Five fatal flaws of some unfortunate clients

Writing last month’s Chalkboard article“Five Disciplines of our Most Profitable Clients,” inevitably got me thinking about the darker days of being a CEDF business advisor.  It doesn’t happen often, but I’ve been the sad witness to a handful of business failures over the past five years. One might conclude that this is unavoidable for an organization with a mission of lending to small businesses that cannot obtain traditional bank financing. After all, banks have failed borrowers too and our clients are by definition riskier.  CEDF has an admirable success rate and we believe the involvement of our business advisory services program is an important element in our ability to reduce bad outcomes.

As I looked for common threads in the stories that didn’t turn out so well I found five recurring circumstances. Unlike the “Five Disciples” list, where most of the most profitable clients are doing all five admirable practices, it sometimes takes only one risky condition to sink a ship.

1. No ability to create credible financial reports. This is often the flip side of maintaining up-to-date bookkeeping but the kicker here is that sometimes up-to-date bookkeeping is up-to-date nonsense. If the bookkeeping consists of putting information into the wrong accounts it can be terribly unreliable and impossible to use to make informed business judgements. I also see many cases where the P&L appears OK, but when one looks at the balance sheet, it is clear that the accounting is a mess, which calls into question what’s on the income statement.

2. No time or willingness to learn.  Being a small business owner requires continual learning to adapt to the changing economy, changes in one’s own industry and the broader impacts of technology on one’s business, or even simply new methods of marketing.  A business owner who has no interest in wanting to learn, or perhaps one who is saddled with so much responsibility for production in the business that there’s no time left over to learn is at a serious disadvantage. Lacking the curiosity to stay on top of what’s happening in one’s own field can hardly be forgiven. Lacking the time to manage (because it is a management responsibility to seek and absorb crucial information to plan for the future) is a failure of prioritization.  If a business owner failed to learn QuickBooks, I have no stones to throw at them. But if they fail to outsource bookkeeping and fail to learn how to read and use financial statements, I think they are reckless.

3. Too dependent on the business for a living. You might raise your eyebrows at this contention because so many of us went into business as an alternative to employment, or because suitable employment was not easily available. I don’t mean that business owners can never rely on their operations for their own livelihood, simply that this raises the risk, the capital requirements and the performance requirements of the business substantially. Add a few young children to feed and the stakes get really high. When I read entrepreneurship articles urging that one prepare for a couple years of not making a profit, I shudder at the idea. I would not personally have the stomach for, say a tech venture, where I expected to be unprofitable for so long. But unspoken is that there are many much more conventional businesses that are capable of making a profit from month one – with a proviso. The owner can’t expect to prudently take any capital out of the business, and probably the operation won’t be capable of supporting an owner as a W-2 employee (given appropriate tax filings) for a substantial length of time. Months. Years.

4. Too dependent on a collaboration. I see cases where the business plan contemplates that two individuals will pool their talents and conquer their markets. It’s a noble idea and the classic success story of so many well-known stories in business. But the numbers of famed outcomes are far fewer than what usually happens. And that is circumstances change and a partner is no longer available, no longer willing to contribute or unexpectedly ineffective in the role they are called to fill. And the business can’t overcome this because it has no financial or organizational capability to outsource the now missing talents. Friends and spouses make wonderful business partners until they aren’t. I suppose you can’t say this about relatives because they are still related to you?

5. In too much of a hurry to prepare adequately. This might sound similar to the “unwilling to learn” flaw, but it is really about business planning and frequently about raising sufficient capital. Entrepreneurs are relentlessly positive people. So the question of “what will I do if X doesn’t work” seems to be asked infrequently. When it is articulated, the answer might be some sort of “nose to the grindstone, hope for the best, we’ll make it through” sentiment.  But what’s lacking is a real Plan B. Raising capital is tough, which is why small business owners end up at CEDF’s door. And while our lending process has check points dealing with capital contingencies, collateral, and alternative ways to service a loan, the reality of whether a business has raised sufficient capital to handle all essential operational needs stands alone.

As mentioned above, any one of these conditions can be enough to do in a business. A couple will surely cause a catastrophe. Three or more makes a perfect storm.

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