Protecting against the downside is important and too often overlooked. Statistically, recessions hit about every 10 years. Some are worse than others, of course, but they do occur with predictable frequency. Planning your company’s approach if the financial situation deteriorates doesn’t have to be an emotional acknowledgment that a downside is coming. Instead, think of it as good, thorough planning.
I’ve worked with business owners who didn’t want to give any attention to the risk that their company’s position could deteriorate. Doing so, they reasoned, would detract from the 100 percent optimism and focus necessary to keep the business going strong. I think that’s stupid. When that kind of mindset gets confronted by an unexpected challenge—such as a key customer failing to pay his or her bills or a lawsuit against the business or an overall downturn affecting your industry—the stage is set for an otherwise good business to close its doors.
A savvy business owner sets his or her business up to maximize success when something positive happens and to minimize failure if something bad occurs. It’s that simple. Failing to do so is what I call the “ostrich theory,” which is based on the well-known (but false) adage that an ostrich will bury its head in the sand to avoid danger, pretending no real problem exists. By comparison, in my experience, the most successful business owners are those who promote the approach of candor, transparency, and preparation.
Sadly, good businesses that are loved by customers, that have great missions, and that are staffed by passionate employees close their doors all the time. The ability to keep any business running is a simple math equation, one that must factor cash inflows minus cash outflows in relation to all of the cash an owner can come up with to loan the business when the company’s bank account hits zero.
If there is a deep level of additional capital to contribute to the company, such a business might be able to survive while losing money for a long time. Of course, even when an owner has an incredibly strong desire to put a struggling company on his or her shoulders to carry it back to success, at the point a company runs out of cash and the next payroll is $100,000, there just may not be enough money left in the owner’s personal bank account to turn the corner back to profitability.
When I started a small business earlier in my career, my rule was to put three percent of gross margin into savings each month. Early on, the amount was fairly insignificant. After a year, though, I’d built up a little reserve. After two years, I had the flexibility to make some decisions that favored the long-term success of the company at the cost of a little cash commitment up front.
Building such a cash reserve for your business is one of the ways to protect against downturns.
There’s a difference between being a profitable business and having the cash to operate. If I run a business that consistently earns $50,000/month in revenue with expenses of $40,000/month, I have a profitable business. However, if I borrow $100,000 to cover my cash needs while my top customer doesn’t pay its bills for a few months, my business is at risk if that customer ultimately goes bankrupt and doesn’t pay me what is owed. In that scenario, I’m the one stuck with $100,000 in debt, monthly principal and interest payments, and a significant loss in anticipated revenue. Now my business is only one small mishap away from not having the cash to make its next payroll or to pay a key supplier before that supplier cuts off delivery.
When a company can’t fund its payroll or a key supplier, the demise of that company can come quickly once employees stop coming to work or the supplies needed to fulfill the next job don’t arrive.
As is true with many of the discussions in this book, not all suggestions and rules apply to all businesses. Some businesses find a unique niche, such as a technology or software company. Their approach might be to borrow significant amounts of money to grow exponentially and sell the company for an enormous price in just a few years. Other businesses are never intended to become an entity that can outlive its owner, and the sole purpose of the business is to deliver all the profits in the company to the owner each quarter, leaving no excess in the company. A small business that is financially backed by a billionaire or wealthy investors may not need to protect against any downside risk because there are infinitely deep pockets to provide that kind of support. (I once saw on a company’s Balance Sheet that they had spent $100 million with no revenue. They were funded by investors to develop technology and build something innovative. A couple of years later, they sold that technology to a public company for $400 million.)
For most business owners, once the business gets beyond the initial challenges of its founding and has developed a recipe to bring in customers and become profitable, one of the strategic areas of focus should always be on making sure the business will still be viable in 10, 20, or 30 years. The closer any business moves from Level 2 to Level 4, the more that long-term focus needs to be an integral part of the strategic decision making.
When consideration of the long game of keeping the business alive indefinitely is regularly part of a company’s strategic approach, the decisions its managers make are likely to differ from those made when the focus is on the short term. Business owners who are mindful of the steps necessary to make sure their companies are still around in the decades to come are more likely to succeed in their endeavors than those who aren’t.
To some, this long-term, defensive approach might sound like the conservative rant of a CFO type rather than the aggressive attitude that comes more naturally to a sales-oriented CEO who wants to take over the world. I beg to differ. Consider the words of Bo Burlingham in his book Small Giants: Companies That Choose To Be Great Instead Of Big: “We all need a little accountant inside of us, saying, ‘Hey, asshole, what are you doing?’”
You already know that half of all businesses don’t make it past five years. The whole point of encouraging business owners to plan for the long game is to provide them with encouragement and wisdom so they can thrive rather than become just another statistic of failure. Do you think the businesses that fail within five years are the conservative ones that actively plan to protect themselves from downside risks, or the aggressive go-getters who think adding 15 percent to revenue this year is more important than building a firm foundation?