Archive March 25, 2024

Execution Risk is one of the lending decision topics that is deeply gray. Bankers have black and white scoring models for leverage ratios, cash flow and other measurable decision components. Properly evaluating the grey area of execution risk is more of an art form than statistical analysis.

Let’s get the jargon out of the way first. Execution risk is the risk that a business will not be successful if they implement their plan, or that they can not successfully pull it off.

Yes, some components of execution risk are embedded in the measurable lending criteria. Perhaps the business is too leveraged, or does not have adequate cash flow. One may look at non-traditional achievements to see part of my point. For instance if someone wants to climb Mt. Everest but does not have the equipment or conditioning, they will likely fail. If someone wants to play sports, but they are not trained in the nuances of the sport, the odds are against the person. The same holds true for businesses. Equipment, preparation, training, facilities and support are all likely components in a successful business plan.

If someone is trying to launch or grow a business without proper equipment or the company is under capitalized, the banker’s decision process is pretty simple. Bankers decline the request and refer the business to a collateral lender, broker, consultant, accountant or investment banker. What if the business seems to have many or most of the core components in place? How does the banker measure planning, conditioning, knowledge, training, and staying power, among others?

To help explain this grey area, I’ve taken eight examples from our five most recent credit applications. I’ve formatted them as rules to assist your loan application presentation.

1. Your materials should be consistent and tell the same story. Inconsistencies communicate that you might not be telling the truth, or that you may fail because of a lack of attention to detail.
2. Speaking of the story, tell one. Explain where you are and how you got there, not just were you are going. The context of the story will make any oddities in your plan make sense.
3. Finalize your plan before you present it. I don’t mean be cocky about it. I just mean that focus and determination can become apparent if you have a finalized plan. Otherwise the banker wonders where you are really going and if you will really get there.
4. Don’t overpay for a business, even if you can afford it. Many entrepreneurs will get overly excited about an opportunity and agree to things that they should not agree to. This communicates that you may make similar mistakes about other decisions in the future. The banker will tend to not trust your judgment.
5. Always have a back up plan. Especially if you are getting approvals from cities, counties or other government entities. Government agencies often take longer to approve something than the typical business owner expects. Planning tells the banker that you have your eyes wide open and are ready to react to surprises. Indeed, Murphy lives.
6. Understand your cash flow and how everything will affect it. You should be the expert on your cash flow, margins, terms, industry preferences, and collections. If you cannot talk fluidly about these items, then the banker will have good cause for concern. They will think … as an analogy … that you are flying a plane blindfolded.
7. Be fully prepared to manage your growth. Too much growth has killed a number of companies, just like insufficient capitalization has. Tell the banker how you will keep from growing too fast. You want to find a way to get the banker to trust your judgment.
8. Take the time to understand how financiers think. Also, know when to approach different types of financiers (banking, collateral lending, and fundraising) because they all have their own niche in financing businesses.

So, if you are guilty of any of these, fix them as soon as you can.

If you need more help, consider hiring a business consultant to assist you. My biggest caution on business consultants is that some of them veer from your real plan, substituting their plan. Do not let this happen. It is good to be trained and coached, and then implement your plan, taking ownership and responsibility for the entire plan.

If you need assistance in finding a good consultant, I am happy to point you in the right direction. Just drop me a line.

Bob Stackhouse, President, Asset Commercial Credit
© Bob Stackhouse – All rights reserved – March 2014

Most people start off their lists of business failure with businesses being undercapitalized. Unfortunately that communicates that money can solve everything. It cannot. It also doesn’t get to the core components that speak to the likelihood of success in bootstrapping the business or the likelihood of obtaining credit or investment. Therefore you will see that my list takes a different look at the problem of success/failure.

I’ve been in the business risk assessment business for over 34 years. I know it well, having financed over 3,000 businesses and managing a portfolio of over a billion dollars of small business loans. Clearly, things go wrong in all businesses. The single most important point is whether or not management has their eyes open, watching risk and has contingency plans. I hope you do not find yourself in the risk categories below:

1. The number one reason businesses fail to thrive is that the principals do not understand the risk of the business and therefore are not watching. Think of a cruise ship sailing without navigation charts … or without someone at the helm. Imbedded in this reason is also the situation where management does not know enough about their business and does not align themselves with people who can help them. This includes engineer business owners who do not know accounting and other knowledge based flaws.

2. The number two reason businesses fail to thrive is lack of focus and clarity of Mission, Vision and Values. Employees can get distracted with their own priorities, likes and dislikes. Whereas clear Mission, Vision and Values combined with laser focus on objectives that are tied to them makes it easy to know where the ship is sailing and how to get it there.

3. The number three reason businesses fail to thrive is that they have either too much structure or too little. Many businesses are started by people who cross over from successful corporate industry. These individuals often implement procedures and processes that worked well in their old jobs. Unfortunately the old job was with a company that might have been mature in their industry, while the new company needs to be entrepreneurial. If they do understand business lifecycles, they might forget to implement structure as they grow. Successful entrepreneurs understand business lifecycles and the need to match structure with their lifecycle stage. This is one of my consulting specialties where I have taught CEOs to be more effective and productive.

4. The fourth reason is that management creates too much capacity in the form of their plant, qualified labor (thought to be irreplaceable) and other fixed overhead. When sales become volatile, the overhead absorbs the profit, and often one of these elements is responsible for a loss or business failure. Outsourcing manufacturing can lessen the risk of this element. Over the last few years, many businesses did not shrink fast enough. Luckily many businesses ultimately did reduce capacity. Shrinkage actually creates cash flow. Unfortunately, when their management wants to grow again, they will find that they do not have the balance sheet support to find the financing that they once had.

5. The fifth most common reason is that they grow too fast and do not have the capital to traverse the growth curve. Basically, they have too much money tied up in inventory and receivables. This is the traditional “undercapitalized” business. Banks allow a certain amount of leverage. If your business outstrips a bank’s pallet for risk, alternative financiers such as Factors or Asset Based Lenders are available to lend to support accounts receivable growth.

6. The sixth reason is they build something that isn’t really wanted in the marketplace, or at least not at the price that it can be profitably delivered. Too many people believe in “build it and they will come”.

7. The seventh reason relates to the long term price support given competitive forces (elasticity of demand). This really breaks down into two things, pricing and competition. We’ll start with competition. Competition includes alternative methods of solving the core issue that are resolved by the product. Too often management ignores the alternatives that our customers have. One must look at all the alternatives when one is evaluating how to price one’s products. Your customers will certainly look at alternatives.

8. The eighth area of general business risk is theft (internal as well as external). Theft and fraud are interesting topics. It is appropriate to design systems and processes to keep honest people honest. Moreover, one must keep an eye on key financial indicators to be alert. It seems that thieves are always coming up with new ways to sneak under the radar. One must keep one’s radar diligent, flexible and current.

9. People management is the next area where productivity is harmed, thereby causing issues with operating margins. The foundation of management is to have clearly understood Mission, Vision and Values. Once established, decisions must remain consistent with this foundation. Follow through, communication, respect and appropriate rewards must be valued by management.

10. The last issue on my top ten list spans both start-ups and traditional businesses. I like to refer to it as Murphy lives! Whenever something can go wrong it will. This especially includes things taking longer than one wants them to, or projects them to take. My best advice is to always have a back up plan and know that things take longer than you want them to.

OK, so there you have it. If you have any of these attributes/issues, give me a call. Once you are aware of the attribute/issue, you may be poised to solve it yourself. You may need the assistance of a Certified Management Consultant that specializes in the area of concern. In any event, subject to availability, I’m happy to have a conversation on your issue, provide you with support including an introduction to a consultant or financier.

Bob Stackhouse, President, Asset Commercial Credit

© Bob Stackhouse – All rights reserved – January 2024