lend up to 80% of the purchase price, higher with SBA underwriting.

3. The Harder Way to Valuation — The problem in consolidating existing long-term loans is that both the “encumbered” (already pledged as collateral) and any unencumbered equipment will need to be appraised (could be $5,000 and up). Even if the same lender is doing the bundling, he or she wants to make sure that the market for the particular equipment has not gone south since its purchase date.

4. The Leasing Trap — It may come as a surprise, but you don’t actually own any equipment that you have on lease — the leasing company does, and it’s usually getting a premium rate of interest. They’ll relinquish it so that you may use the equipment as collateral elsewhere only if you meet their full prepayment penalty — you’re in for the sum of the remaining payments, which includes interest to the end of the loan. (…which is not to say that leases aren’t useful financing options.)

5. The Analysis — Estimate your weighted average cost of long-term capital by figuring how much interest you will pay on each loan during the next twelve months (the lender should have provided you with a monthly principal and interest schedule), then taking the total and dividing it by the sum of the outstanding balances of all your term loans at the end of last month. Just as with a home mortgage, compare that with the lender’s current offer, factoring closing costs into the equation.

6. Avoiding Paralysis — Because banks like to be able to track how you’re doing at any time and get first dibs on your cash in the event of default, they almost always want all of your business (deposits plus debt financing). When you contemplate shifting all of your accounts to a new lender, inertia is your current loan officer’s best friend. But whether you move or not, you should reassess your bank relationship at least every two years — competition among lenders for good loans is intense.

Whether the Abrahamsons move or not, they’ve had to reassess all of their relationships on our little island, in particular those with their abutters, some of whom want in on any deal. For the sake of a single easement, it’s for sure that traffic flow will increase on glorious summer weekends, affecting the value of every home in the neighborhood.

You can bank on it, but you may not be able to borrow on it, unless you’re operating a lemonade stand.

Draining the Swamp

From the Robert Half (“Accountemps”) 2012 Salary Guide:

Note: Salaries indicated are the national mean for companies up to $50 million in sales, except General Accountant, which is up to $25 million. Adjust by applying the following geographic factors: Boston +32%; Springfield +4%; Manchester/Nashua +10%; Providence -3%; New York City +41%; Chicago +22.7%; San Francisco +35.5%.

October, 2011

In her unending effort to catalogue the best retail resources in New England, my wife Anne several years ago chanced upon an unobtrusive store in mid-coastal Maine, about five miles north of Moody’s Diner (itself well-known to value-seeking eaters).

Alongside Route 1, just beyond The Well-Tempered Kitchen, behind a relic of a cash register in a dimly-lit shop sits Bob Havenstein, an octogenarian who presides over the largest collection of jigsaw puzzles in New England, right there in Nobleboro. His business, appropriately enough, is called I’m Puzzled.

Annie’s summer Down East isn’t complete without a visit with Bob, and she invariably ends up supplementing our puzzle stock, which appears now to be sufficient to absorb a house full of guests for forty days and forty nights of steady rain. Fortunately, this summer the guests and the rain never overlapped, so the puzzles sit on the closet shelves, waiting.

Anyway, there I was in the narrow aisles of Bob’s store, surrounded by puzzles of all vintages, trying to calculate whether a 1,000-piece puzzle takes twice as long (or more?) to complete as a 500-piecer, when it dawned on me that I could never do 1,000 pieces in one sitting. Which is why I never buy these things — I hate to start something that I won’t have time to finish the same day.

“But,” Annie reminded me, “you do like puzzles. It’s just that yours come in the form of spreadsheets.”

There it was. Harsh reality. I had admitted to her not too long ago that, for me, completing a financial spreadsheet projection was like solving a multi-layered puzzle. While it’s not to be confused with completing the Big Dig or the Burj El-Arab, a well-considered, well-documented spreadsheet that integrates a projected income statement, balance sheet, and cash flow forecast for twelve months is the sine qua non (that means it’s the Holy Grail) of financial management.

In addition to the fact that you can complete it in one sitting (once you have arrayed all of the pieces) consider these additional benefits:

1. Comprehensiveness — There, in a single document, is your total strategy for the year, summarized in dollars — marketing, sales, compensation, product development, supply chain. This is your game plan.

2. Documentation — With every assumption annotated, you’ll never have to scratch your head in mid-year wondering what you could possibly have been thinking as you gazed into your crystal ball.

3. Integration — That 20% revenue growth target is no more than a dream unless it results from an exercise that brings together well-supported assumptions about lead generation, individual sales targets, product development schedules, incentive compensation, customer persistency, and so on — all of these elements arrayed in separate schedules in the spreadsheet file.

4. Resource allocation — What are the key drivers of growth and profitability, and what will be spent on new people, new equipment, new incentives, new products, new markets?

5. Expense control — You’ll know you’ve achieved it when your managers, instead of asking “Do we have the cash to pay for it?” say “Is it in the budget?”

6. Direction — No one has to ask “Where’s this company going?” Line up the projection for the next twelve months with the results for the past twelve months and compare line by line to get the answer. If there’s no year-to-year change, then the answer is probably “Nowhere.”

7. Goal-setting — The big metrics in the financial statements are comprised of a bunch of little metrics produced by individual contributors. Employees who understand how their results flow into the group product are usually more productive, especially in the presence of a group incentive.

8. The answer to “How Much?” — It’s right there on the top line of the balance sheet. If the cash numbers are all positive once you’ve incorporated your current financing package, your cash requirements are covered. If, on the other hand, those cash numbers are surrounded by brackets, the largest of them (in a negative sense) is your cash shortfall.

As this indicates, the budgeting process doesn’t start and end with the income statement.

You may be producing a solid “bottom line” of profitability, but if you grow faster than your profitability allows, you can easily drain all of your cash in funding inventory, receivables and equipment. The three-part spreadsheet, by integrating a balance sheet forecast and a statement of cash flows, solves the puzzle, answers the cash question, and provides the array of other benefits.

The jigsaw puzzle, on the other hand, provides just a single benefit to me. At the risk of sharing a secret with the rest of the family, I will say that if someone else wants to clear the dining room table, dump out the 1,000 pieces, and take ownership of the exercise, I will probably jump in. I can then be as socially involved as the next person, without any need for completion. After all, the answer to the jigsaw puzzle is right there on the front of the box.

Alligator Bites

“In Toronto last week one Fred Shipley did a jigsaw puzzle while his apartment burned. Forcibly ejected by firemen. Puzzler Shipley finished his puzzle under a blanket on the sidewalk.”

“In Chicago the Century of Progress (World’s Fair) was about to issue an official jigsaw puzzle, picturing a panorama of the fair grounds, for 25¢.

“In a Manhattan speakeasy patrons worked feverishly over pictures showing cinemactresses in circumstantial bedroom scenes.

“Eddie Cantor sat up nights writing a jigsaw song.

“And a Mr. Morris M. Einson of Long Island City, L. I., went vacationing in the West Indies, leaving behind him a business which had increased its payroll 250% since last summer, was making 3,000,000 jigsaw puzzles a week, and had become so prosperous that it could retain smart Lawyer Mabel Walker Willebrandt to fight the Government’s contention…

“…that a puzzle of over 50 pieces is no child’s game, should pay the 10% wholesale tax on adult amusements. Most puzzles are 150–500 pieces. Her argument: no matter who plays with them, or how many pieces they contain, jigsaw puzzles are childish, picayune, taxfree.”

— Time magazine, February 20, 1933

September, 2011

Radon test. Check.

Utility bills. Check.

Smoke and carbon monoxide detectors. Check.

On went the list, like seven-card stud — condo docs, insurance coverage, chimney inspection — check, check, and check.

We were all over it. Each time they raised the bet, we covered. The result? There were no contingencies last month when the high bidder signed the Purchase & Sale agreement to buy our Waltham condo. We had everything lined up and threw it all into the deal — washer, dryer, refrigerator — including the kitchen sink, to make sure it would happen.

We knew the drill — anticipate their questions, respond to the Buyer immediately, and lay your cards on the table. They got their mortgage, and we got our deal, which has subsequently closed.

It’s no different with a small business these days. Banks and private investors are scrambling to put their money to work. Yes, they’ll kill a lot of trees to paper the deal, and they’ll securitize themselves six ways to Sunday with collateral. Yet for a well-run company in this environment, it’s a buyer’s market for funding.

BUT (ahh, you knew there was a but coming, didn’t you?)…

…you have to be ready. A year’s worth of rising sales, a solid pipeline of prospects, new products on the drawing board, and an experienced management team add up to very little if you can’t bring your cards (in the form of credible documentation) to the table in short order.

When the bankers or the investors come calling, here’s what you need to have readily accessible with a few clicks of the mouse:

1. Three years of CPA-reviewed financial statements. Producing just a tax return doesn’t do the job. The notes to an accountant’s review summarize your historical financial strategy. They’re an important point of departure for discussing where you’re going.

2. Year-to-date financial statements compared to budget and to same months last year. The critical component of the narrative is your explanation of the key variances, year over year, and budget vs. actual. Special props go to those who have it all arrayed in an Excel file, with cellular comments documenting the monthly variances.

3. A projection of revenues and expenses, balance sheet and cash flows for the rest of the year. To the extent that this has been regularly updated, incorporating your latest financial tactics and strategy and detailing your assumptions, you win early credibility with potential financing sources.

4. The “cap table,” detailing the capitalization of the company. Who invested how much, when, and on what terms? Coupled with the Shareholders’ Agreement, this sets the stage for constructive dialogue about the next equity financing deal.

5. The receivables and payables aging statements and the list of fixed assets. In addition to providing an excellent barometer of your day-to-day financial management capability, this information for a banker helps to answer the early question, “What am I lending against?”

Of course, being a good poker player, you can leave these five cards face down until you know the game and the stakes. Your simple acknowledgment that these documents are readily available will move the conversation in your favor, as will showing your “cards” in turn as you tell your company’s story. And because there’s no substitute for experience, inviting a banker or two in for a trial run will help you determine whether or not you’re holding a winning hand.

My wife and I had a strong hand when — out of the blue — a prospective condo buyer came knocking at our door, but we were still sorting our cards when he folded. A week later, our cards were aligned. Check, check, check, check: four bidders, one at our asking price. Not bad for a couple who a few months ago hadn’t even considered jumping into the market. With a saleable asset, you’re never that far away… from Showtime.

Alligator Bites

When it comes to forecasting, the alligator has for decades relied on The Kiplinger Letter to provide a meaty digest of political and economic perspectives from Washington. Last week’s Letter signed off with a paragraph that predates even our first foray into the Swamp, but is fully applicable in the current muck and mire…

Note the following Kiplinger Letter analysis from 1957. Sound familiar?

“People ask why government won’t cut taxes and spending. OK, here’s why:

“The whole system is geared to spending more…on practically every front.

“Every government administrator, big or little, wants more for his functions…and is backed by like-minded lobbies in Washington, lobbying for more.

“Every member of Congress tries to get more for his district, his voters.

“Even the average citizen, perhaps even you, has some special interest, and wants government to spend more for that, and economize on other things.

“Almost no one dares stick his neck out for cuts… on any specified front.

“The total forces for spending exceed the total of forces for cutting.

“And, mind you, this applies to the general public as well as to government.”

August, 2011

“I think it’s getting just a little whiffy around here,” I said to my daughter Katie as I extended my arms toward her. Five-month-old Brooke, my youngest grandchild, just a few seconds ago had been cradled against my chest. Now she was at arms’ length, my hands tight around her chest.

“She’s all yours,” I reminded Katie. Not that she needed reminding.

A generation makes all the difference. Thirty-four years ago, when Katie was that age, if the first whiff happened on my watch, I was the one trudging off to the changing table, babe in arms. Now, except during my rare service as DCCP (Designated Child Care Provider), that’s no longer in my job description. Having met the prerequisites as Dad to produce prolific progeny, I’ve been promoted to Grandpa.

Other benefits accrue to this title. Grandson Noah, age 16, visited Princeton for the first time last weekend. According to my daughter Beth, he loved the place and immediately decided that’s where he would go to college in two years. As Dad, my first reaction would have been “Good grief — $50K+ per year!” My second, “Noah, to get admitted here, you’re going to have to… [fill in the blanks with future high school attainments].”

But as Grandpa, all I had to say was “That’s terrific. What a great goal. I’d love to see him at Princeton,” my competitive juices for my own alma mater notwithstanding.

Surrounded by multiple generations of family last weekend, I had job descriptions — or at least roles — on my mind when I accessed an email message from a former client. Having downsized his small consumer-goods company significantly during the past two years, he is finally on the way back. He asked me to review the resumes of seven candidates for the position of Controller of his company in Portsmouth, NH. Unfortunately, the job description that he furnished to the candidates, and then to me, was for the role of a Staff Accountant.

The difference is more than generational. The title said “Controller,” but the description talked mainly about keeping an accurate set of books. The need is for management, but the verbiage said “handle a wide range of accounting duties.” There was a brief reference to corporate strategy, but the six “included responsibilities” were all focused on recording financial history.

When we met in person a couple of days later, he acknowledged that the ad was misleading, but he’d wanted to convey the sense that this was “a hands-on job.” My response: in companies of his size, and on up to at least $20MM, there are very few jobs in any functional area that are not hands-on. In Finance, whether your title is CFO, VP Finance, Treasurer, Controller or Accounting Manager, you are responsible for the numbers. You may not be doing the data entry, but you have to be involved enough to identify results that don’t make sense.

Facility with, and accountability for, the numbers may be the common denominator, but the emphases of the Staff Accountant and the Controller diverge from there. In my 30-year experience with smaller companies, the major differences include the following:

• Perspective —
• Accountant: Historical; maintaining the financial records of what happened in the past.
• Controller: Future; anticipating the financial implication of the range of events that could happen in the next twelve months.

• Size of firm —
• Accountant: Provides adequate coverage until there’s need for ongoing budgeting and financial planning, often the point at which the founder/owner gets too busy to handle it.
• Controller: Critical to companies with complex transactions, including debt financings, major capital equipment purchases, multiple business units, international issues, outside reporting.

• Skills —
• Accountant: Thorough knowledge of account recording evidenced by complete and timely accrual-based financial statements and by expert capability with employer’s accounting software.
• Controller: Ability to accumulate, assimilate, and analyze data from multiple sources in order to identify variances, to hold managers accountable, and to initiate discussion of appropriate changes in tactics or strategies going forward.
• Accountant: Tracking and ensuring the reporting of those aspects of the firm’s business that might result in income and/or expense. Accurately recording the assets of the organization.
• Controller: Establishing policies and procedures to ensure the control of and accountability for revenues and expenses. Responsible for safeguarding the assets.

• Behavioral tendencies —
• Accountant: Precise, meticulous, thorough, follows precedents, responsive, conscientious, steady, concrete.
• Controller: Active, initiator and coordinator, inquiring, analytical, logical, judgmental, conceptual.

• Keys to career progression —
• Accountant: Having mastered accounting, has to demonstrate depth of cross-functional understanding by providing useful and unique analyses to departmental leaders.
• Controller: Has to move beyond income statement to take leadership in balance sheet management, understanding financial analysis and being able to convey knowledge effectively to the rest of the management team.

Which brings me back to my career progression as Grandpa. Even with two sons still enjoying bachelorhood, I am blessed (always!) with six (count ‘em) grandchildren. As the conversation last weekend ranged from day care costs (accounting) to projected college expenses (controllership), however, I reverted to type, and all agreed — it takes constant financial planning. For the Senior Financial Manager, that’s what really counts.

Draining the Swamp

“Do you ever wonder what people in other industries make? Below, you’ll find median compensation levels for 10 positions at companies with 250 or fewer employees in eight industry sectors…” [Click here for the other seven positions, plus geographic and company size data.]

— Inc. Magazine, July/August 2011 Compensation Guide