Cha Cha Changes
It’s the idea that when things are good, they’ll remain good. But when things are bad, they’ll soon change and become good again.
Yet, when that thought process is evidenced by the owner or senior manager of a company, the company is at the greatest risk of ultimate failure.
We were reminded of that refrain and the reality recently when we had the opportunity to meet with the CEO of a closely held family owned manufacturing company. The business had been a leader in its industry, but recently a large offshore competitor had been making significant investment in new products and in marketing in the U.S.
As a result the company was both losing market share and becoming unprofitable. The CEO believed that he understood what needed to be done, but his plan called for investment in new products and marketing. The family owners believed that everything would once again be “fine over time”, but were mostly driven by the fact that the investment necessary would reduce the “dividend” that they were currently receiving from the company.
As we explored the nature of the “dividend” a couple of key issues surfaced:
1. The company has a working capital line of credit that is coming due for renewal. The loan, while current on payments is not in compliance with several of the loan covenants. The company’s balance sheet would currently not support the line of credit.
2. The “dividends”, which most of us would view as coming from the profits of the company are actually coming from drawing down the line of credit. Available working capital is reduced making the competitive situation worse on an ongoing basis.
Despite these facts and the expressed concerns of the CEO who is responsible for the company on a day to day basis, …
” … the owner and members of his family believe that …the line of credit will easily be renewed since “we’ve been a good customer of the bank.”
We often read about companies reporting substantial profits yet reducing payroll and other expenses. It seems counter intuitive. If things are good, why impose the strain of reorganization on management and employees. But this is exactly the time to consider all of the possibilities of the future and make the changes necessary to meet the challenges of that future.
“Profits create the ability to make choices.”
And making the choices necessary to face the future is exactly the role of senior management, boards of directors and owners.
Obviously the reason to own and/ or operate a business is to be able to take money from the business for yourself and your family. It’s widely recognized that the fiduciary responsibility of management is to the owners or shareholders. However, if a company reaches the point where it is unable to “meet its financial obligations as they become due”, that duty switches from the owners or shareholders to the creditors.
In privately held companies with limited ownership, this concept, which is recognized by both state and federal courts, is not well known by company owners.
In thinking about the company in question, a reasonable question would be: What happens to the company if the line of credit is not renewed? When that question was raised by the CEO, the owner and family members characterized it as “negative thinking.”
Consider the risk: A total loss of the dividend that they are so anxious to protect. Or, should the business reach a point where it cannot actually support the required loan payments; the possibility of a personal guarantee by the owner being called on leading to a significant reduction or the loss of personal assets. These risks are one negative banking decision from being realized.
Negative thinking or good planning?
It’s a question that everyone who owns or operates a business should be asking themselves on a constant basis.