It’s fairly rare that I can write about the jobs I take on, this one is an exception to that rule and there are some lessons here that can help any entrepreneur, even the ones that are doing well. This is a tale about trust and growth, it has a very unfortunate ending.
Going bankrupt is exceptionally easy if you go down one particular route. You simply buy something for about the same or more than you’re selling it for and you forget to factor in all your variable costs and/or overhead.
Every now and then I end up advising companies or executives of companies that have hit a rough patch. Usually these stories end quite well and everybody lives to tell the tale of a close call but in this particular case there was nothing left to be done other than to pull the plug on the patient. That hurts. Here is how it happened.
A services company was growing like crazy. The CEO and CFO had bought the company several years earlier using an earn-out construction and they had been growing the business revenue wise substantially, double digit growth for three consecutive years.
The market the company operated in is highly competitive, margins are slim and customers are using their knowledge of the market and the players to negotiate agressively in order to get the best deal. In a market like that - very price sensitive - you have to be extremely aware of what your exact position is because the difference between making money on a deal and losing money on a deal is small but very significant.
In 2010 the company made a substantial profit, in 2011 the profit was still there but lower, in 2012 the company lost substantial money. The reason I got called in was because there were some irregularities with one of the current accounts but as I gained more insight into the situation I realized that the company was probably doomed. We moved for a scenario where the company would get temporary relief from their obligations in order to restructure but after a few days more it turned out that that was so unlikely to be successful that they filed for bankruptcy.
This is a pretty tough affair, bankruptcy is a bad thing to happen to a company for many reasons, not in the least because as executives you can be held liable for mis-managing the company if there are substantial reasons to suspect this. But in this particular case it was unavoidable, the company had entered into several expensive contracts increasing its overhead, had been bidding so aggressively on various deals in order to increase their turn-over that they lost sight of the bottom line and were actually losing more money on the deals they closed than they were making in the first place, once all the variable costs and overhead were accounted for.
But because the CFO was asleep at the switch and the CEO did not check up on him (trust is a good thing, but verify if you value your company and if you take your responsibilities serious) and probably did not have the financial chops required to do his job properly this wasn’t noticed until it was (much) too late.
So, in spite of double digit growth they ran out of room to manoeuver when the cash reserves built up during the years when they were still making money on the majority of their contracts ran out.
The lessons you can learn from this tale are quite simple in principle but can be hard to apply in practice:
- Make sure you know what your counterpart is doing if you share the responsibility for the company
In this particular case, the CEO is an extremely nice, somewhat overly trusting man. By keeping him out of the loop the CFO was able to hide the problems (including some irregularities involving private accounts and the corporate current account) from his partner. This allowed the situation to continue to the point where there was nothing to be done about it.
- Make sure you factor in all your costs when bidding on a contract
The slimmer the margins and the more competitive the field you are operating in make sure that you know what your walk away bid is, in other words, what you have to make on a deal for that deal to be profitable. Turnover is meaningless if more business decreases your profitability, the whole idea is that by increasing turnover you gain some advantages due to economies of scale working to your benefit. If the economies of scale turn against you then you are killing your business by making it grow. Know your business inside out so that you can make the right decisions.
- If you are not able to function in a certain role, don’t take that job
A CEO should at a minimum be able to read a balance sheet, work through a liquidity prognosis and to check up on other parties actions on behalf of the corporation. He or she should be able to work fairly well under pressure and should be able to read and understand basic contracts and to estimate the consequences of actions or inactions. You should also be able to understand the exact responsibilities and if applicable the rights that come with the job. Being CEO of a company with close to a 100 employees is not something you should do on a lark or as training on the job, it means that you are indirectly responsible for close to 300 people and you should take such a responsibility extremely serious.
- when in doubt, get professional, unbiased advice
If you are in a situation where you need legal advice make sure that you are the person paying the lawyer and pick a lawyer that is not in any way associated with one of the other parties. A lawyer that you do not pay is not working for you.
- if you receive questionable advice then this goes double
If you receive advice that you find either curious or questionable then get a second opinion immediately, igorance of the law is a very bad defense (in fact, it is no defense at all) and a lawyer that is working just for you will be able to quickly dispell any doubt about whether or not a certain activity is (a) in the interest of the company, (b) in your own interest and (c) legal. Especially the latter can get you in hot water, more so if a company should default and you were at the helm.
Bankruptcy is something best to avoid, make sure it does not happen to you, lest you end up being witness to an asset sale and possibly subject to a personal liability to boot.