I was intrigued by an article on and individual and his business and his book (Boss Life) today. They all deal with the same subject: small business failure.  Specifically his business which, after thirty years of struggling, apparently is always on the verge of shutting its doors. You can read the article of course but its importance to a business buyer is obvious. Could this happen to me?

By way of background, Mr. Downs, an Ivy League grad and owner/founder of the same cabinetmaker for 30 plus years, has had nothing but a tough time in keeping it afloat. In fact his plight has pretty much dogged him from 2009 during the height of the great recession right up until now in 2015. I will say right off that, although  I have not read his book, I have sympathy for this guy –  it sounds like he has a some real challenges at home that have not helped his cause.  I am also not in a hurry to read his book because – I have been there and survived that – but more productively I think I can share my own insights to help first time business buyers or even business starters learn from his experience as well as mine.

So you guys sort of know what I teach. Leveraged Buyouts, the kind of business buyouts that are one step above the typical barber shop and a bit bigger than a small $1-$2Million manufacturer. I keep them bigger for a reason, which might by illustrated by journey of Mr. Downs. Recognize that I will now make some assumptions to make my points but which aren’t necessarily linked to his narrative but more to mine. I have nothing but respect for Mr. Downs as a guy in the trenches trying to keep a business working that might be bucking his attempts to keep it tame.

First let me lift the very last statement he makes and use that as the main theme of this post:

“Small business isn’t an easy road to success. They’re not dot.coms like Facebook. They are pizza parlors and hairdressers. We rely on them to make our communities vibrant.”

Absolutely true. I could not possibly say it more frequently than I have throughout this blog. Community businesses are not easy. Indeed they are one man operations much of the time and, although it may be a noble endeavor to run one,  and may contribute to the “vibrancy” it cannot be assumed to be a profitable route to go.
So read the above article and/or the book (I am not getting paid to push it). Then take a look at the picture of the operation. Do you notice anything about the picture?

There are no employees and the place is huge. Does this indicate a small business failure?

The operation itself looks pretty spiffy, well lit, if cluttered and actually sprawling as you might expect a cabinetmaker’s floor to be. Maybe too big in fact for the amount of work they have in house.  It is also curiously absent any employees. In fact it looks pretty deserted.  Does any of this matter? I mean it is just a picture, mainly of the CEO and his book. Maybe they took the picture at night. So I will mildly suggest that this business looks a bit quiet.

But we know his business hasn’t failed although the title of the article seems to suggest just that. Rather the business may be undergoing a slow death which is quite common. The book chronicles the month by month negative cash flow struggle. Yet he still survives, albeit with layoffs and downturns and difficulties which apparently haven’t ended. The good news is that this is a testimony to how resilient small businesses are no matter how bad things get. I don’t disagree one iota that small businesses are tough, but I also believe that in many markets the smaller the business, the tougher it can be.

He even becomes the bank. Something I haven’t heard in a while but that is a phenomenon where the owner routinely lends money to the company to meet payroll or other expenses. In fact this can go back and forth with the owner giving and taking money on  daily basis which is kind of a ridiculous position to put yourself in. If you are the bank you may be letting your company off the hook. Yes the interest is less than a bank charges but then interest rates aren’t exactly high right now. And often times this practice tends to compensate for lax business practices such as the prompt collection of receivables which is critical to cash flow. This is a condition that suggests to me that the company is so small and strapped there is no room for error nor  even any room for a banking arrangement which could smooth out the cash flow.

Is this how it is supposed to be after 30 years? No, but I think there are many of us buyers out there that would be tempted to acquire this type of business, because it might go for cheap. Would this be a good buyout? Only if you had a plan to pump up the sales.

So What Really Is The Business Failure Here

In this case the business failure isn’t a chapter 11 or a shutdown of the facility. This is a company struggling at a low level and the owner declaring it a failure. Things could be worse. Of course the problem is if a company bleeds from negative cash flow for too long then the following things occur:

  1. Payables are stretched to the point where vendors will not sell you any product except on a COD basis.
  2. You may not have enough money to make payroll.

Missing a payroll will put a quick end to the business. This is why it is important to conduct layoffs fast and make sure cash is conserved for payroll. Thus businesses that are short of money will usually stretch the payables.

What is causing all these problems? Quite simply, he doesn’t have enough business and the business he does have many not be profitable enough. I cannot even guess at his margins, but if I wanted to I would sign a few NDA’s and see what cabinetmaker’s are doing for gross margins these days. I would guess they aren’t too high, maybe below 25%.  Cabinetmakers by the way are not exactly new economy rockets. This could be said about furniture companies of almost any sort.  Although the company may have had a good stretch of a couple of decades, things change. He also apparently struggles at $2mm or so in backlog of contracts which apparently isn’t enough to support a full complement of employees. So let me throw out a few takeaways from this scenario because these things keep coming up almost like history repeating itself.

How Business Buyers Can Avoid Business Failure

  1. Make sure you have a very good feel for the industry. If the company has been struggling over the years there is a good chance there simply isn’t a good market for the product….. anymore.
  2. Anytime the owner is the bank, anytime the payables are slow or stretched, anytime the company is leveraged, there is an excellent chance the company is strapped for cash. That means the buyer will have to finance it. So don’t make the mistake of putting a lot of cash in the owner’s pocket.
  3. Companies that don’t grow over time lose value over time. What happens is this: expenses increase while sales stay stagnant. Which means profits decline over time.  The world is littered with these type of companies. You will not only encounter them but you will want to buy them. This is why the minimum profits of our target company is a nonzero number. It’s why we look for $300-$500,000 and above.
  4. Finally, realize when a company depends on marketing and when it doesn’t.  Most companies, but not all, are in a competitive environment and must initiate a sales effort. A furniture maker most certainly depends on marketing for its sales numbers.  Does it seem that this small company has been successful in its marketing effort? If you can’t figure out some marketing to bring to the table then perhaps you should reconsider the deal and focus on a company where sales isn’t an issue.