EP17 - Risky Business - Focus on risk related to Access to Capital.

I'm so glad you could join us today. I am the ESOP guy and let's continue on this journey to an ESOP. Now this podcast is really for those uh businesses or owners or or management that they're thinking that they might want to transition their company to an ESOP, whether that be for a growth strategy, a succession strate strategy or an exit plan, or a combination of all three of those. So if you're, if you're just joining today, and this is your first episode, and you have an interest in the other episodes of the podcast, please go to journey to an ESOP.com and you will find all those available to you. Now, for some companies, as of January and February of this year, they could have been on a pace to be, to have really a record year of all time. Um, many companies that I talked to, uh, did so well in January, the economy was really uh doing so well, but, um, we hit COVID as an economy and as a world, and everything really has changed, um, ever since then for the last month or two. So we're we're right now living in the midst of it. And that's really generated this idea today that I wanted to get into. This episode is called Risky Business. So every business, no matter how great, maybe how wonderful they have performed in the past, has uh risk, has business risk. Now, how do you as owners and managers of your, of your companies understand the risk of your business? You know, risk is quantifiable as a business valuator, it's quantifiable. Um, and affects the business valuation both from a positive and a negative standpoint. And so for companies that are on their way to sell to an ESOP or really any other buyer, this is a really important topic to understand and To really incorporate. This type of, of understanding into the way you manage your companies. So this episode is really all about better understanding specific business risk and being aware of not just understanding it, but really how to mitigate that risk. But this is such a big topic, we're really going to get into really one aspect of business risk and we're going to deal specifically with the risk of a company's access to capital. So what do they have available in capital sources? Now, to me, this resonates because right now we're dealing with, um, we're dealing with as a CPA firm with our clients, but we're dealing with this issue of who got the PPP loan and who did not get the PPP loan. And in some cases, this will be a differentiating factor that um would, would give one company more of a competitive advantage over another. That's certainly true. In some cases, this will be a differentiating factor as to whether that business is going to stay in business. So it's, it's very, very important and it's Something we never even heard of, you know, last year, the PPP loan, but the idea behind this is the risk of access to capital and how that affects your business. So if you like what you hear, please subscribe and share it with a friend. And also, I was gonna recommend, leave a review as well that'll help me and others um when they look at this podcast to determine whether or not they want to use it as a resource. Now The title Risky Business, first of all, I am not a uh a Tom Cruise lookalike and Um, if that's what you were thinking, and that's why I came up with the title of this, uh, podcast. You know, some people might say I look like him, and actually no one has ever said that to me, but I just kind of wanted to, to throw that out. I have, however, seen the movie, um, a long, long time ago. And let me summarize the movie because it's my title of the, of the podcast. There's a spoiled kid, high school kid who learns how to be an unethical business person. By having a huge party and leveraging this party to get himself into and admitted into Princeton University. So not exactly a lot of good stuff to build your life on. Not a lot of good business lessons really, to say the least. And really for me to base the podcast on it, on business risks, really not a lot of stuff there. Um, I just simply borrowed the title cause I liked it. Um, but I understand this though, as I connect the dots. Um, he does take a risk and it does pay off. A lot of times when I'm talking to a business owner, uh, you know, they, they, they know what that's, that's about, right? They, they have taken a risk in their business, and they have been rewarded for that risk in many cases when their business is successful. And so there's this idea about business risk, which kind of uh hovers at this surface level as, as we are risk takers, we're gonna and we're gonna be able to Uh, capitalize on that risk and get the reward behind, um, jumping out and making a, uh, you know, an investment or of, of, of what we're doing, our time and our capital. So it's the reward side that um when it's, when rewards are happening in our business, that really do they cover up the uh the the actual business risk or they, they hide it in some ways. So when we are making good money at business, we kind of forget how risk really works and, you know, really comes down to when stuff starts hitting the fan, or when things are not working out like over the last two months, then we realize, whoa. We really do have business risk. And so, when I start talking about this, um, you know, it's important to kind of like start talking on, and I'm really going into the bigger, uh, higher level, 30,000 ft level for a second as we, as we come down into the real topic of the podcast. So there's many, many risks and as business risks that that we deal with and as I'm not an insurance person and we, and we did a podcast interview with an, with an insurance person that analyzes risk. Um, when you look at, say, for instance, your, your building risk and how your uh building presents a risk to your business in terms of its size and capacity. Location risk, maybe you're located close to some dangerous, you know, situation where fires or hurricanes or tornadoes, maybe that's, that's a risk. Um, the human risk, the people that might do things in your business that will, will hurt the business. There's technology risks and, you know, one of those right now is just this idea everybody's working from home. Do we have the technology to, um, to keep our businesses going? You know, if your people weren't ready to work at home and they had to suddenly work at home, definitely a risk that that has impacted some companies in using, you know, new technology for the first time or using the cloud when they weren't there before. Uh, there's risks related to strategy, strategy risks. So, you know, as, as we look at, um, investing in research and development and, and developing a new product or new, new service and, and the related risk of that, of launching that, um, is strategy risk and how does that get interpreted. Um, and so kind of just covering some highlights of, of just high-level risk. Uh, one in particular that, that sticks out to me is the, you know, industry risk right now. When we look at some industries from COVID have been seriously hurt and really hurt bad. Um, we live close to the beach and, um, when we go out, my wife and I go out and have a, um, a date night, we'll go take, take some takeout and we go to the beach and we, but we look out on the ocean and there's a bunch of cruise ships parked out there. And I cannot imagine the amount of revenue that's being lost in the cruise industry right now. Now, 1 or 2 years ago, these industries, you know, the cruise ships, the, the, the hotels, hospitality, uh, they were being rewarded heavily for the risks that they took, um, in the marketplace. So they were doing really well and nobody would have foreseen any of this kind of thing. So the companies back then that were investing heavily in new cruise ships. Um, that were, were budgeting the, uh, the amount of revenue they needed to pay for those cruise ships. Obviously, that, that isn't, that is all of those risks coming together at once and it's really the perfect storm. So sitting there, you know, looking at these cruise ships thinking, wow, I cannot imagine how much losses that they're going to incur. During this time, it makes me think about how easily it is that we, when we look at, when we're looking at businesses that do really well when we're, we're doing well in our businesses, how easy it is for us to overlook things that are very important business risks, that's very important to address and identify. And how really important and essential this is. And it's kind of like, it only, it happens now when we wake up to, to the reality of things that, hey, if, if they could go back in time. Would those businesses um really focus in on a plan or and really the question here is, um, when times are good, should we be um proactively dealing with business risk really preventatively. And I think that's, and that's a real, that's a real focus topic, I think with this is that, um, you know, it sometimes it's too late to go back and and do that, but I think it is a lesson for all of us and every business, needs to have an ongoing effort to address business risk and deal with it proactively and reactively when there's some things we just can't do until it happens, but as much as we can proactively. So, for example, you know, if a company had been doing this, they may have diversified their portfolio of companies and acquired other companies that could hedge the revenue risk that they had in a down market. Um, so that might be, um, you know, a lesson, but there's many, many ways to mitigate risk. There's many ways to look at it, but you have to, the, the, the real part of this that I want to get, get past is, the real point of this is you have to address and continually address business risk as an ongoing issue in your business and continue to deal with that as you deal with other issues in your business as well. So as we, as we segue into the, the bigger concept of business risk and the idea of risk and reward, I want to get into the idea that behind for a company that's going towards an ESOP. And when we go over the very beginning step of doing an ESOP, what we are always going to do is build a valuation model upfront to understand the business risk of that, of that company. And that's going to obviously bring us to a place where we can estimate the evaluation range. But it really does identify areas um and ask, and, and it helps us and it helps the, the, the client to ask these specific questions about um areas of business risk that they may not have thought of. And I think that part of the process, you know, all of it to me is a very healthy part of the process of, of helping the company prepare not only for an ESOP, but to also prepare to be better at what they're doing and to uh continue to strengthen what they, what they have as a business. Um, really internally, but also, um, bringing that back into their, into their plan as well. So, the idea, one of the aspects of, of questions that we have is what, what is your access to capital. Um, over my career, I've helped thousands of companies in dealing with this issue. So the risk of access to capital really is the idea that, you know, companies that get access to capital have, um, and have access to capital have lower risk than companies that don't, and that's kind of the simple thing. It correlates to the companies. Ability to keep up with their, the growth of their business and, and certainly in a down market, um, companies that can sufficiently weather a downturn. So before I was working in a CPA firm or partner of a CPA firm, I was a commercial banker, and this is a long, long time ago and it's way after I saw the movie Risky Business, by the way. So back then, I had a client that had a great product, and based on their business model, The problem that they had is, is they had a great product, but they couldn't keep pace with the growth because they had so much every time they got a new contract, they had so much initial outlay of dollars at the front of each of the contracts that they had to buy more equipment for. And so they were kind of constantly chasing their tail from a cash flow standpoint to keep the pace of growth going that they needed. So the company's owner did not lack a work ethic or a commitment to the company or a passion or a vision or a desire to succeed and or great employees. He had all of those things. He lacked simply the cash he needed to keep pace with the cash requirement of his business model. And so he sacrificed everything he had, and I remember working, my job was as a banker was to work out the deal with the client so that the bank didn't lose money, and that's a difficult process to do. But he sacrificed everything he had. He put his, he mortgaged his house to the, to the hilt. He depleted his 401k plan. He sold everything he had outside of the business to make it work. And, you know, many times that really does, um, you know, not always lead to a good end of the story. Now, in this case, um, what I like about the story is actually has a, has a nice ending, um. Right at the end when everything was really, really bad, he had a huge public company come in and pay an unbelievable multiple because they identified this technology in the marketplace and they really liked it. And so instead of dying a pauper and, and having the worst life ever, he was able to really retire really well and um you know, such, and he sacrificed everything. So it's one of his greatest entrepreneurial stories of one of my, in my career and it's just, it's when I think about it though. What it, what it does though is it pulls together this access to capital risk, I think, probably better than anything else. And to see, you can have everything going right, but if you can't get the cash you need to fund the business, then things are not gonna go well. And that's when you start seeing the business risk, you know, rear its head at you, um, because it's, it's a difficult and a very hard time when you're trying to work through that process. So really wanna, I want to then look at, OK, so that's the issue is, is the business risk associated with the access to capital. And it's not as much about spending time to assess it, either you kind of know whether you have access to capital or not. Um, my first piece of advice in this is, number one is to build a forecast. And if you haven't checked out my Nostradamus podcast, it's all about forecasting. Uh, forecasting is an essential step on the way from, for a journey to an ESOP. And so you're gonna have to do it. We do it at the very front end of the work that we do because it's so, so material to and significant to your not only your evaluation. But everything kind of ties itself in that, in that forecast. And really the place that we start with is this idea behind what is your business, you know, first off, historic, we all know this, like historically, historical cash doesn't pay for future, future expenses, right? So, historical only gives us an idea of what you're gonna have going forward and it gives it some level of reasonableness and reliability. But what your business is gonna have going forward is really kind of the test of what the market is, is bearing. So right now the market is bearing very difficultly for some industries. So every business is going to need to start in this place of, uh, you need a strategic plan and you need to know strategically how you're going to get your business where it needs to go and what are you aiming at. Out of that strategic plan, you're going to be able to create a business plan. I mean, what are the elements of your business plan to execute strategically what you just created? But the forecast itself is the document that tells the financial story of your business plan. And so that it pulls that starts pulling it all together. So, so the advice is make sure you have your forecast built so that it can then develop out of that forecast, and this is really what we use it for for evaluation and for the planning for an ESOP is out of that, you can then build your cash flow model. And it's from your cash flow model that you can then prepare for um your, anything, anything that's gonna happen. It's out of the cash flow model that can, can help me to make a determination. How much cash am I gonna need to finance my business? And that's gonna be really important as you start building the partners you need to help your business grow. And as we start thinking about that is that is really the next piece of advice is Let's evaluate your banking relationships because they're a critical element of, of every business and My coming out of commercial banking, I mean, I, I, I, I've always seen this and going, and I've had the unique opportunity to go from commercial banking into the CPA world. As a commercial banker, I felt like I was always a pretty good advisor um to my clients. And in a CPA world though, we are, you know, in a terms of advisory, we're way more involved with our clients than the banks are. And I, and I really want to challenge that notion with, with business owners is trying to get your, your, uh your more your, your banker more involved than what you, and what you're doing. I think that's really important and I think that part of the industry of banking um has been hurt because of all the turnover, the, the, the owners' experience with their commercial bankers. I think that's definitely hurt, but I do believe there's an absolutely important role the banker plays as a source of advisory. And I think that my biggest thing in this is if you don't feel like you have a banker that has that skill set, I think you should find one because I think it's really important. Um, so when times are good, My, my advice for everybody is always invest in a good banking relationship. Get a line of credit when you don't need it, and this is easy to say now, but this is something that I think is, is critical. Um, it really is, you know, when you get a line of credit, and some companies have told me, I don't get, I don't use debt, don't use it if you don't need it, but have it available when things go wrong, but really have it available to fund this business plan that you, that you've created as well and help it, you know, bring that together in your cash flow model. Um, to, to not only, um, you know, make sure that you're, you're strategic about it, but you have the resources in place as access to capital to support your vision of and your growth plan of, of the company. So You know, one question I have in this for people that, that asked me about, what do I, what do I do? I want my banker to be an advisor, but um he's he or she's continuing moving to different banks. Um, and there's really two schools of thought here. When it comes to this question, I've known businesses that have stayed with you know, the institution, the banking institution, and Their banker that they had, you know, when we go on and, and they'll stay there. And then others have consistently moved their business with their banker. My, my answer to that question is, what should I do when my banker leaves is really because I think it's important to have this person. If you find a banker that you like, my, my opinion is that you should stay with that banker, um, because they're the ones, you build a long term relationship with the bank. With the banker. Now the banks are are wonderful institutions, but they don't always stay completely within the boundaries of what they set out to do. So they, they can change and they shift um in terms of the profile clients that they want. And sometimes when the economy changes, they may say, you know, I don't want that kind of business anymore. So my advice is try to find a banker you really like. If you don't have one, go find one, and stay with that banker and you're looking for them to invest in you and you and you to invest in them. The third, um, part of this is in terms of access to capital and trying to mitigate and improve your your sources of capital, is think outside of the box, you know, certainly nonconventional access to capital exists, it's existed for a long time. Um, I don't want to paint the picture that your bank is the only one that can provide financing or be a source of capital. There are many companies that have grown, high growth companies that have used non-conventional sources of capital. Um, it needs to work within your business plan and it needs to work within your financial models because it's way more expensive to use non-conventional, um, financing. However, um, in some cases when it really matches up with your strategy, then it, then it really works. Um, bankers are cash flow lenders. They're not necessarily, um, they want to be secured with good collateral. They're not necessarily looking to get a big return on that loan. And so, Um, in some cases, it's really relevant to have a non-conventional access to your capital. And look at multiple sources. One conversation I had just today with a client was, I'm so glad I had multiple relationships with different banks because I was able to get the PPP loan at another bank, not my primary bank, and I thought, wow, that's actually pretty good wisdom. And I know bankers are calling companies all the time, but have Have multiple relationships with banks, I think that makes a lot of sense, um, you know, so, so ultimately, the better you can build access to capital for your company, the more you're going to, to mitigate this risk from your business. And really, if I had to nail down the benefits of this in terms of mitigating the risk of access to capital, I'd say the first benefit is it's gonna improve your business valuation, hands down. Um, if you don't have access to capital, definitely hurt your business valuation. Secondly, and this is probably just gonna be so true for right now, it's gonna make your life better as a business owner. I mean, the type of peace of mind that you're gonna have. So many people over the last couple of weeks have stressed out so much over the PPP loan. Um, had they had that once they get the PPP loan, talk about peace of mind, they feel so much better. So, and then the third thing is, is it opens doors and possibilities of your business plans. So the more access to capital, the, the more you can think and think big as in terms of where your business needs to go, and you won't be boundaried by, well, I can only borrow a million dollars or $2 million as you build those resources for access to capital. And I think that the idea behind this benefit is, obviously, it takes the discipline to use debt in the right way. Companies that get in trouble and using debt in the wrong way, that's a whole different story. It needs to make sense in your business plan. If you're gonna try to grow and borrow this money, it needs to make sense, um, in how you're balancing all of that within your financial statement. So those are the benefits. I'm so glad you could join us today and, and deal with, you know, very important topic relative to uh business risk. Um, so I hope you find it helpful and, you know, as we go through this economy together. And your company is on this journey to an ESOP. Um, my hope is that these will be, this will be helpful for you in, uh, really shaping and helping your company go through the changes it needs to make. And so again, if you like what you hear on the podcast, please share it with a friend and subscribe, and we will see you next time.