Archive for the ‘Family Businesses’ Category

Most family businesses are corporations but they are more institutions than businesses. The owners expect loyalty to the organization (ie them) and there appears to be a higher calling than the profit motive.

I have been around them most of my business career. They may have some or all of the following characteristics:

  1. Very tight ownership control – 100% owned by 1-3 family members
  2. Poor internal controls – no budgets or forecasts
  3. Longevity – many are second generation or longer
  4. Their market is local so this does explain #3.
  5. Not well capitalized.
  6. The business net worth of the shareholders isn’t available.
  7. The sole source of remuneration is a salary.
  8. There isn’t much if any consideration to succession planning.

All of the above might appear to be pejorative on my part. It isn’t a criticism but a statement of fact – after over 30 years experience in this sector.  Like any business, the family business faces daily challenges. There is an extra strategic challenge that the family business faces. How does the business enable wealth transfer from generation-to-generation yet ensure the replenishment of the family ownership ranks?

The above isn’t easy. This unique challenge is facing the baby boomers right now. The boomer who is an employee may be able to retire with a pension, convert their RRSP to a RIF or have outside sources of (investment) income to supplement their retirement years. Maybe!

The boomer(s) who own businesses have their retirement wealth invested in their business. Their business is their RRSP.  That is obvious. What is the solution?

I feel that one of the greatest challenges facing the boomer business owner (BBO) over the next 10-15 years is – devising their exit strategy. This is one of the most difficult decisions the BBO will ever make.

Have you given any though to your BBO exit strategy?

 

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Federal Reserve Chairman Ben Bernanke announced recently that the printing of money will start to decline. The Federal Reserve has been buying up to $90B per month of Treasury Notes. This has been the policy of monetizing massive US deficits. Interest rates in OECD countries are at legislated rock bottom rates. Inflation is about 2% per year and, by some accounts, the US economy is growing.

Don Drummond, a respected economist, told everyone that economic growth in the developed countries would be between 2-3% for the foreseeable future. So it will be difficult for Canada to grow into its debt.  Our Minister of Finance likes to point out that our federal debt to GDP is the lowest in the developed world.  Maybe, but he conveniently forgets to mention the provincial debt burden. The world’s largest debt rating agencies haven’t overlooked this. Canada’s GDP is $1.5 trillion. Our combined federal and provincial debt is about $1.1 trillion. This makes our total debt to GDP about 73%. We aren’t as good as we boast.

Ironically, large publicly traded companies have clean balance sheets. They used to consider OPM (other people’s money) as leverage. At the end of the day, it is debt. It has to be repaid and the debt service costs are subject to “prime plus ?” interest rate swings.

There was a study published by a economic think tank that an inflation rate of 4-6% would not be unwelcome. It would encourage governments to be more responsible. Yeah right!  Look at the possible impact on the consumer in general. Mortgage rate increases would make servicing of existing mortgages ($350,000+) unsupportable, not to mention the servicing of other personal loans.

Small business is always in a precarious position when it comes to the availability of bank credit. Banks would tighten up their credit policies and new loan growth in the small business sector would be very specious.

 

 

The formula is simple: Know your client + know how to make money = add to your net worth! It seems so simple doesn’t it? The businesses that make money on a year-over-year basis should have an amendment to this simple formula: monetizing your net worth.  This is the hard part.

I had a small business owner lament to me that: “I’ve invested about a hundred thousand dollars into this business and all I’ve done is bought myself a job.” How true!

Small business corporation shareholders receive a salary (and a T4 at year end) but I have seen only a couple receive T5s (investment income – specifically dividends).  Why not? Given that the sum of shareholder loans plus shareholder equity represents a large percentage of the total net worth of  shareholders,  why don’t shareholders integrate their payouts? (salary plus dividends).

It’s a good point. If a shareholder’s remuneration was $75K a year (in salary income) and it was changed to $50K in salary and $25K in dividends, the tax bite would be lower. The $25K is NOT earned income and as such would be excluded from contribution room to an RRSP but, seeing that a small business owner considers their business to be their RRSP,… well .. why not investigate the advantages of this remuneration split?

There must be sufficient equity to pay a dividend of course and no bank loan covenants preventing the declaration of dividends.

There must be billions of dollars tied up in the Shareholder Equity section of small business balance sheets across the country. This is the biggest dilemma facing baby boomers who own CCPCs and are trying to retire.

The old maxim holds: “.. use it or lose it.”

 

The last couple of posts illustrated some metrics that small business owners should be acutely aware of. All of these metrics will help you understand how your business performs and help you make the right kind of decisions to turn your business around, restore it to profitability or improve profitability.

The retained earnings section of the balance sheet is the location where the fruits of your labour should be seen. Hopefully, this will increase year-over-year. A business that adds retained earnings to the balance sheet will improve the balance sheet, make the balance sheet more attractive to lenders and will improve the capitalization of the business.

It seems intuitive – but it isn’t.  If the business generates good retained earnings it allows the business to add more external capital to put to work – that will increase profits in the future and further increase retained earnings. Many small business owners don’t understand this.

There is another challenge that small businesses with good retained earnings face – how to monetize these retained earnings.

This will be dealt with in a subsequent post.

It has been my experience that a family business gets into trouble when .. the business gets into trouble.  I have worked in a quite a few troubled businesses and the shortcomings of management become evident. Here are a couple of the usual disclaimers:

  • “I don’t know what has happened to the economy and our market?”
  • “I don’t have any more capital to put into this place.”

Both of the above bullets are correct in: (a) management never watched the market very closely so, they certainly would have no idea what happened in their market (b) the scion of the family has ALL of his/her  livelihood tied up in their business.

There is a third bullet that I will now elaborate on: The newest (family) members in the business don’t have any experience running a business or in any of the key components of the business like: operations, sales and marketing or accounting and finance.

A family business that has been in business for 25-50 years has no guarantee that it will be around in the future. The weaknesses inherent in a family business become obvious when the business gets into trouble.

New competition, new technologies and better delivery of service is something that catches the family business off guard. The bromide of delivering great customer service misses the point. Customers expect great service from any business. Large corporations are adjusting to a new paradigm and small businesses must learn to do so as well. Unfortunately, the family business that refuses to get out in front of the market and their customer pays .. and pays dearly.

The family owned and operated business is one of the real gems of entrepreneurship. The reins are handed down from generation to generation and it might appear that this type of business will continue and succeed indefinitely.

This thinking it wrong. It takes moxy and chutzpah as well as skill to keep these businesses operating. Many small businesses are unprepared for the inter-generational challenges. After all, the new blood got there by virtue of DNA – not ability or experience. I do not say this to criticize all small business management. I started out, right after university in a family owned business – in management and with no prior business experience. I did not appreciate it at the time but I was getting the same kind of real-world training that many MBA programs offer.

I have been around many small businesses and they have a lot of similarities and (unfortunately) pitfalls:

  1. There is no business plan – just an assumption that the business will be around in the future for family members to join.
  2. The newest members don’t have much if any formal education or prior business experience.
  3. The newest members learn from the incumbents.
  4. Wealth does not automatically accrete. In fact many of these businesses are under-capitalized so the retirees cannot enjoy the fruits of their years and years of labor. This is one reason why small business owners delay retirement for so long – they can’t afford to retire.
  5. There is no real succession planning and as such, no estate planning. So, serious illness or death can have disastrous consequences for the family – not to mention the business itself.

There are many steps that the current generation of family business owners can take to preserve their wealth and help the succeeding generations of business owners.

More on this in a later post.

The whole issue of business growth is a compelling topic. Growth is the objective of most entrepreneurs with whom I have come into contact. Growth in volume that is……..

This topic deals with growth from the perspective of a business that has: (a) employees (b) external leased space and (c) fixed assets deployed in the generation of revenue. It might appear that “more is better.” How so?

The above business should have a business model and the pricing of their goods or services should be based on:

  • Current production or service levels
  • Understanding of the profitability of the current production levels on a per unit basis.
  • Have a budget or forecast that details the incremental costs and resulting impact on profitability and cash flow.
  • Has the management in place to manage the growth.

This doesn’t sound too difficult in theory.  In too many cases, there isn’t any impact analysis of growth alternatives. Some considerations include:

  1. What will the “delta” be for incremental customers? In other words how many more clients/customers will be required to recoup the incremental costs?
  2. Do you know what the fixed cash burn rate of your business is now? What will the new fixed cash burn rate be after additional fixed costs are incurred? It might surprise you.
  3. What will the new revenue breakeven point be? It could be surprising as well.
  4. How much additional financing be required to support increased trade receivables or inventories?
  5. Is your market that solid that you can harvest additional revenue from the investment you will make?

These are issues that most small business owners don’t even consider. They consider their potential market a vast, untapped and eagerly awaiting market.

Nothing could be further from the truth.

 

 

 

It contend that growth in revenue should not be a mystery. At its most basic level: (a) there is a need for your product or service (b) your business fills that need and (c) there is an available and ample market. That’s the ideal of course.

Since most small businesses don’t plan then a new set of parameters apply: (a) new business is discovered by the market (b) the market is not well investigated and (c) the market is razor thin.  Unfortunately, management thinks the growth will be continuous and growth is “on spec.”

I have been around many small businesses that have grown in the correct manner and many that haven’t. Here are a couple of examples where growth has occurred correctly:

  1. A towing business that wins a municipal police contract for exclusivity in the removal stalled or damaged vehicles from busy roads. Instead of investing heavily in new equipment and personnel – brokers (aka independent contractors) meet this need. If business expands this expansion is done via variable costs. The broker and their vehicle doesn’t cost the business a dime if times are slow.
  2. A trucking business that successfully gets a new trucking route. The trucking firm many have to buy or lease 6-10 new trailers but they contract out most of the route to brokers who have a $100-$125K investment in their own tractor. The cost of servicing heavy trucks is enormous. These service costs falls squarely on the shoulders of the owner/operator.

I’ve been around several businesses that haven’t grown correctly. Most have been in the white collar service industry. Revenue expands quickly and new staff (salaried) are hired to meet the needs imposed by increased volume. There hasn’t been sufficient due diligence performed to warrant the hiring of new staff.

The issue that most small business owners have problems with is the idea of “scale.” Quite simply, I define scale as: the ability of a business to grow using variable cost inputs rather than ramping up fixed costs to meet a perceived demand that may not be permanent.

We see good examples of scalability in the IT business where business growth is handled using contractors who have billable hours/days targets.

You can “grow yourself out of business.” More to follow…………

The title of this post seems strange but upon closer examination – not so. Growth is the objective of any business. It is better than declining business or flat volume right? I guess the first question I would ask an entrepreneur whose business has grown rapidly is: “how did the growth come about?” Was it planned or based on a seized opportunity?

The main problem I have with growth is the predictable  growth in costs and their unforeseen impact on profit. Small business owners are impulsive. They don’t need a committee to approve expansion plans. They simply plunge forward. The moment revenue starts to grow the major concerns are:

  • The business doesn’t have enough office or operational space so larger leased premises are sought.
  • New staff are a priority so, one or two new staff are sought.

It has been my experience that costs (fixed) rise lock-step with increased revenue. I forgot to mention that the new space will always require “fit-ups” (aka leasehold improvements) to get the space ready for occupancy. So, another fixed cost is added to our bullet list – amortization of leaseholds.

The owner of the small business confidently boasts that revenue has risen by 20% over the previous year. Fixed costs probably have risen by the same percentage.  Possibly the move might have been accretive to profits in the first year but what are the risks?

A business that continues to grow may be able to keep a step ahead of problems but they will catch up if not understood and planned for in advance.

Since small businesses rarely plan the previous statement is moot. I’ll discuss some more growth issues in the next posts.

It has been my experience that continued revenue declines without remedial action will result in reduced cash. Duh!! As rhetorical as this statement appears, it doesn’t seem to resonate with many small businesses.

It has been my experience that not being proactive when revenue is flat or declining is one of the two mortal sins of a small business owner  (The other is being impulsive and making capital commitments at the first sign of a revenue increase). Lower revenue means lower trade receivables  60-90 days out. Lower receivables means less money to deposit in your bank account. Unfortunately, while revenue and cash flow may decline, overheads remain the same and eat up an ever increasing chunk of declining deposits.

One knee-jerk reaction to kick start lagging sales is to reduce prices. This is quite common in the retail sector. It can be a prudent strategy, given that retailers have a huge investment sitting on their balance sheet in inventory.

Revenue is a barometer. If revenue declines what is this telling you? If your business is cyclical or seasonal then maybe this can explain why the decline has occurred. Is this the reason or are there other reasons?

If you forecast that revenue will remain flat or will decline for more than a fiscal quarter, what will you do? Doing nothing is not the answer.