A Peak Inside the Boiler Room
I got another boiler room broker call today, so I guess the recent downturn has not flushed out all the cockroaches. A while back I discussed the frequent calls I get from boiler room stock promoters. The approach they use with me is this:
So the other day, I accidentally let one of them go further than I usually allow. He said he was from Olympia Asset Management. (There is an Olympia Asset Management web page, but I don't know if it is the same company and the web page has not been updated for several years.) I let him run for a bit because a friend of mine runs a very well-respected financial planning firm with a different name but also with Olympia in the title, and for a moment I thought it might have been one of his folks.
Anyway, he proceeds to try to convince me that we have talked before and discussed a certain security. "Remember me, we talked six months ago about ____". Of course, I had never heard of the guy. At this point I usually hang up, because I have heard this crap before -- it is a common pitch.
Its pretty clear to me now that this is what he is doing:
- Trying to imply that we have some kind of relationship we actually don't have. Or worse...
- Trying to convince me that he touted stock A six months ago, so now he can tell me stock A has gone up in price. Many reputable brokers built their reputation by cold calling people and saying: Watch these 3 stocks and see how they do and I will call you back in 6 months. That way, you can evaluate their stock picking without risk. The modern sleazy approach is to pick a stock that has gone up a lot in the last 6 months, and then call some harried business person and pretend you called them with that pick 6 months ago, hoping that they will give you the benefit of the doubt.
The call just went downhill from there. I hung up after his discussion of throwing Molotov cocktails into the cars of people he doesn't like. That was right after I asked him if Tony Soprano was standing beside him listening in on the call.
Anyway, beware. The guy today called me and asked me if I remembered him calling 6 months ago predicting the downturn in the mortgage market and the crash of the financial stocks. You are not crazy - no matter how certain the guy seems, you really did not talk to him 6 months ago.
By the way, I am not the only one getting this pitch. Ed Moed got the same pitch from the same script from the same company. Many of his commenters share similar experiences.
Update: Wow, they sure do like Mitt Romney over at Olympia Asset Management. I'm sure there was no arm-twisting here, when every single employee of the company seems to have given the max donation to the same candidate, with no breaking of ranks.
Update #2: Mike Murphy, CEO of Olympia Asset Management, was "a member of the [Hoffstra's] elite football team." Wow. Remember that time Hoffstra ripped through all those SEC teams? Yeah, neither do I. Anyway, this achievement does not hold a candle to the fact that I was once captain of Princeton Tower Club's elite intramural coed field hockey team.
Update on Corporate Compliance Minutes Scam
I got another one of those scam letters from a company that attempts to trick businesses into thinking their bill is actually a requirement of a state regulatory organization (original post here). This one is from the "Indiana Corporate Compliance Business Division." It looks like one of the millions of small fees a business actually does have to pay to state governments for all kinds of random stuff, but is actually a business solicitation. I will give this one credit - the font size at the bottom where they say this is a business solicitation and not a bill from a government agency is actually a size larger than similar language on the last one I received. (click to enlarge image below)
I did not take them up on their offer, so I do not know what one would get back, if anything, from them. It is indeed important to keep minutes books up to date. But I do know that the information they request in addition to the fee is not nearly enough to create a meaningful set of minutes for one's corporation, so my guess is it is a ripoff.
Small Business Credit
Reader Tim Allen writes:
I wanted you to consider that in a recent previous post you had mentioned that people are filling up their gas tanks before they previously would, and they are filling up all their other cars, and spare gas tanks because of the fear of not having enough necessary gas. This is a market reality and is completely rational considering the way the game's rules are set up (no gouging, as per the govt).I would like you to consider that I, as a small business man, maxed out all my lines of credit and deposited the money in my bank accounts. If fear is driving this market, and if it causes banks to dry up credit, I want to be the first to be tanked up on money, so-to-speak. The negotiated rate of interest is not high enough for me to be disinclined to borrow, at least until this credit storm blows over. I know I am not the first person to have this idea and I won't be the last, and we (together) will create the situation that you think can't happen. The tighter credit gets, the more people will borrow, if just to have the cash on hand, to not need to borrow in the future.
I have done the same thing. I am maxed on my line of credit, because the interest rate is low and I would rather have the money in hand and pay the interest rather than find out later my line is somehow revoked or frozen. The money is not needed for near term expenses, but I want to have resources in hand if the recession creates a business opportunity that requires funding. Does this worsen the near term crunch, the same way panic buying of gas worsens local gas shortages? Probably. And again, price is the key. Like with gas, I would rather rationing by price rather than shortage. In other words, I would rather my line of credit go up to a 15% interest rate, if that what it takes to put things in balance, than to be revoked entirely so a few businesses can still have 6% money.
I have never said that letting banks fail was without cost. I just think the cost is going to be there, one way or another, and the cheapest and quickest solution is to let the whole mess sort itself out.
By the way, the notion that small business lives on short term credit is a hoot. ExxonMobil may have access to the commercial paper market on short notice, but borrowing for our company, even in good times, generally takes a panzer division and a long war of attrition. Even layup deals have taken me 6 months or more to finance. Stephen Fairfax, via Mises, makes this point:
None of the small business owners I know depend upon easy credit to make their payroll. When things get to the point where you need to borrow to pay your employees, the end is near. Most small businesses fail in the first few years, in large part because business is not easy, it is hard. Not everyone is good at it. But it is an essential part of free trade and the market economy that businesses fail, so that new, better ones can arise in their place.
Few small businesses depend upon easy credit. Banks are generally reluctant to lend to small businesses, with good reason. Most small businesses are funded by owner's savings. Sometimes start-up money comes from loans by parents or friends. While I can understand that small businesses involved in building houses might profit from easy credit, the market is sending unmistakable signals that there are too many houses that are too expensive. Flooding the system with still more easy credit can't be the cure, it is the problem.
Business Biorythms Just Hit A Triple Low
People who say that bad things come in threes never ran a small business. Bad things can come in much larger, Costco-sized lots. Such is the case today in my own little corner of the American economy. Expect blogging to be light for a few days. Also, I may be slow to fix the RSS problem that has been reported. Sorry.
PS- The big lots of bad stuff seem to come just after one was thinking "gee, its kind of quiet around here, maybe I will take a day off this week..."
If I had to Summarize Entrepeneurship with One Observation
Working for someone else: Days are way too long.
Working for myself: Days are way too short.
When an Ivy League Degree is a Handicap
Why is it so much fun to hate Ivy Leaguers? In part, because they (well, we*) can often be so hateable. For years, I toyed with the idea of offering a prize to the first Harvard grad I met who did not, in the first ten minutes of conversation, manage to work that fact into the conversation somehow.
OK, I have a couple of Ivy League degrees, so now I have fallen into the trap as well. But I say that mainly to tell a story about running a small business.
Running a service business that is dispersed across many locations in 12 states, I cannot personally be on top of everything. Not even close. I depend on my employees taking the initiative to tell me when they think the company should be doing something differently or better. However, many of my employees do not have college degrees at all. This is not a problem for their job performance, as most have a lot of life experience and they do their jobs quite well. Unfortunately, if or when they find out I have a Harvard B-School degree, the very likely outcome is that they stop making suggestions. They make the assumption that because I have a more expensive piece of paper on my wall than they do, that I must know what I am doing. They are embarrassed to try to give me suggestions. Which is a crock.
I constantly have to hammer home two messages to my employees, both of which are hard to get people to believe despite the fact that they are true:
- Most of my employees do their job better than I would do their job. They tend to assume they are somehow an imperfect proxy for me, when in fact, because their skills and interests are different, they usually do what they do better than if I focused on the same job myself
- If the company is doing something stupid, it is probably not because I want it that way. It is probably because I am ignorant, either of the problem or of the better way to do it.
Startup Looking for Help
I know a gentleman named Alan Shapiro who has come up with what looks to me to be a nice new boat concept he calls the "Raptor". Pictures of the boat are below (click on any picture for larger image)
He knows how to design and build the boat and has pretty good contacts for selling it, but needs help from a CFO/Strategist/business-type to push the company forward. He has a prototype built and the production model fully costed-out and sourced. However, he is about to look for a new round of financing and need help in that process. He is offering equity in the company but can't pay a salary. The job would not be full-time in the beginning. If anyone has some time on their hands and has experience with startups and likes boating, this may be something to look into. I have helped him a little bit, but I am out of time and need to focus on my own business.
I do not in any way warrant whether this is a good opportunity or not. Don't assume that because Coyote seems like a smart guy, that this must be a viable business, because I just don't know. I have given him a bit of startup money in exchange for some future boats, and a bit of advice, but that is the extent of it. He has a draft business plan I am sure he would share with qualified candidates.
What I like about the product is that in the rental business, there really is a need for a personal watercraft or jetski that is enclosed, such that it will rent in colder waters and does not require renters to get out of their street clothes. If you know what a mouse boat is, these are much higher performance versions of that type product. He takes jetski engines, from 50-110HP, and puts them into this really fast hull shape. This boat is fun to drive (see the video linked above) and my opinion is that it would rent well, but I of course have not been able to prove that with actual boats. Alan believes there is also a strong market for individual sales, but I can't confirm or deny that from my own knowledge.
If you are interested, or know someone who might be, email me at the link on the right with some information about yourself and I will pass it on to Alan.
Communications are a Pain
It always happens this way.
Pick a random message: Let's say I want my folks at Matagorda to know that what they do is important. So I visit from time to time and tell them they are doing a great job. I will email them with the same message, emphasizing how important Matagorda is to the company. Each quarter I will compliment them on their results. I will show Matagorda in all my long-term strategy documents as one of our core operations. Every time I am on the phone with them I thank them for their had work at so important a facility.
And then one of our employee's mailman's wife's gynecologist's dog's veterinarian's receptionist might say at a social gathering that she heard our company was leaving Matagorda and the next day I will have 8 people emailing me to ask me why I was about to fire everyone and, further, how mad they were to hear about it second hand.
Sometimes I want to just give up.
Privatizing Public Recreation
A bit over five years ago, I wrote an op-ed piece in our local paper calling for further privatization of public recreation. The editorial was in response to a proposal for a large bond issue to rebuild recreation infrastructure. I argued that the state should instead be focusing on attracting private investment. Not only was there more money for recreation in private hands than public, but I sensed that private funds would more likely be invested in facilities the public really wanted, rather than goofy politically correct projects. Further, private operators could operate recreation facilities much less expensively, in part because they are not tied to ridiculous public pay scales, pension plans, and job classifications.
Soon after, I had a business broker call me and ask me if I wanted to put my money (such that it was) and time where my mouth was. After a lot of twists and turns, I ended up the owner of a recreation concession company. In a recreation concession, a private operator pays the government rent in exchange for the ability to charge visitor fees and run the recreation facility for profit. In most cases, our company can operate a property and make a profit on fees lower than the government must charge just to break even.
My business, Recreation Resource Management, has prospered since then. And as I have gotten deeper into public recreation, what I have learned has only confirmed what I wrote in that editorial. I have seen that when the government runs recreation facilities, it almost never spends enough money on capital maintenance and refurbishment. The reason seems to be that legislators, given the choice, would much rather spend $X on a shiny new facility they can publicize to their constituents than spend $X maintaining facilities that already exist. I laugh when I here progressives argue that private industry is too short-term focused and only the government invests for the long-term. In practice, I find exactly the opposite is true. Think about hotels, or gas stations, or grocery stores. Private businesses understand that every 15-20 years, they need to practically rebuild existing infrastructure from scratch to keep them fresh for customers. This kind of reinvestment almost never happens in public recreation.
Except this week!
After years of building up our business, we just completed a project with California State Parks that is what I have always wanted to achieve with the company. At McArthur-Burney Falls State Park, California State Parks had an aging concession store and an outdated section of the campground that it really did not have the money to rehabilitate (by the way, this is an absolutely beautiful park -- I highly recommend it). We crafted a two-part lease with the state which eventually led to us investing over a million dollars in the park: In phase one, we built a new concession store (old store on left, our new store on right):
In phase two, just complete, we took an old tent-camping loop with no utilities and added 24 new cabins. These cabins not only refurbish an aging and dated section of the campground, but they also add new amenities to the park to attract visitors who may not own an RV and who don't want to sleep in a tent. In addition, since they are insulated and heated, these cabins will extend the camping season -- in fact, we already have a number of reservations for Thanksgiving, a time when no one would have wanted to tent camp here.
So, in answer to the question I so often get, "why does a libertarian run a company that works with the government?" Now you know why. I will admit that from time to time I find myself on the losing end of libertarian-intellectual-purity debates because I choose this path rather than, say, living in a cabin in the wilderness and manufacturing rifle barrels for a living. *Shrug*
Postscript: One lesson I have also learned is that state governments are not always a monolith. Texas and Florida, for example, while being beloved of libertarians for having no state income tax, can be horribly bureaucratic in certain areas (e.g. sales tax reporting and vehicle registrations). California, on the other hand, which in many ways is one of the worst states to do business in, actually has what is probably the most innovative and business-friendly state parks organization in the country. Go figure.
PS#2: By the way, the cabins shown are actually modular buildings, built here in Phoenix by Cavco, and shipped to the site. The classy interior work was done my by maintenance supervisor.
Lileks, Power Tools, Movies. What More Could You Want?
One of my favorite bloggers, TJIC, also runs a business called SmartFlix which has an enormous collection of instructional videos, from crafts to outdoors to home improvement, all for rent. Most of these niche videos are incredibly helpful, but are almost impossible to find anywhere else.
Anyway, TJIC apparently wrote James Lileks, a really fun-to-read columnist and author, with the following come-on:
We send you a video. You watch it, or watch 10 minutes of it, or don’t watch it at all.
Then you write something, which might be a review, or might barely mention the video at all. For example, a short review on a video that instructs one on how to play pool might mention the fact that you watched 10 minutes of the video, and then segue onto a story about you playing pool 15 years ago with The Giant Swede…
In short, I propose a business relationship where you do whatever the heck you want to.
Royally Bad Day
Small business tip of the day: If you find yourself waking up on Monday, thinking that you have finally climbed on top of things and everything is humming pretty well, expect a torpedo to hit you. Maybe several.
The red lights are all flashing here and the bulkheads are leaking. Blogging will be light for a couple of days, while damage control progresses.
Viva Las Vegas!
There are probably a lot of reasons out there to criticize Las Vegas, but one thing it is great for is that it is perhaps the best and least expensive place in the country for a small business like mine to put on a national managers meeting.
We bring 60 managers in from all over the country. We held our event at a hotel/casino a mile or two off the strip called the Orleans, where two years running we have gotten nice clean rooms and great service. Beyond the good service and more-than-acceptable rooms, we get:
- $60 room rates for mini-suites
- Two days of lunches, breakfasts, snacks, coffee, an open bar with appetizers, and a meeting room all for less than $100 per person
- Bar none, the best airline connections of any destination city except maybe Chicago, and they are all cheap (lots of America West and Southwest flights)
On top of all this, my people love it there. Anyone running a national meeting on a budget should definitely consider it.
Sometimes entrepreneurs are successful enough to buy themselves sexy toys: It may just be a nice pool table for the office, or it might be that new Gulfstream jet bought with the IPO proceeds. But little did I know that entrepreneurial success would allow me to buy this beauty (click to enlarge):
This septic tank truck can really haul a load, carrying over 3800 gallons of, uh, poop.
We have a new facility at Pyramid Lake we run in LA County, where, due to its location, all the bathrooms run into series of underground holding tanks. At some point in the past, someone converted all the bathrooms into flush toilets, which in this area makes for a real waste of water and creates a lot of liquid waste we have to pump out and dispose of, at the cost of over $80,000 a year. This truck is the intermediate solution, letting us cut our pumpong costs in half. The long-term solution we are working with the US Forest Service on is to replace the bathrooms with a great composting technology from Bio-Sun, which will cut the waste and water use both to near zero.
How to Get an SBA Loan
I recently went through the process of obtaining an SBA (Small Business Administration) loan. These are loans that are what I call "cash flow" loans, secured more by the companies earnings rather than collateral (though collateral may be required, see below). SBA loans are written by private banks to standards set by the government. If these standards are met, then bank loans under this program get a partial guarantee from the US government.
Before I go on to describe the process, I feel compelled to note that as a libertarian who does not believe the SBA should even exist and who believes that such loan guarantees are a subsidy program that should be eliminated, I was obviously conflicted by whether to seek out such a loan. What finally made the decision for me is that this government program has crowded out all other private options. Banks get about the same rate for an SBA loan as they would for a commercial loan without the guarantee. Since the guarantee is out there and doesn't cost the bank anything, the bank has no reason not to insist on it? Therefore, as a small company in the SBA size range, there just are not any banks willing to lend without the SBA guarantee. This does not mean that in a free market without the SBA there would be no loans - it just means that when such a free subsidy program exists, banks are going to take it.
Types of Loans
The following is a gross simplification, but for a small company, there are basically two types of loans: secured loans and cash flow loans. Secured loans are by far the most common for small businesses. I, like nearly every entrepreneur I know, have had to pledge my house at various times as collateral for loans. While it is fairly easy in today's market for a small company to get an equipment loan (typically lease-finance of a purchase) secured by hard assets, few lenders will provide loans for general business and working capital needs unless they are secured by something tangible -- homes, vehicles, receivables, etc.
However, most businesses need capital for more things than just to buy hard goods. Seasonal businesses may need loans to pay the rent in off-seasons, retail businesses need money to grow inventory and pre-pay for new leases, while opening new divisions may require paying salaries well in advance of first revenues. Unfortunately, most businesses that claim to be business banks have no desire or talent to understand a business well enough to make a cash flow loan. I am not talking about just Ethyl's Bank, but large banks like Bank of America and Wells Fargo who were stumped when I wanted to discuss some unique financing needs in my business. I know people with a half million dollars a year in free cash flow out of their business who have trouble getting bankers to make unsecured cash flow loans. And, as mentioned above, those who do make cash flow loans typically insist on having the SBA guarantee.
How an SBA Loan Works
I will not pretend to be an expert on all the intricacies and rules. The SBA has a number of programs, offering loans of different lengths of time and for different purposes. The SBA has programs for both revolving lines of credit as well as standard 10-15 year loans. Each of these programs has different under-writing criteria, fees, and limitations, which your banker will have to explain to you. Most SBA loans, including mine, fall under the section 7(a) program. The SBA site tries to explain some of this.
As stated in the intro, an SBA 7(a) loan actually is issued by a bank, but to SBA underwriting criteria and with an SBA guarantee. The SBA only guarantees a portion of the loan, something like 50-75% depending on the exact loan type, with the bank taking the rest of the risk. These loans are issued at a floating rate of prime plus a percentage, and the SBA has rules that caps the rates as well as fees the bank can charge. The SBA charges a substantial fee, in the 2-3% of total loan value, up front to the borrower for the guarantee.
Banks participate in the program in one of two ways. Most any bank can originate an SBA loan, collecting all the (very substantial) paperwork needed by the SBA and forwarding it to the SBA for approval. In addition to the underwriting time at the bank, the SBA can take many weeks to complete this analysis. A smaller subset of banks have been pre-approved by the SBA to act as their underwriting agent - called a preferred lender or PLP. This means that they can do the SBA's analysis for them. This often greatly accelerates the process. My total time form the bank's first data request to the final loan closing was less than a month, which is very fast.
Choosing the Bank is Critical
From the section above, it should be obvious that you should strongly consider working through a bank that has the preferred lender status with the SBA. Note that having or not having this status does not necessarily correlate with bank size. The "expert" I was hooked up with at Bank of America (my main bank) was useless, and told me in so many words that it would be impossible for me to ever get an SBA loan. I ended up working with Silver State Bank, a relatively new business bank out of Nevada. They had the whole process automated, and when combined with a very knowledgeable banker on the front end named Jerry Woods here in Phoenix, the process was as smooth as silk and very, very fast. In fact, I got the whole loan done in less time than it took BofA two years ago to do my line of credit.
Costs and Other Considerations
SBA loans are not cheap, and I would strongly urge you to pursue secured asset-backed loans as far as you can. My total fees, including the cost of the guarantee, ran to about 3% of the total loan value. In addition, I STILL had to put up collateral to back the non-guaranteed portion of the loan. In retrospect, I think I did a bad job of negotiating with my banker on this. No matter how good they are, bankers are still bankers and are going to attach every asset that can sit still for collateral whether they really need it or not. I should have pushed back harder on this issue. Overall, though, I am excited that I now have the capital to continue to grow my business.
PS- If you want to enjoy some of this capital at work, come to Lake Havasu and rent a jet ski for a day! All those other entrepreneurs out there are investing money in dead-end stuff like microchips and improved manufacturing -- Ha! There is nothing like being able to tear around a big lake on 110HP to really make America competitive!
Whats on My Desk
The original purpose of this blog was to pass on my experiences and lessons-learned running a small business. Over time, though, since I have the attention span of an 8-year-old boy mainlining Hershey bars, I have gone many different places with this blog, well beyond day-to-day experience of a small business.
However, today I will return to this original goal, at least for one post, by asking the question "what's on my desk this morning?" I tackle this question for two reasons. First, it is interesting to compare how different the issues I struggle with day-to-day are as compared to my previous life as an executive at several Fortune 50 companies. I am sure I did more, but all I can remember from my daily activities at large companies seems to involve either working on PowerPoint presentations or traveling to give them to somebody. The second reason for visiting the contents of my desk is to reinforce my usual libertarian political points, which I think will be made sufficiently obvious just in the description of my to-do list that I won't need to editorialize further.
So here is what's got to get done today [ed note -- while published on Sunday, this is based on my worklist on Friday morning, May 13.]
- Sales tax returns have to be completed, which I usually do myself. We file monthly returns in six states, but one of those is Florida, where we have to file multiple returns county by county. This month I also must complete a lodging tax return for two counties. If it was the end of the quarter, an additional three state returns and two county returns would be due.
- We are nearly completed with a sales tax audit from Washington state. I have written before how complicated the WA sales tax return is, but the funny part was seeing a trained tax accountant from the state of Washington sit in my office for nearly 6 hours and still not be able to figure out how much tax I owed. She kept encountering crazy exceptions like "such-and-such county requires 2% lodging tax unless the facility has more than 63 rooms or campsites and then it owes 50 cents per room-night except if it is in the Seattle convention district where it owes an additional .25% or if it is on a metro bus line where ... etc." When tax law is too complicated for the paid employees of the tax department to figure out, it is too complicated. Wonder of wonders, though, we may get a refund!
- Also sitting on my desk from Washington is a notice that I did not pay my leasehold excise tax last year. For those who don't know what that is, it is a way that states like WA and CA effectively charge property tax on the US government, evading the federal rules against such (basically, I have to pay the tax for the Feds, and then I take it out of the rent I bid to the Feds). Actually, though, I did pay it. Well in advance of the due date. The state has spent the last 2 weeks trying to decipher their own records, and so I need to call them back today to see if they have figured everything out yet.
- The department of Health in one California county is holding up my building approval because the condensate line from a refrigerator condenser coil runs out and drips fresh water on the ground (about a gallon a day). If you have an air-conditioning system at your home, it is very very likely your air conditioning condenser does the same thing. Unfortunately, the county wants this to run into the sewage system. Why the county wants extra load on the sewer system, I don't know, but fortunately my builder caught this early so the change won't cost us much money.
- Speaking of inspections, the ADA inspector at another California facility ruled yesterday that our sales counter was an inch too high and our ramp a half-degree too steep to the front door, so I spent part of this morning already getting the original contractor out there to tear these improvements out and redo them. Interestingly, we previously had the bathroom that was originally in this modular building ripped out, because it could not be made ADA compliant. This was not a big headache for our employees, because there is a public bathroom building next door. However, the local health inspector is now reluctant to approve the building because... it has no bathroom and hand-wash sink. The only food we sell is packaged (think Twinkies) but some health inspectors still want you to follow the same requirements as if you were a restaurant. I am not sure how we are going to resolve this.
- I just got a call from a customer who was mad that the county Sheriff would not respond to several complaints about drunk and disorderly conduct in the early morning hours at one of our campgrounds. A few of our campgrounds, like this one, are too small to justify a live-on-site staff, and the rowdies seem to get the word out which campgrounds do not have on-site security. I promised the customer a refund, and made a note to myself to talk to our manager about having one of our employees come by a few times in the night on a security sweep.
- I have a meeting at 3:00 to meet with my accountant to finish up our income taxes. Since we have to file a federal, 9 state, and a number of county tax returns, our total company return fills two 3-inch binders. Today we are trying to sort out the depreciation schedule, which in and of itself is hundreds of pages long given that we have so many small assets.
- We are still trying to get a liquor license approved for our store on Lake Havasu. The whole liquor license process is one of those funny holdovers. Coming out of prohibition, most states wrote tough procedures to make sure that the organized crime figures who control liquor during prohibition did not receive licenses. As a result, to get a license, my wife and I and my managers have to be finger-printed and have FBI background checks. The applications tend to be long and tedious and small errors cause the application to be returned for corrections. Worse, though, I have found that many towns use the licensing process as an anti-competitive protection for incumbents. In California, if a County is "over its limit" (set fairly arbitrarily) in terms of licenses, it requires the county board of supervisors to meet and approve the new license. In one California county I was told that this was really for my protection - they are protecting me from getting my business in a situation where I might fail due to too much competition. Anyway, I suspect that the strong powers-that-be in Lake Havasu City may be holding up our license, and I need to try to figure out what is going on,though I am not sure how to go about it.
- While I have been writing this, I got a call from a county DA in Arizona. Most states have bad check programs where, if you have a bounced check and can't collect, you turn it over to the courts and they seek collection. In extreme cases, they will arrest and try the offender. I have never been entirely comfortable with this situation. Sure, bounced checks irritate the heck out of me, but arresting people for a $20 bounced check feels like sending someone to a Victorian debtors prison. This morning, I spent about 30 minutes trying to talk the DA out of prosecuting the heck out of some guy who claims that he paid us and we lost his check. I give his story about a 30% possibility, but whatever is the case I have no desire to prosecute the guy. The DA's blood is up, so it takes me a while to talk him out of it. I am adding to my worklist something I have put off for a while, which is to investigate 3rd party NSF check collection.
- My bank just called and still needs yet more paperwork before they can complete an equipment financial loan. AAARRRRGGGG.
- I just finished my annual rant with Arizona Game and Fish about fishing licenses. We sell fishing licenses at a number of locations. We only sell fishing licenses, we don't sell hunting licenses or duck stamps or all kinds of other special licenses that the state seems to sell. Unfortunately, if you are a Game and Fish registered license seller, you can't get just fishing license inventory from them. You have to take their full range of licenses, which they send you piles of in January. We take all this stuff we don't want to sell and put it in the safe, and hope that we can keep track of it for the next 12 months. If we somehow misplace anything and don't return it the following year, we pay for it (and some of those stamps and licenses cost hundreds of dollars). Many of you will recognize that this practice of the state government would in many situations be illegal for a private company. There are many laws out there that limit a manufacturers ability to force a retailer to carry their full line of inventory, or worse, their ability to send the stores a bunch of inventory they did not order.
- I have been putting off registering our 15+ trucks in Washington, but I am going to have to get to it today or this weekend. Last year Washington passed a law that vehicles had to be registered with an in-state physical address (no PO Box). I am not sure if this is a tax or terrorism thing, but it is obviously awkward for an out of state corporation, so they have finally relented a bit and said that you can still have to have an in-state physical address but they will mail paperwork to an out of state address. I or my assistant will need to spend a couple of hours soon typing in two addresses each on all these vehicles before we can register them.
There are a million other things going on, but that is what is burning me up today. In fact, since I have been spending the last hour writing this post, these tasks will probably also be occupying me this weekend. An alien from another planet in reading this post might question whether I am really working for myself or this "government" entity.
My Most and Least Favorite Business Activity
In the span of one hour this morning, I got to "enjoy" both my most and least favorite business activity.
My least favorite activity is always paying taxes, but within that broad category (remember that being in 10 states and 25 counties means that I file over 50 different tax returns or one sort or another every year) my least least favorite are business property tax returns. If you have not run a small business, you may not be aware of what a pain these are (individuals don't have to file them, and large companies have poor schleps in accounting to do it).
First, business property tax statements usually have to be filed by county, so I have to do a zillion of them. Second, governments require that you report every year and in great detail on essentially every asset your business owns in a state or county. A business must report these assets, usually with a description, date purchased, original purchase price and estimate current market value. Imagine as an individual if you had to report this information on everything in your house - furniture, computers, appliances, tools, etc. Now imagine doing it for a business, which owns a lot more miscellaneous stuff than you have in your house.
What really irritates me is that filing some of these statements requires the person filling out the statement to take a chance. Clearly, no one is going to list every asset, down to the last pencil and paper clip -- you are going to establish some reasonable cutoff, and group similar assets into catch-alls like "miscellaneous tools" or "office supplies". Note however, that this is taking a chance: In counties that require detailed asset listings, there is never any statutory language like "you can ignore items under $100 as de minimis" or "you can group similar items". Technically, you are supposed to list them all. Take my word for it, this is very, very tedious.
But wait, as the Ginsu knife guy would say, for our business there is more aggravation. We do business as a concession holder on federal lands. For example, we might run a US Forest Service campground. By US law, states and counties may not charge the US government property taxes on these facilities. BUT, certain of the most acquisitive states, including California and Washington, have devised taxes that get around this requirement. These two states make me pay the federal government's property taxes for them at the facilities I operate. This is kind of like being forced by law to pay your landlord's taxes for him. I always find this terribly irritating, all the more so since now that I know the game, when time comes to bid on concessions in these states, I just subtract the estimated taxes from what I am willing to pay the government in rent, in effect ensuring that the US government ends up paying the tax.
This whole enterprise left me feeling depressed, when a couple who I had called about a manager position at a new store concession of ours at Clear Lake State Park in California called me back. It turned out this couple is incredibly entrepreneurial, has great business experience, and are very well-suited to running my operation with minimal supervision. I was thrilled to find them, and they were in turn thrilled to find an outdoor summer job opportunity in a nice location which could be flexible enough to accommodate a person with a disability (one of the couple has Parkinsons). There is NOTHING I enjoy more than finding great people to work for me, and finding such people is all the sweeter if I can offer them an opportunity that uniquely fits their own needs.
Ups and Downs of a Small Business
Running a small business can be quite "interesting". Last summer we dealt with 4 hurricanes that shut down our Florida operations for over a month. This winter we have had great success winning new contracts, including one we are very excited about at Pyramid Lake, California. We got all our investments made to support this contract, got all the necessary staff on payroll, and wham, a local pipeline company spills over 100,000 gallons of crude oil into the lake and it is now closed for weeks, with a substantial loss of revenue in prime spring boating season. Sigh.
Financing Small Business Growth
Then, there are the banks. From my experience, it is very, very difficult to get a bank to make an collateralized loan - i.e. a loan that is secured only by the cash flow of a company rather than by assets. In fact, I have never been successful at that. About the only way that I have found that banks will make a loan is if it is an SBA loan, where the SBA basically guarantees the loan for the bank. The SBA goes through cycles of being very open to lending to being very tight. I have not dealt with them for over two years, so I don't know what their stance is today. Remember, though, that the SBA is not going to approve any loan where the buyer has no experience in the industry or where the buyer is not putting down his own money as well. The SBA has a lot of information here.
This statement is still mostly true but I have learned a lot over the last couple of months. The following is an update.
One of the things they tell you all the time in business school, but frankly I always found impossible to really internalize, was how much cash growth takes. I guess I always thought of businesses with cash flow problems as being unsuccessful, slowly sliding down the drain and trying to make ends meet. Wrong. Growth is tremendously expensive. And stressful.
My business is based on concession contracts. Each winter, we are usually presented with the opportunity to bid on many contracts. We narrow the field down to 4-6 we bid on, hoping to win about 2. One of the things I did last year was greatly improve our standard bid materials, hoping that would help us win good projects. Did it ever. We bid on 6 last year and we won 6 (including Burney Falls, Pyramid Lake, and Lake Havasu). Yea! But then I began adding up all the investments in new inventory, new equipment, salary (you always have to hire people before the first revenues come in), licenses, building improvements, etc. Eeek!
After a lot of work with bankers, I stand by most of my statement above. Most bankers will not lend to businesses on cash flow, and always want some type of collateral (like my home equity). Over time, though, I have found a few bankers who are willing to lend on cash flow and really understand business growth and why maybe I don't want to have my business's growth rate limited by how much equity I have in my personal home. There are bankers who will put together packages of long-term loans backed by the SBA plus short term working capital loans that will now let me grow faster. The folks at Copper Star Bank, for example, have been great.
One of the reasons I felt the need to post this update is that I have been told that my difficulty finding a good business banker was due in part to my location here in Phoenix. The Phoenix banking market is very real estate driven, so bankers usually come from that background rather than a business background. I am told that those of you on the east coast or in the Midwest may have an easier time finding good business bankers.
Postscript: By the way, you might ask how I feel as a small government libertarian about accepting the government subsidy implicit in an SBA loan. The answer is "conflicted". Some libertarians are fine accepting government services, on the theory that they certainly have paid for them with all their taxes. Some try to avoid government services, but that is almost impossible in today's world (such as using government roads). I generally try to be pragmatic, operating somewhere in the middle.
As far as SBA loans go - I don't know what the commercial banking world would look like without SBA loans. I think that the banking world would have found an alternative way to mitigate the risk (e.g. via securitization) without the government gaurantee, but we can't know. The fact is that SBA gaurantees exist and banks would be crazy not to use the gaurantees in making business loans. So, the reality is, if I want a cash flow based loan for a company my size, it will likely carry the SBA gaurantee. My appologies to all those whose taxes support my loan gaurantee.
Hey, this may be a first -- audit blogging. I have an auditor from the Washington Department of Revenue in my office right now auditing my last two years sales tax returns. She's a nice lady and so far the interaction has been pleasant.
Here is the funny thing - she has spent about 3 hours now trying to figure out what tax rates should apply at my various locations, and she is still at it. I have written several times about the complexity of WA state sales tax variations for lodging, and how they vary by geography (here and here). OK, if your experienced auditor has to spend hours in frustration trying to figure out what tax applies, the system is too complicated.
Update: At halftime I am ahead, with WA owing me $800. Stay tuned.
UPDATE #2: Small potential setback in the 3rd quarter. Several years ago I shifted assets (vehicles) I had bought in Arizona and used for years in Arizona to Washington for operations there. The auditor suggested I may owe use tax on the vehicles in WA. Huh? Use tax drives me up a tree in general, but this seems really crazy. WA is hyper sensitive to this issue because they have high sales taxes and very high vehicle registration fees and neighboring Oregon has not sales tax and lower registration fees.
Don't Get Hung Up on the Degrees
Last Thursday I spoke at the the Phoenix Enterprise Network about buying your own business, a topic I discuss in more depth here. The audience was pretty full, not for me, but in expectation of Sharon Lechter of Rich Dad, Poor Dad fame. Since Ms. Lechter and her partner Robert Kiyosaki have become the chief evangelists of starting your own business, a lot of people were there who were interested in that topic.
I found that for at least one reason, I was probably the wrong person to speak at this function. Many people in the audience seemed fixated on my Harvard MBA and felt intimidated that somehow they were under-qualified or undereducated to be entrepreneurs.
I tried as hard as I could to convince folks that everything I learned at Harvard was virtually useless for running a small business. I told them (truthfully) that my Harvard diploma hangs in my laundry room, since that was the only thing I really learned to do well at school. I emphasized that knowledge and passion about the business you want to start is much more important, and that everything else could be learned. Night courses in certain areas could help, and I would focus on two areas:
- accounting: it is always good to know accounting. It is never good to entirely trust someone else with the books.
- marketing and competitive advantage: the one "framework" that still serves me well from my MBA is that I never look at an idea or business without asking what I am going to do with it that is different than competitors.
In reality, the Harvard sheepskin on my wall actually hurts me running a small business as often as it helps me. For example, many of my employees when they first work for me seem intimidated by the degree, and assume I must know everything and therefore they are afraid to raise concerns or share ideas. Any of my managers who read this will probably laugh, because most have gotten some version of my speech on this topic:
DO NOT assume Warren has a secret plan or brilliant idea on any subject that he has not told you yet. Assume that if you have not heard from Warren on a topic, he either has no clue there is an issue at all or else he has no idea what to do. Therefore, do what you think needs to be done, and call Warren if you need help.
By the way, if you are in the Phoenix area, the Enterprise Network not only has one of those exceedingly rare and valuable two-letter URL's, but it is a great group if you are an entrepreneur or you business sells to entrepreneurs.
There's Always an Entrepreneur Smarter Than You Are
It's called Kona Nigari, comes from 2,000 feet down off the coast of Hawaii, and it's bottled by Hawaii Deep Marine.
Kona Nigari is a seawater mineral concentrate you mix with regular water. You can buy some at the Key of Life store in the Royal Hawaiian Shopping Center in Honolulu.
As always with expensive weird shit, the Japanese are driving the market. They can't drink it fast enough.
They are apparently selling 80,000 2 oz. bottles A DAY to Japan, with each bottle going for $33.50. Wow.
Directory Listing Checks are the Worst Non-Internet Scam
I don't know if you get these, but about twice a month we get what looks like a refund check in the mail, usually for a couple of dollars and change, from some yellow pages company. Today we got one from "Directory Billing, LLC" for $3.25. We get a lot of small checks for pay phone and ATM commissions, NSF check refunds, etc, so sometimes these almost slip through - be VERY careful.
Why? Well, the check looks all normal and innocuous, but in tiny grey lettering in the background of the endorsement section on the back, there is a lot of legal verbiage that amounts to the following "by endorsing and cashing this check, you are signing up for a directory listing in some random yellow pages you never heard of for some god-awful amount of money which we will bill later".
Services May Be an Exception to the Declining Power of Brands
Marginal Revolution cites a James Surowiecki article on branding, arguing that increased information flow, particularly over the Internet, is reducing the power of brands. This seems right to me. Brands exist and command premiums for many reasons. One role of brands is that they serve to reduce risk - without any other information about a product, many people would likely assume an electronics product from Sony to be more trustworthy than a no-name brand with the same features, and might be willing to pay a premium for the Sony product. However, with all the review information on the Internet, people may be more comfortable buying the off-brand, if it has good reviews, and saving the Sony premium.
Of course, brands serve some communication roles that are likely not threatened by the Internet. For example, high end brands like Prada or Gucci have power because they allow the owner to communicate things about themselves to others.
I would argue that, even with Internet reviews, brands will continue to be powerful in the service sector. In fact, with the growing complexity of some service offerings and the increasingly high standards of consumers, they may be more important. Why? Consistent product quality is much easier than consistent service quality. A no-name product maker can get high quality product all over the world from one single factory -- all they have to do is to get that one location right. This is much easier to do than with McDonalds, where there are thousands of locations, or even in our business, where we have hundreds of locations. Service quality happens in real time, often in many dispersed locations miles away from supervision and the management staff.
Also, in many cases, service failures are more critical and are harder to correct than product failures. If my printer does not work, I get mad and box it up and return it for a new one. But what happens if FedEx fails me on a critical shipment? Or worse, what if United Airlines fails on me mid-flight?
An interesting way to prove this is to go to a site like epinions. Service reviews are generally much more variable than product reviews. Compare Fedex, who's review is a mix of the lowest and highest scores, with this Apple Ipod, where reviews are much more consistent. Even when products get a mix of low and high scores, often the low scores are driven by service and support and not the product itself. In positioning their brand today, does Dell emphasize the product or their service around the product?
Favorite Fiction Book about Business
First, I will say there are no books out there about what business is really like, probably because reality can be pretty grim -- I don't think that people would be hanging on the edge of their seat reading about a manager arguing with the Department of Labor about a fine for his minimum wage poster not being in the right location. Maybe if Dave Berry wrote it.
Anyway, most fiction that involves a business is either about some rapacious capitalist who is stealing or killing or destroying the environment or whatever or it is a sort of Machiavellian opera ala Dallas or Dynasty. Few actually portray a business leader as a hero.
For business people that are heroic and multi-dimensional, and exempting Atlas Shrugged as in a class by itself, I recommend James Clavell's Noble House. This zillion page book covers but 8 days of time in early 1960's Hong Kong, but is epic none-the-less. I just finished reading it a second time and I enjoyed it even more than the first time.
Feeling Guilty About Employee References
I am feeling a little guilty tonight. I just dumped a pain in the butt troublesome employee on another company. Without warning. Specifically, we fired him a couple of weeks ago, for a variety of issues, but mentioned no negative information in his reference check from his new employer. Here's why.
It has become dangerous to give out negative references. Ex-employees have become increasingly succesful at suing employers for bad references. I don't have to tell any small business owners that lazy, incompetent, unreliable, whining, trouble-making employees never believe that they are lazy, incompetent, unreliable, whining, or trouble-making. You give them a negative reference, and before you know it they are in front of a jury saying "I never did any of those things, that employer was just biased against me, that's why he fired me and then tried to get revenge on me by lying to all these other companies and blackballing me from getting a job to feed my family". Now, you are stuck trying to prove in a court of law that the reasons for termination, and what you said in the reference check, are valid. It's always good to document these situations well, but no business documents this stuff well enough to survive a plaintiff's attorney's cross examination.
As a result, our company policy is to not allow any employee to give out any references whatsoever. They are not allowed to give out any information about employees except the dates of their employment. They are most definitely not allowed to discuss reason for termination. In a few cases, I will make an exception for good employees, but even in that case I require their permision in writing.
So, sorry employers out there. I feel bad about it, but I have to protect myself because the sharks are always circling. While its inconvinient to hire a bad employee in our business, it can be a disaster in places like hospitals that have life and death situations. Crazy? Check this out.
Dear Congress: If you would like to do something useful for a change, please consider granting employers some sort of liability shield for the information they give out in references.
Let Down by FedEx
Most of the facilities we run are concessions on government lands. To get these concessions usually requires a bidding process, where the government authority evaluates qualifications to run a quality operation as well as the amount of rent (usually as a percentage of sales) "bid" by the concessionaire. Like most government contracting processes, proposals are usually due by a hard deadline (say, 2:00 Tuesday on X date). No proposals are accepted at 2:01 (unlike some arbitrary government regulations, this is actually for a good reason - there is plenty of history of late proposals coming in based on some insider knowledge of the contents of other proposals that have already been opened).
Anyway, we had such a deadline in Florida on Tuesday of this week. Normally, to make a Tuesday deadline, we will ship overnight on Friday, which gives us a buffer day in case of problems. This time, because we only got the RFP last week, we had to work through the weekend and ship Monday.
So we shipped FedEx for 10:AM delivery on Tuesday (paying $155 for 38 pounds, ugghh). And, of course, since this is the one time we had no margin for error, the box ends up sitting in Memphis for a full day, due apparently to excess demand for Florida that day, and arrived a day late and after the deadline. So all the work we did, all went to waste. Bummer (I have cooled down, I was using much worse words than bummer with FedEx this morning).
I learned this lesson once before about 8 years ago. FedEx is NOT for things that absolutely positively have to be there overnight. They are for things that would be best if it were there tomorrow but the world won't end if it is not. In a case like this, where we miss out on a big contract and we could waste hundreds of man-hours of work, I should have gotten on an airplane myself, checked the box as baggage, and taken it to the door. Yes, it would have cost me a few hundred dollars more, but we already had thousands of dollars in time and effort invested in it.
Odd Things that Sometimes Happen When We Promote Someone
Most all of our managers in the company are promoted from within - this means that they started as a "camp host" with us, collecting fees and keeping the park and especially the bathrooms clean. One of the great joys I have found in business is finding someone with the talent and energy that deserves promotion. Many of the people we hire are retired, and a stunning percentage of my employees are over 70 -- I even have a few in their nineties! In several cases we have found folks over 65 who have never had a management job in their working career, or maybe never have worked out of the home before, who have made fabulous managers for us.
However, once in a while, something strange happens. We take a dedicated, customer-focused, friendly and sensitive employee, give them a manager title, and they become a monster. Something about the title, or rather their perception of the title, turns them into der fuhrer, barking orders at everyone, treating customers with disdain, etc. One of the classic lines I have heard quoted back to me intwo or three of these instances is "this is my campground, and I make the rules here". This line is usually stated at about the same time a customer or employee is being treated shabbily.
Of course, it is not their campground. In fact, since we operate facilities on public lands, it is not even the company's campground. In the end, in these two or three cases, the employees have left or were eventually terminated.
In response, we've beefed up our training and tried to better set expectation for managers, but we still have this problem once in a while. I wonder if it is a generational thing, as older employees whose business experience began in the 50's and 60's are channeling an outdated view of leadership. Anyway, it sure is frustrating.
Quick Convention Scorecard
Here is a quick scorecard of the Convenience Store convention today.
Scope: B decent mix of vendors but repetitious in some odd categories
Relevance to me: C- unfortunately, not many vendors of the type I was looking for
Venue: C Las Vegas convention hall, been there, done that. Positive of new Star Trek show next door offset by the fact the monorail was broken and traffic, as usual, sucked.
Food and Bev: A+ Awesome. This is basically 60% a snack food show and everyone had samples. Plus, all the beer manufacturers there in the middle pouring cold ones
Booth Babes: B- Kind of disappointing -- couldn't hold a candle to the consumer electronics or even better, the auto shows. Would have been a C+ but presence of vendor booths for Playboy, Penthouse, and Hustler staffed, uh, how you might think they would be staffed, brought up the score.
Other: B+ Got two good autographs, one from Raleigh Fingers (sp?) and one from Ed McCaffery. Skipped on the centerfold and Dallas Cowboys Cheerleader autograph lines (which, interestingly enough, were filled with women waiting for autgraphs).
Feet are killing me.
Blogging in Las Vegas
I am blogging today from Las Vegas, here for the convenience store convention. We run a number of small stores in our campgrounds and marinas, and I am trying to figure out how to make these operations more sophisticated.
I don't know if anyone else feels this way, but I am always a bit self-conscious at a convention. The whole thing is so stereotypical from TV and movies and so predictable from past experience, it somehow becomes kind of a caricature of itself. I always feels like a bit of a schmuck walking around with my little badge and doing that predictable little dance with vendors.
Thank God, though, that I am not working the convention tables as an exhibitor any more. "Have you seen the new model T-1000?" Uggh. And the stodgy companies I worked for never even had booth babes.
Customer Loyalty Programs
Courtesy of Business Pundit, this article on customer loyalty programs and whether they actually increase profits.
To me, you can make a good case for them in commodity undifferentiated products like commercial airline service, but now it seems like every store, from Best Buy to Barnes and Noble have them. It strikes me that stores like these should have plenty to differentiate them without a loyalty program.
I'm no psychic, but I can probably guess what's in your wallet. Chances are it's stuffed with loyalty cards from this airline and that hotel, not to mention a handful of point-accruing credit cards. And your key chain probably has a few hanging versions of the same—video store tag, gas station "quick pass," grocery store card. You probably belong to more loyalty groups than you can count.
Do you really think your customers are any different? It's hard to expect your affinity program to inspire loyalty when all of its members carry your competitors' cards as well.
Face it: Loyalty programs have reached the saturation stage. The first-mover advantage gained by the pioneers in this field is long past. Now as common as kudzu, affinity programs have lost their distinction and, as a result, much of their value.
I am actually sick of these programs. It increasingly irritates me to have to carry 354 pieces of plastic in my wallet to get the best prices every where I shop. I am old enough to remember when you had to have every stores proprietary charge card to shop there - so you had to have a bunch of department store cards and gas cards, etc etc. I am thrilled nowadays to shed all that crap in my wallet and just use my Visa card everywhere. Now, though, we are rolling back the clock to plastic proliferation. I find myself actually growling at the poor Borders Books checkout person when they ask me if I have (or want) a Borders loyalty card.
Coming soon, I hope, is the backlash, with stores competing with a saying like "you don't have to have a special card to get our best price".
Selling your Business
Since I just completed a three part series on buying a business, which starts here, it seems appropriate to link to this article on selling your business from Entrepreneur.com via the Entrepreneurial Mind.
The amount of disclosure that buyers require can be mind-boggling. Putting it all together in a reasonable fashion is just one reason to consider hiring outside help. An intermediary, such as a business broker or an investment banker, can relieve you of some of the work while also keeping the buyer engaged. "We always recommend that a third-party intermediary represent you," says Minor.
Buying a Company, Part 3
This is the third (and hopefully last) installment of a series of posts on how I went about buying my current business. You should also refer to part 1 and part 2. This installment will focus on options for financing the purchase of a small company and what kinds of legal documents you will need to complete the transaction.
Financing the Purchase
First, you have to figure out how much money you will need. The obvious answer is the purchase price, but this is usually too low. In the vast majority of small company sales, the sellers will strip out all of the cash and working capital. In addition to the purchase price, then, you will need to be prepared to inject additional cash as working capital. Go back over historical financial statements to get a sense of the requirements - and don't forget seasonality. In most businesses, there is a time of year when sales drop but costs stay up and the business demands more working capital. And, if you are growing the business, you will probably need even more (unless you have figured out how to have negative working capital like Dell).
No matter what any book has told you, you are going to have to put in some of your own cash. And that cash needs to be real equity, meaning cash you own and not cash you have borrowed. I don't know how low you can go with equity, and it probably varies a lot anyway. You probably need to plan to put in at least 20% as equity.
The rest you will have to borrow. The first, best source of borrowed funds is the seller. It is very, very usual that sellers will "carryback" a part of the purchase price. If you remember from part 2, we said that it is important to make sure that some of the purchase price is deferred, so that you have some leverage to recover funds against the sellers various guarantees and indemnifications. Thus, this seller carryback or loan serves two purposes. Sellers should always be willing to carryback at least 20% of the deal, and I have seen cases where they will carryback 50% or more. It all depends on the deal and how eager they are to sell to you.
The next source may be family and friends. This is where I ended up closing the financing gap for my company. This might be in the form of gifts or loans. If the funds are a gift, make sure you get a letter stating that from the giver - many banks will ask for this if they ever are considering a loan for you. If it is a loan, you will probably want to try to get them to agree to subordinate their loans to any current or future bank debt. Banks will be willing to lend to you even when you have family or personal debts IF those other lenders are willing to sign an agreement subordinating their debt to the banks (basically, this means that if you go belly-up, the bank gets paid first).
Then, there are the banks. From my experience, it is very, very difficult to get a bank to make an uncollateralized loan - i.e. a loan that is secured only by the cash flow of a company rather than by assets. In fact, I have never been successful at that. About the only way that I have found that banks will make a loan is if it is an SBA loan, where the SBA basically guarantees the loan for the bank. The SBA goes through cycles of being very open to lending to being very tight. I have not dealt with them for over two years, so I don't know what their stance is today. Remember, though, that the SBA is not going to approve any loan where the buyer has no experience in the industry or where the buyer is not putting down his own money as well. The SBA has a lot of information here.
The other way that banks will lend to you is if you have some asset you can commit as collateral. Your home equity is an obvious source. A less obvious source is the very assets in the company you are about to purchase. If you are buying a company with a lot of equipment, particularly with a few large expenses pieces of equipment (e.g. street cleaning trucks in a street cleaning company) it may be possible to get a bank to lend against these assets. Or, if these already have loans on them, it may be possible to assume the loans. Remember that assuming a $50,000 loan from a seller is just the same as paying him $50,000.
Finally, try not to max yourself out. Ideally, you would like to have a bank line of credit with some extra room in it to handle emergencies or opportunities. I began with a line of credit equal to 4% of sales that I have grown to 10% of sales. This credit line has become a competitive advantage for us - it lets us quickly take on new opportunities that our competitors cannot finance.
Once you put together a financing package you think will work, you need to test it to make sure you can make all the payments. You need to put together a spreadsheet by month for at least three years of what you think the P&L and cash flow of the company will be, and make sure that you can make your loan payments. Then try things - what happens if sales drop 30%? If wages go up a dollar an hour? Get comfortable that you can live with this transaction. You are buying a company to make your life better, not drive yourself to an early heart attack.
The Purchase Agreement
This is the key legal document you will prepare. It should include:
1. What you are buying, for what price. In an asset purchase, it includes exactly what assets are purchased - don't forget soft assets like trademarks, contracts, customer lists and other intellectual property. In asset purchases, it also includes an allocation of purchase price to the various asset classes. In an equity deal, you will need to agree on exactly what the balance sheet will look like. Since levels of working capital tend to fluctuate daily, there usually is a price reset mechanism to adjust the price based on the net working capital on a certain day.
2. Guarantees, certifications and indemnities by the seller. For example, they should indemnify you against all past legal actions, against any past taxes due, etc. They should also certify that the historic financial statements you used to buy the company are true and accurate, that there are no undisclosed legal problems or lawsuits, etc. In out case, we attached almost all the key due diligence documents (tax returns, bank statements, P&L's, insurance loss runs, etc.) to the purchase agreement with a certification by the sellers that it is all true and accurate. These certifications and warranties are important - get your lawyer and broker to help. Note that what the seller will not do (unless he is a real sucker) is certify or guarantee that the financial results you get will be as good as his were.
3. A good purchase agreement will specify a mechanism that allows the buyer to net out penalties for these certifications and warranties being incorrect directly from the carryback without going to court.
The next most important agreement is the non-compete. Get one. Every time. No matter what the seller says about not ever wanting to be in that business again (and he may be sincere at the time), at some point in the future he will probably want to get back in. The entrepreneurial recidivism rate is higher than for ex-convicts returning to crime. The non-compete should be for at least 3 and preferably for 5 years, and clearly define what businesses the seller cannot get into. It should also specify defined penalties for breaking the agreement.
Assuming you have a carryback, you will probably have a loan agreement specifying terms and interest rates. In many cases, you may want to retain the seller as a consultant or to help with certain tasks. They should generally provide 90 days of help for free - after that, it is up to the two of you to decide what kind of agreement to hammer out. In my case, the previous owner still works for me part time nearly 2 years later.
A final note on documents
You need to understand and "own" every word in these documents. DO NOT just rely on your attorney to draft and negotiate them. Your attorney does not have to live with the deal, you do. By the third time I did this (remember that I had two sellers back out at the last minute) I was writing everything myself and getting my lawyer to check it. There is no magic about legal work. Yes, they know things you don't, and have standard clauses that need to be added that you don't know about, but that's their job and they will fix those things. Believe me, if you are going to run a small business, you can't run to a lawyer for $400 an hour to draft every little document -- you are going to start learning a lot about being a lawyer whether you like it or not. You might as well start learning now how to write these documents yourself.
I hope this is helpful. Please don't be intimidated -- yes there is a lot to learn, but I started out knowing just about none of this stuff and I managed to figure it out. Running my own company has been fantastic. The actual acquisition and startup part was hugely stressful and time consuming, but I am happy I did it. Good luck.
By the way, I am not a lawyer, accountant, investment adviser, and broker. More importantly, even if I was, I am not your lawyer or adviser. Please don't take this post as advice - treat it as background so you can be better prepared to work with your own advisers.
Should have read my lease
Our company employs hundreds of seasonal workers and managers, but most of these folks all work near or in the recreation facilities we manage. As a result, our corporate "world" headquarters is a 600 square foot office with me, my bookkeeper, a copier, and several printers. About a year and a half ago I signed a three year lease for this suite.
A few weeks ago, my landlord called and said that they needed to move me to another suite. I said, hey, you can't do that, I have a three year lease for this one. I have way to many vendors and contracts to hassle with changing an address. They patiently explained to me that, so sorry, but I had signed a lease that said they could move me. And they did.
Well, you know, after looking at the thing, I did sign a lease that had a clause in the back that said if I lease less than 2000 square feet, they can move me without my permission. The good news is that they did all the moving and actually got the new office looking nicer than the old one. So things are generally working out, though I am still sending out change of address letters.
Beware - I am told that this is a very common clause in most commercial leases. As part of this move, I actually got it negotiated out of my lease so they can't move me again.
Buying a Company, Part 2
In the previous post on buying a company, I discussed what I have learned about finding and valuing a small company. In this post, I will discuss a second technique I used to find a seller, and then show how we conducted due diligence and selected the form of the deal (e.g. C vs. S Corporation, Asset vs. Equity purchase). In the next installment, we will get to the various legal documents and financing strategies.
A second way to find a target company
If you were reading the first post carefully, you will note that I am running a recreation services company but initially started to buy an industrial products distribution company. As it turned out, I got all the way through due diligence and within 24 hours of signing the agreements with company A when the owners (and founders) got cold feet about selling daddy's company and changed their mind. Bam, back to square 1. Four months work down the drain. I then found a second company, a marketing products company, and went three months down the road to buying them and - oops, they changed their mind about selling too. Eventually the third time was indeed a charm, and I ended up buying the recreation services company. Apparently, while my experience was extreme, it is not that uncommon for sellers to get cold feet.
Anyway, back to the point about finding companies to buy. When the first company backed out, I had already quit my job. I was left unemployed and without a company to run. Worse, though I did not yet know it, the SBA had stopped writing larger loans of the type I had obtained to buy the first company (we'll get to financing in a minute). Since I had no job, I could not sit around for months hoping for something interesting to come onto the market. My broker (Janice Staripoli referred me to a second broker name Walt Lipski who had a process for cold-calling on local businesses to see if they might be thinking about selling. (By the way, if you are in Arizona, I would recommend either of these folks to you - Janice handles smaller businesses while Walt handles larger ones).
Walt created a letter and sent it out to businesses in SIC codes that were of interest to me. From over 1000 letters, we ended up with 20 or 30 interested companies, many of which we went to visit. In retrospect, this was a very fun time - never had I imagined the diversity of businesses and interesting ideas right in our area. Anyway, through this process we identified company B, which fell through, and eventually company C which I bought.
Due Diligence is a fancy legal word for kicking the tires. You need to gain confidence on a number of issues:
1. Are the historical financials trustworthy - do they really reflect how the business has been performing
2. Are there any hidden liabilities, like lawsuits, unpaid debts, aging equipment that needs to be replaced, pensions, etc.
3. Are there any looming business problems or opportunities that could radically change the company's performance in the future. For example, if you are buying a small hardware store, the fact that they are planning to build a Home Depot around the corner might make a difference. Or, if the business depends on low cost labor, a looming hike in the minimum wage may be significant
4. Can the business survive without the previous owners, or does it depend on their unique skills and/or relationships
5. Does the business make sense to you? Is the customer base strong and growing? Do they have a good plan for starying ahead of competitors?
Accountants are the perfect resource for answering question 1. There are many local accountants (your broker can recommend some) who have experience checking sellers' income statements. In my case, my accountant compared the sellers tax returns, bank statements, and income statements. Your main worry is that the seller is overstating income. Sellers who do this seldom also overstate income for taxes (because it would increase their tax bill). Even if they misstate taxes as well, it is very hard to explain why all that extra income is not appearing in the bank accounts. If these three match, the seller's statements are probably (but not definitely) OK. Also, you can learn a lot about the sellers by the quality and detail of their statements. If they are detailed and well-organized and meticulous, they probably expended the same care in the rest of the business. If they are cheating the IRS (which I found a LOT in looking at small companies) they may be cheating you too.
Questions 2-5 have to be answered by you. You need to question everything and everybody. You need to inspect all the facilities. Do not rely on others - its is your money. You need to have confidence that there are no surprises. When you and your attorney write the legal documents, you can protect yourself on some of this stuff but not all!
What are C and S Corps?
I won't go into lengthy details, but many of the older businesses you will encounter are organized as C Corporations. This structure tends to create some tax management problems due to the double taxation of dividends. You will find sellers who have C corporations to have made large loans to themselves over time- this is a normal alternative to dividends. These loans will be closed out in the sale. If you have any choice in the matter, you want your new company organized as an S corp - it avoids these double taxation problems. Of course, work with your attorney and accountant on this, don't just take my word for it. More on corporate structures here.
Equity Purchase vs. Asset Purchase
While this issue may strike you as arcane, it is critically important to you as a buyer. The answer to which is better depends on the situation, and you definitely need to have a long talk with your lawyer, your broker, and your accountant about this issue. Here is how they differ:
In an equity purchase, you are buying the stock of the company. In doing so, you are buying everything - their assets, their debts, their corporate shell, their tax ID numbers, their pending lawsuits, everything. You are also buying the whole company history. You can get sued for past actions of the company even before you bought it. If the company has taxes or debts it owed, even if you did not know about it, they are your debts and liens now. You never, ever want to buy the equity of the company without first:
1. Having the previous owners indemnify you and the company for all debts, taxes, lawsuits, etc. prior to the acquisition date, and
2. Setting some money aside to assure that the previous owners have the resources to satisfy #1. For example, it is very normal in an equity purchase that 20-50% of the purchase price be deferred payment for several years. The purchase agreement will specify a process where the buyer can net out costs to satisfy the indemnity from the deferred money owed.
Despite these problems, equity purchases happen a lot, for at least 3 reasons:
1. The company is a C corp, and the seller refuses to tolerate double taxation of the proceeds of an asset sale
2. The seller has a really high equity basis and low asset basis, such that an equity sale results in a lower capital gain
3. The corporate shell has value. This is sometimes the case for multi-state businesses, where there are a lot of tax and business registrations necessary, or businesses where there are contracts that are not transferable to another company.
In an asset purchase, you the buyer are going to form a new company, with all new registrations, and then that company is going to buy the assets, contracts, trademarks, name, and intellectual property of the selling company. Unless agreed to in the purchase agreement, you therefore inherit none of the debts or liability or history. (there are some exceptions to this - for example, most states require that you inherit the selling company's unemployment reserve account and history whether you want it or not.)
Asset purchases are generally more work for the buyer. You have to form a new company, and get all the necessary pieces of government paper for that company (Federal tax ID, state sales tax number, state unemployment number, state withholding number, foreign corporation registrations, trademark registrations, local occupancy licenses and health inspections, etc.) and you will have to amend many contracts and vendor files.
I guess the obvious question was, what did I do? The seller had an S-corp with a very low equity basis. While they initially asked for an equity deal, they accepted an asset deal. After seeking lots of advice, I formed an S-corp to act as the purcahse vehicle. In the case of the company I bought, the paperwork to get things set up in this new company was ridiculously difficult, since the assets I bought were in 11 states. I spent months and months learning what every state needed, and I guarantee that in the fine federalist form of government we have, every state does things differently. Trying to get this all in place was probably the most stressful period of my whole life.
One other note - it is absolutely critical that in the purchase agreement for an asset purchase, you and the seller agree as to what value you are going to be putting on the assets for your taxes - its has to be the same. Lets say you did a $200,000 asset purchase. While there are other factors, basically you will allocate this price either to the purchase price of the assets themselves or to goodwill. Goodwill is the accounting way of saying "purchase price in excess of the asset values". It is basically the amount you spent for the intangibles of the business - their place in the market, their customer relations, their good name, etc. It is generally in the buyers interest to allocate as much as possible to the asset values, and as little as possible to goodwill, since you can depreciate tangible assets much faster than you can goodwill. The seller, due to a little known tax concept called depreciation recapture, often want the opposite.
In our case, the assets were relatively new and still on the books for a high value so there was not a lot of debate about their value. In addition, since a lot of the value of the company was in the contracts I was purchasing, we were able to assign some of the purchase price to these contracts and depreciate these values over the life of the contracts. As a result of the asset purchase approach, for the first few years of operation, we are getting a tax break as these assets and contracts are creating a lot of depreciation, which reduces taxes without affecting cash flow. Like most tax breaks, this is really just a deferal, with the taxes getting paid whenever I resell the assets. So the trade-off in the selection of the asset purchase has been a huge amount of work vs. some tax benefits.
To be continued
OK, things are getting long-winded again, so I will continue with the various legal agreements involved as well as financing the deal in the next post. See part 3.
Buying a Company Part 1 (or how I got into this)
When I describe what I do, the most common reaction is for people to ask "So how did you get into that?" The answer, as they used to say in the old electric razor commercials, is that it interested me so much, I bought the company.
Now, at some level, corporate acquisitions were not new to me -- I had worked with acquisitions and acquisition analysis in many of my corporate jobs. But these were large acquisitions - at least $20-$40 million in sales, and it was funded out of a large corporation's cash flow.
One fateful day, I decided that A) I hated working for other people and B) I had no groundbreaking entrepreneurial ideas of my own so that C) if I wanted to own a decent sized business, I would have to buy one.
Unfortunately, I had NO CLUE how to go find companies that were for sale and that I could afford. In fact, I was not sure at that point such opportunities even existed (again, when the rubber met the road, my Harvard MBA let me down). And, if the questions I get asked all the time are any indication, I was not the only one who didn't know how any of this worked.
OK, the first step was relatively straight forward, and may be one you have already tried. I went to Google, and plugged in "business for sale arizona". Now, that looks encouraging - pages of results (actually, a lot more comes back today than when I first did it). Now, start clicking the links. Hmm, kind of thin, huh. That's because most of the stuff that ever makes these web sites is either out of date (ie sold or off the market) or the dregs that have been listed for years and months.
This did not necessarily daunt me - the same issue often exists with Internet home listings. But these listings do give you a very good lead on who are the brokers selling companies in your area.
Who are these brokers?
Business brokers are like real estate brokers in that they generally get paid by the seller based on a percentage of sales (8-12% is not uncommon). The buyer can (and should) have a broker representing them, and, again like home sales, the buyer's broker is usually (but not always) paid out of the seller's commission. Brokers, in terms of their skills and outlook, tend to fall along a continuum. At the low end, selling smaller businesses like retail shops, they look and act a lot like real estate agents, and in fact many are both. These brokers tend to handles smaller sales up to a few hundred thousand dollars. At the other end of the scale are full fledged investment bankers, who tend to handle sales of $20 million or so and up. In between are the dedicated business brokers, who really specialize in mid-sized transactions.
Why is no one returning my call?
So, based on my web searches, I started writing and calling and emailing various brokers. Nothing. No answer. If you grew up watching Loony Toons, think Daffy Duck on stage with the crickets chirping. I could not for the life of me figure this out - if I had called real estate agents, they would be pestering me every 5 minutes.
It turns out that business brokers are inundated with what they consider unqualified buyers. People apparently read one of these "nothing down" get rich quick investment books and start calling brokers, trying to buy large companies with no down payment, no relevant experience, and no real liquid assets. No matter what is written in any book, its not going to happen. To buy a small company, you need AT LEAST one and preferably both of these:
1) available, liquid assets or home equity value equal to a substantial percentage of the purchase price or
2) vast, directly relevant experience and history of success in the exact industry of the target company
Without #1, you will need a loan, and no one, including the SBA, will make any kind of substantial loan without #2
So, inundated with twenty hopelessly unqualified buyers for every one good one, brokers seldom return calls. Finally, one broker took the time to at least explain the above to me. I then sent a new set of letters to brokers. In these letters, I was more precise about the target company I was seeking, I explained, in the same detail I would for a job interview, my experience in these industries, and I even included a detailed balance sheet to show my financial capability to buy something.
Finding a Company
The approach above was ultimately successful. Once I had a broker, we starting going through the lists of what was available. Most communities have what amounts to an MLS for companies, though it is much less developed than its real estate equivalent. If you want a restaurant or a micro-brewery or a craft store, you are probably in luck. Every time I have looked, our local listings were dominated by these type businesses (though if you are smart, you might want to try to learn something from the fact that so many are up for sale). I was looking for a manufacturing or industrial products distribution company in a certain price range. Sometimes, the right company is available, and sometimes you may wait for years for one to come up. In my case, I was lucky, and something likely was already on the list.
You could write a book on corporate valuation, and in fact many people have. There are many ways to value a company, and I spent a lot of time with big spreadsheets at large companies doing sophisticated cash flow analyses. You can do these for small companies, but most brokers and sellers will stare in confusion at your work. Do these analyses anyway, if you know how, but no matter what, you need to understand how the seller and broker are valuing the company. The good news is that the standard approach tends to yield some pretty attractive valuations.
First, you need to get to a number known as the annual cash flow to owner. To get to this number, you begin with the company's stated profits from the previous years, hopefully arrived at by some acceptable accounting method. You then adjust this number as follows:
1) add back non-cash expenses (such as depreciation)
2) subtract out cash expenditures that aren't booked as expenses - generally capital investments
3) add back the salary or other compensation the owners took for themselves
4) add back any one-time expenses that aren't expected to recur in the future and subtract one-time revenues that won't recur
Number four is where sellers get especially creative. They will claim all kinds of things are unusual one-time expenses that won't recur. Take these with a grain of salt (or two). Also, in number 4, depending on the owner, you may start finding odd stuff. For example, I was looking at a security alarm company, and the owner had an add back of $100,000 in cost of goods sold. That was very odd - I had never seen an ad-back in COGS, since ad-backs are usually overhead items (e.g. cost of special insurance policy that covers the owners). It turns out that the owner had the company purchase $100,000 of materials for his vacation home construction and had slipped these personal expenses into COGS so that he could write off the cost of his 2nd home. Once verified, I agreed that it was a valid ad-back, but for me, it was also a huge flashing red light that caused me to lose trust in the sellers and their business. If they were cutting legal corners here, where else were they cutting them? I could probably shelter myself from liability for their past actions, but what if I had to raise costs to get in compliance - e.g. if, as actually happened in the business I ended up buying, I had to raise labor costs to come into compliance with wage and overtime laws.
To this cash flow, owners and brokers will apply a multiple to arrive at a sales price. These multiples usually range from 3 to 6 times the annual cash flow to owners. So, if a company has a cash flow to owners of $100,000, they might try to sell it for anything from $300,000 to $600,000. Note that many large companies can pay 8 or 10 or even more times cash flow when they acquire companies. When you buy stocks in the stock market, you might be paying 15 or 20 times cash flow.
This makes small companies potentially attractive acquisitions. But there is a reason for the low multiples. Much more can go wrong with small companies, and small companies are much more likely to have hidden problems, falsified financial statements, etc. Companies without much performance history and dodgy accounting statements will trade at the low end, while companies with very clean financials and solid performance history will trade at the higher end.
Of course, this value analysis is only a starting point. Far more important will be your estimates of future earnings and cash flows, but we will save this for part 2.
To be continued
I am tired of writing and you are tired of reading. In the next installments, we will discuss what steps to take in investigating a company and how to protect yourself in the acquisition agreement. We will also discuss some related subjects like the difference between C and S corporations and between asset and equity purchases. Finally, we will talk about financing strategies. Here are links to part 2 and part 3.