Give Your Business a Stress Test
Bill Warner Tuesday, May 12, 2009
Hey, here’s an idea. If banks can undergo a stress test, you might want to consider doing the same thing for your business. This might be worth your time if you do it with the objective of determining if you can withstand the worst of economic situations.
Determine the stress on your business
Start by making some reasonably pessimistic assumptions about your industry and market segment. Don’t be ridiculous, but make assumptions that represent the worst case you can realistically imagine. For example:
- Assume your market segment growth is flat or even down year to year; whatever is indicated by the changing trends in your industry.
- Make assumptions about the cost of goods and services, all of which will have an effect on your gross profit.
- Project what might happen to prices, especially if you see new competitors emerging or the possibilities of price reductions by your current competitors.
- Assess what will be changing about your customer’s purchasing behavior. Will the sales cycle be longer? Will the need for your products and services survive budget cuts?
- Take account of what is happening in the legislative and regulatory world. Will changes in government subsidies affect your business or your customer’s business? Will tax increases affect you or your customers.
Calculate the changes in your financial outlook
Any of these stress factors will have an effect on your ability to do business and need to be reflected in your financial forecast. Express these stress factors quantitatively so that you can reflect them as changes in your Excel spreadsheet assumptions that drive your financial forecast:
- How will marketing productivity be effected?
- What will happen to sales productivity and closure rates?
- What changes will have to be reflected in your cost of marketing and sales?
- Will there be changes in your assumptions for operating expenses?
- What changes should be made to prices over the next couple of years?
Perform what-if analysis
With your new assumptions, update your financial forecast spreadsheet and let Excel determine what will happen to your financials over the next 18-24 months.
- Will your gross profit still be viable?
- Does your expense structure still work?
- Are you profitable?
- Do you maintain a positive cash position?
Determine required actions
With your completed stress test, make some judgments as to what you need to do to assure your survival if your pessimistic assumptions become reality. You may find that you need to make certain changes now or at least determine contingency plans that could be executed if the situation requires them.
- Should you raise money to pull you through the tough times?
- Are their cost and expense actions you should be taking right now, just to strengthen your financial position?
- Will you be able to realistically cut costs and expenses further if times get tougher? Create a plan for such actions.
- Should you take preemptive action on prices now?
- Do you need to reduce staffing now?
Be totally objective
We are talking about your business, so be bluntly honest about your market situation. This is not a time for unfounded optimism. Be optimistic about your chances of survival, but be realistic about what challenges you face. If you are, you will come up with actions that will save your business. By taking action now, before a disaster hits you, you are giving yourself the maximum chance of winning.
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The Stress Test You Don’t Read About
Bill Warner Saturday, May 09, 2009
Well, great news. The banks have passed the stress test; although some have to raise some more money, no problem. We have bottomed out, and back on the mend. Right? That’s what most of the media and the administration are telling us. So, it must be true.
There’s another stress test in town
Not so fast. Take a look at this report in The Nation about another stress test done by The Institutional Risk Analytics Bank Monitor (IRA). This is the group that provides an independent assessment of the banking system to organizations like the FDIC. Their report is the exact opposite of the administrations stress test. IRA claims that there is a dramatic increase in the stress in the US Banking system, mainly driving by the loss of stability due to negative net incomes of over 1,500 banks. IRA’s Bank Stress Index jumped three fold since the end of 2008.
It’s not all about Wall Street
The administrations stress test might have some good news about the large Wall Street banks, but is sure missed what is going on in the rest of the banking system. What they are missing is the slow but sure deterioration over the last nine months of the nations other banks. This has been driven by business failures and loan losses that continue to mount. These banks cannot just live on interest alone and cannot make up for these losses with new service charges. The result now is that an increasing number of US banks are on the brink of failure. This may be why it is still so hard to get a loan. Do you think?
Keep tightening the belt
The best advice I can think of is to keep tightening the belt and run your businesses with extraordinary discipline. A large portion of the banking system is not going to be able to help much for quite awhile. Search for the banks that are truly financially healthy, both in profit and balance sheet strength.
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GM Restructuring Its Way Out Of The US
Bill Warner Friday, May 08, 2009
What a kick in the head. As part of its restructuring plan, GM plans to dramatically move manufacturing offshore, taking advantage of cheaper foreign labor. In addition, an increasing number of its cars will be sold in foreign countries. The taxpayers, through the Obama bailouts, have paid billions to save GM. At the same time, Obama has pounded GM management for a new plan, as the unions compromised nothing. Well, they now are about to have the plan from hell that will eliminate more US jobs, putting thousands of auto workers on the street.
The unions are destroying GM
What the heck did Obama and the unions expect. GM has a failed business model, mainly due to expensive management negotiated union contracts and an unaffordable debt structure, that cannot be fixed under its current labor cost assumptions. Now Obama is between a rock and a hard place. He has to decide if he will put further restrictions on GM to keep the US jobs, which will spell the demise of GM, or suffer the wrath of the liberals who elected him by losing jobs to foreign countries. This is yet another lesson why government should stay out of private sector businesses.
The bailout was a bad investment
Our taxpayer dollars have been spent foolishly, as Obama tries to save a company that is tied in knots with union contracts and work rules. Any investor looking at this deal would walk in a second. The business model is just not workable and needs a total bottoms up restructuring. GM is predictably trying to do that by getting out from under the oppressive unions by moving manufacturing operations overseas.
Let the free market system work
None of this had to happen. We should let GM declare bankruptcy and undergo a court ordered restructuring. The free market system would have fixed this situation quite nicely, and we would have had a great chance of saving a lot of auto worker jobs in the process. GM would have been saved. Now we face losing it all.
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Inflation Proof Your Business
Bill Warner Tuesday, April 21, 2009
I am certainly no economist or master of the US financial system, but when I see how much money is being poured into the economy by the Treasury, red flags of inflation flash in my face.
Take a look at the trends. What I think this data says is that by early 2008, the money supply had reached $4 trillion, by the 4th quarter of 2008, it had reached $5 trillion and it is being reported as over $8 trillion. Recent news reports add another trillion in March. By the beginning of 2008, the money supply had doubled since 2002. In one year, it has more than doubled again, with $4 trillion being added in the last few months. I don’t know about you, but that is frightening to me. Yes, we are in a recession, but I am worried that in short order the devalued dollar is going to leap into the forefront as an issue causing price increases and higher interest rates, the key elements of inflation. This recession might snap like a rubber band into a period of rapid inflation.
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A More Positive View On Economic Recovery
Bill Warner Monday, March 16, 2009
Well, Ben Bernanke is speaking out. This is a very unusual thing for a Fed Chairman to do. Bernanke is being widely quoted and did a piece on 60 minutes as well, where he is carefully projecting that the economic turnaround could occur later this year.
Balanced view of the potential recovery
Bernanke is careful to say at the same time that it depends on “getting banks to lend more freely again and getting the financial markets to work more normally.” It would seem that it is very important to know that our tax dollars for these bailouts are really going towards the improvement of lending and not for international expansion, acquisition of other banks and funding executive bonuses. Bernanke is particularly irked by the recent announcements of $165M in bonuses to AIG executives. Bernanke does also explain that unemployment will probably go to a double digit percentage before this is over, but once the financial system is working, we should recover. He also confirms that the Fed is printing a lot of new money. It has risen by three trillion dollars since December 2008. Bernanke recognizes that he is playing with potential inflation, but also says that the plan is to reduce the money supply once the financial system is working again. He never said how that would be done, but it sure does seem to be a crucial action in order to avoid rampant inflation next year.
Keep this all in perspective
Keep in mind that most of our regional banks are doing just fine. The only things we seem to read about are the few very large banks that unfortunately represent a large chunk of our economy, and how bad off they are because they bought into the toxic securities created by the sub-prime lending disaster. As business owners, you are quite safe and quite frankly acting responsibly if you are working with local banks that did not get themselves into this kind of trouble. When approaching a bank for credit or a loan, simply ask them what their financial position is and make them explain in quantifiable terms that they are comfortably solvent and are in a positive lending position; that is, their balance sheet is not full of junk.
We are all getting tied up by what is going on nationally and the federal level. For business owners, it comes down to running your companies with sound judgment and keeping your eye on the ball of the basics that make any business successful. If business owners employee solid business practices in the execution of their business operations, they will survive this recession and come out of this even stronger.
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Creating an Attractive Business Model
Bill Warner Wednesday, March 11, 2009
Now, more than ever, investors need to see a business model that both provides an attractive return but is easy to understand and implement.
*It starts with a solid value proposition and customer traction*
Tom Taulli talks about some of the important elements of an attractive business model. Certainly having a compelling value proposition is necessary. Its key elements are:
- Solving a compelling and important customer problem
- Offering an innovative solution to the customer’s need
- Clearly fitting into the customer’s purchasing priorities
- Having a solution that is a winner over all competitors
- Providing an attractive return on the customers investment
The more you can bring this value proposition to life by citing real customer traction will make the value proposition much more believable. Reflecting potential customer reaction resulting from your market research, describing customer satisfaction from early use of your product or service, and certainly early sales results all tell investors that you have something that buyers really want.
*More is needed to round out a business model*
Investors have to see even more than a strong value proposition. Some of the additional things they consider are:
- Is the marketing and sales approach easy to implement and can it be scaled up quickly, looking for sales cycles that are well understood and easy to navigate
- As a result, will the company be able to achieve attractive revenue growth quickly, looking for revenue streams that are easy to accomplish and also easily renewed
- Is the barrier to entry to competitors high and is their good protection of the intellectual property and know-how of the company
- Will the company achieve financial results that have the potential of providing the investors good returns in a relatively short period of time
Of course, investors always look at the management team to ultimately decide, but their story about their business model has to be compelling and convincing, and the management team has to show that they can really pull it off.
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Surviving the Coming Inflation
Bill Warner Wednesday, February 18, 2009
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Raising Capital - Consider Grants
Bill Warner Tuesday, November 25, 2008
With private equity being squeezed by the economic downturn, sources of start-up financing are becoming harder to find. If you don’t have some immediate cash flow to bootstrap your business, or assets against which to borrow money from a bank, you face an ugly world where money is harder to come by.
So far, government programs like the Small Business Innovation Research (SBIR) and Small Business Technology Transfer (STTR) grant programs are still going strong. These programs are a very good way to get some early financing to perform your market research and then to perform commercialization on your business idea. Usually divided up in two phases, an entrepreneur can initially get $100,000 for research and then another $500,000 to $1,000,000 for commercialization work, depending on which agency you are working with.
These programs are quite selective in that only a few government agencies sponsor them and there are strict timeframes in which grant applications can be made. The beauty of these programs is that the grants to do not have to be paid back and there are matching programs from certain states, like North Carolina, that can add further funding on top of the government grant.
To learn about these programs the place to go is the Small Business Technology Development Center (SBTDC). Their website at www.sbtdc.org offers a wide range of small business development assistance, including guidance on how to apply for government grants. They know all about how to apply and know the process for each of the agencies. Talk to John Ujvari, who can help you get started. Note also the events page for upcoming seminars. There is one scheduled for December 10th and 11th, in Fayetteville. You can learn about the “art” of completing one of these applications.
Although a long and competitive process, this can be quite an effective way of getting early financing. Many companies have gotten their start on these kinds of grants and sometimes continue applying for additional grants to carry them through the first few years when cash flow is minimal. Of course, you should also search for other foundation grant programs in your area. Check with your local economic development organizations or state department of commerce for guidance as to what programs are available in your area.
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Stock Options - The Next Dilemma in the Market Downturn
Bill Warner Sunday, November 16, 2008
As in most market downturns, the value of employee stock options often drops below the stock price at which they were offered. This undermines their primary purpose of providing an incentive for employees to stay with their companies and later reaping the proceeds of having high valued stock in their company once the vesting period has ended. Well, we are here again as most public company stock options are “under water.” Some reports say that over 80% of public technology companies have “under water” stock options. The same could be true of private companies as their market valuations get tamped down over the next several months.
Companies, usually with stockholder approval, can reprice employee stock options, or offer a stock option swap for new options at a lower price, thus resetting the option price to a new level consistent with the current company stock price. This would naturally make employees quite happy.
The dilemma is that it will not make stockholders very happy. Hey, stockholders don’t get a chance to reprice their stock. Why should the employee stock be repriced? Stockholders took the risk to invest. Why should the employees be sheltered from the same risk? After all, employees knew what they were getting into when they hired onto the company. Stockholders are not terribly interested in further diluting their stock by such a repricing action.
On the other hand, employees say that the decline in the stock price had nothing to do with them. They didn’t cause the credit melt down that started the downturn. They need to be rewarded for achieving their milestones, those things that they have control over. Of course, employees should also be accountable for their results. If they have not met their milestones, then it becomes harder for them to argue that their options should be repriced. The real situation is usually a mixture of missed milestones and general market downturn. So, where do you draw the line?
The lesson here is that employees don’t really act like stockholders and view their stock options as a form of compensation that could represent great upside potential if the company performs well. They are not thinking of the broader market risks when they get a grant of stock options from their company.
The answer to the dilemma probably will come as a compromise between the interest of employees and stockholders. Some companies are trying to pre-empt shareholder opposition, designing “value-neutral” plans that allow employees to exchange existing options for a smaller number of new ones at lower exercise prices. That will help protect part of an employee’s grant but avoid large-scale dilution or additional accounting charges.
Company boards are very motivated to solve this issue quickly. None of them want a mass exodus of key employees and executives to other companies that will grant their stock options at today’s prices.
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Raising Capital - Consider Debt Financing
Bill Warner Friday, November 07, 2008
Debt can be your friend. It can be used in many ways to strategically fill out your overall financing plan. However, there is no doubt about it, loans have to be backed by some form of collateral and the money has to be paid back over an agreed upon period of time and interest rate. Here are some important possibilities for the use of debt financing:
- Early market research can be financed with debt. You can use a credit card or borrow against your assets. A nominal amount of money is usually needed to conduct a disciplined market research on your entrepreneurial idea. There is usually no need to buy expense research reports, but some money is needed for travel for testing the market and for the development of materials for your research work.
- Once you have satisfied yourself that you have a good market opportunity, it is often necessary to develop an early prototype and perform some more in-depth market testing. Again, bank loans are a viable source of financing for prototype development and for filing patent applications.
- Most businesses in the US can actually be started through bank financing, as long as the entrepreneur has the necessary backing. The backing can come from the founder or from friends, family and business associates. Of course, these people that take the risk to back the loan should be rewarded by the company. Approaching local banks that offer SBA backed business loans is an excellent way to get the money you need to start a company. It is not always necessary to approach angels of any kind. This way, the entrepreneur does not have to sell shares in the business and will therefore own the entire company, keeping control of its destiny.
- Also for most small businesses, getting loans from other people is very common. Many businesses get financing from family members, friends and business associates without every approaching a bank. These loans have to be paid back with interest but the terms are usually more attractive than with banks.
- There are several banking institutions that will loan money to early stage companies for them to purchase capital equipment, where the equipment acts as the collateral for the loan along with the company’s cash position after having received its first round of financing. Sometimes personal guarantees are required which founders can consider and perhaps get assistance from their backers to accomplish as well.
- A fairly common use of debt is for investors to actually loan money to a company that will later be converted to equity at the next round of funding. This helps a company gain some financing without having to declare the value of the company until the next formal round of funding. Other considerations are provided to the debt provider in the form of discounts and warrants.
- Companies that have ongoing revenue and a good financial track record can get a line of credit from a bank that can serve to plug the drain to cash flow that occurs during periods when accounts are not yet paid and to meet periodic payroll demands. The accounts receivable backlog can often be used as collateral for such loans as well.
Bank financing can be a valuable tool at all stages of company maturity. As with any financing activity, it has to be approached with discipline and a well thought out and managed business.
