Managing through Turbulent Times
The Inc. Economy
No doubt about it, predictions about the economy are all over the map. But knowing the answers to six basic questions can help you chart your company's course
How do I look at capital markets these days?
Differently. While financing opportunities still exist for good growth companies, the rules of the marketplace are shifting--and will continue to redefine themselves as the various capital markets adjust to current, and seemingly unpredictable, problems around the globe.
Call it the domino effect. Seesawing stocks help dry up the market for initial public offerings, which increases the anxiety level of potential investors who can no longer count on a quick exit strategy if they buy into an entrepreneurial venture. That's what's happening now. But Ben Boissevain, managing director of E Technologies Associates LLC, an investment-banking and consulting firm in New York City, expects the situation to worsen as the angel community becomes more strapped for funds. "One source of money--all those Wall Streeters looking to invest big bonuses--is decreasing," he says. "And all those entrepreneurs who would have gone public and then invested some of their proceeds in other private companies won't have the money, since they won't be able to carry off an IPO any time soon."
The situation among venture capitalists and other private-equity firms is more of a mixed bag. The firms that have already raised funds (either from investors or through recent IPOs) have money that needs to be invested, so they'll certainly remain on the hunt. But the groups that are cash poor, at least comparatively speaking, will have a hard time raising new funds for deals under current uncertain conditions. If the IPO slump is prolonged, expect this source of capital to get tighter and tighter.
Gayle Veber, managing partner of the investment-banking firm Veber Partners LLC, in Portland, Ore., sees no cause for alarm, at least not yet. "The markets aren't closed, except to low-quality, high-risk deals. What I see happening now is that maybe 10% of private deals aren't getting done. The remaining 90% of financings are happening, just at lower valuations." Probably the only type of investor who isn't negotiating for lower deal valuations these days is an entrepreneur's mother (and even friends and relatives may be wising up if they read the newspapers).
There's the rub: with fewer financing options, most business owners have no choice but to value their equity at a lower price than they might have as recently as last summer. And that's not all. "We're seeing much more attention being paid by investors to the way deals are structured," notes Boissevain. "Everyone is concerned about safety. So people are insisting on guarantees that will increase their equity stake automatically if the company fails to meet certain targets." Or they may build a layer of debt into an equity deal as another type of safety net. Are those trends all bad? No, says Boissevain. "With less money to go around, people will have to concentrate on making money, not just raising it," he says. --Jill Andresky Fraser
What are the key financial indicators I should be watching?
That, as they say, is the $64,000 question. Unfortunately, in an economic environment that's as basically unpredictable as this one appears to be, there's not much agreement on which sets of numbers or financial results can help any of us predict what's coming next.
"We're in pretty uncharted waters," says Barbara Grogan, president of Western Industrial Contractors, a $10 million company in Denver. "In terms of the old charts, the old indicators, I'll be damned if I know what holds the answers for us. I'm just glad that I'm not an economics professor trying to make sense of all this right now."
Grogan, whose rÉsumÉ includes a six-year stint as the board chairman of the Federal Reserve Bank's Denver branch, confides that although she reads the business press carefully and takes note of various statistics and market trends, "I don't know if I'm actually making business decisions right now by paying attention to any particular ones. What they do is help reinforce this holistic sense I've got that we're in a new business environment that's unlike anything we've ever seen. After all, we've got companies with hundreds of millions of dollars of market capitalization but no receivables. We've got people who are willing to invest $20 million, $40 million, $100 million or more in companies with no revenues. We've got new industries arriving daily. And we've got plenty of companies that still look strong, even with this conflagration going on in much of the world around us."
Bert Ely, a financial and monetary-policy consultant in Alexandria, Va., agrees that it's tough to try to make sense out of a few key numbers, especially on a day-to-day basis. "We're in a transitional environment in which markets are unwinding themselves from past excesses. Given the volatility we're seeing in foreign-exchange rates, stock prices, and interest rates, you can go nuts trying to figure things out on a daily basis."
Dan Laufenberg, the chief U.S. economist for American Express Financial Advisors, agrees. "You have to try very hard not to get caught up in the day-to-day noise of different statistics, which are probably telling you a range of different and conflicting things. It's the trends that matter. And incidentally, I think those trends are still fairly positive for U.S. businesses." While Laufenberg emphasizes that he never follows one single shortlist of key numbers, he does confide that the unemployment rate and industrial production are at the top of his list.
The best piece of advice for business owners: think of large market trends as background information, but don't focus too closely on them. Instead, as Ely recommends, "keep your eyes on the same measures of real economic activity that directly affect and are particularly relevant for your company and industry." Those might include order rates, inventory turnover, changes in consumer-debt levels, or--closer to home--the aging of your own company's accounts receivable and payable. After all, although the marketplace may be changing, the fundamental rules of running your business haven't changed at all. --J. A. F.
How should I think about debt?
Let's talk about your own company's leverage first. If you borrowed too much when the good times were rolling, you're going to need to rethink your growth strategy pretty fast. What's too much? It's any debt load that your company's cash flow can barely support. After all, unless you and your customers are completely immune to all overseas problems, as well as to those downturns on Wall Street and elsewhere closer to home, you may find it difficult to keep up with principal and interest payments. That kind of situation can spiral downward very quickly.
"If you're already overloaded, don't wait for your banker to tell you," advises Stephen King, president and CEO of Virtual Growth Inc., an accounting firm in New York City. Look for ways to reduce your leverage, perhaps by selling off any assets, like real estate, that don't directly support growth activities.
On the other hand, debt in itself is far from a sin, even these days. "Whatever the state of the economy, a business owner should always take into account the cost of capital when deciding how much debt to take on--and interest rates are very attractive right now," King notes. "Borrowing funds at a low cost to go after revenue growth is still a sensible strategy, so long as you've got a strong balance sheet to support that debt." Make sure your borrowing stays within a two-to-one debt-to-equity ratio.
What if bankers get tougher about lending funds to entrepreneurs? That may well happen, especially among super-large financial institutions with only the briefest of histories in this market. But among community and regional lenders, which have the closest ties to small private companies, basic lending practices may not shift at all.
"Community bankers tend to have experience with those kinds of companies," says Terry Jorde, president and CEO of CountryBank USA, in Cando, N.D. "That means they won't suddenly change their own terms just because the larger economy turns bad." She adds, "Those bankers, as well as their business customers, should always feel the same in good times and bad, which is that cash flow is the key to everything. If you project it conservatively, you always should be able to maintain the same basic leverage strategy."
But just because your basic borrowing strategy remains constant, should you still award credit to customers in shaky times? Absolutely, so long as your fundamental credit policies are sound. "That is a very simple thing to monitor," explains King. "The key to everything is one simple number that every business owner should track: day's sales outstanding--DSO." (To calculate, divide your average receivables by total sales and multiply the sum by 360.) "If you are a service company, for example, and your DSO is only around 30, then you're doing a great job of collection, and you can probably increase your credit exposure in cases where you believe it will add to your revenues and bottom line. But if your DSO is much higher, say 45 or 50 or more, then it's probably important for you to tighten your credit standards and award it only to those companies more likely to pay you quickly." Remember: just as with leverage, credit makes sense only when it helps your company grow. --J. A. F.
Will I ever be able to sell my business?
There may be no single issue causing more anxiety for entrepreneurs these days than the fear that they may have missed the opportunity to cash out. Indeed, given the astronomical values that many growth-oriented companies were able to command in recent years--both in the IPO market as well as through private sales--that anxiety is all too understandable.
So here's some good news. Despite the tumult overseas, as well as the fluctuating stock market here at home, the mergers-and-acquisitions market for privately held companies has been holding up quite nicely. In fact, the chances for many entrepreneurs to sell out may have actually improved thanks to current problematic economic conditions.
"The shaky U.S. stock market has been good for company sales," says Catherine Bienert, a business broker whose company, Bottom Line Management Inc., is based in Atlanta. "When stocks were very, very strong, some people were scared off from buying companies, because stocks seemed like an easier and safer way to earn a return on their investments. Now people are back to realizing that a good, healthy company may be a more profitable, and even safer, way to invest their capital over the long term."
Bill Vogelgesang, an investment banker at the Cleveland office of Brown, Gibbons, Lang & Co. LP, agrees. "In the midmarket range, which is where most of our clients fit, we're still seeing a lot of interest on the part of buyers. Ironically enough, what helps is the fact that these are relatively small transactions, which are usually fairly simple for them to finance. For much bigger companies--the kind that might have sold for $200 million in a deal that depended upon financing from the high-yield-bond market--those are the deals that are running into difficulties right now."
So there's no reason for business owners to fear that their opportunities to sell their companies have dried up. But it is undeniable that sale prospects have changed, most especially in terms of deal valuations. Vogelgesang's own experience suggests what he terms "a drop of somewhere between one-half to a full point, meaning that companies that might have sold for multiples of 6 to 7.5 might now go for 5.5 to 7 times earnings." It's unclear how much further valuations will drop, although the investment banker remains hopeful that the "worst may be behind us."
There are two basic reasons for this type of decline. First, with the IPO market going through one of its all-too-predictable cyclical swoons, business owners can't count on the lucrative public-offering option, which increases the bargaining power of all those potential private buyers. But another factor taking its toll is what Chris Mercer, a valuation expert and president of Mercer Capital in Memphis, terms "an unusual situation on the financing front. Money is cheap, and there are enormous pools of it still available, yet bankers and potential buyers are becoming increasingly cautious. So we're seeing more caution in terms of how much risk anyone is willing to build into a deal in terms of its price and leverage."
One final tip: when market conditions are as unstable as these are, it pays for sellers to be as cautious as buyers. That may mean opting for a lower sales price if it is paid in cash rather than in stock or if it precludes a prolonged and possibly risky payout schedule. And above all else, carefully investigate prospective buyers. "You don't want to find yourself in a situation in which your deal stalls or falls through because the buyer's financing package wasn't sound," advises Vogelgesang. -- J. A. F.
Twenty percent of my business is international. Any advice?
Retreat! Run away! Yankee, go home!
Wait, scratch that. "It's time to retrench but not to retreat," says Attila Yaprak, a professor of international business at Wayne State University's School of Business Administration. Despite the apocalyptic pronouncements about many foreign economies--and the understandable urge to pull back to safer shores--he and other experts are counseling small companies to stand their ground intelligently.
Step one, they say, is to mitigate risk. "Insurance suddenly becomes a mighty attractive option," notes Michael R. Czinkota, a professor of marketing and international business at Georgetown University's Robert Emmett McDonough School of Business. Insuring your receivables, for instance, can guarantee that money will be flowing into your coffers--even when your Malaysian customer can't come up with the 64,000 ringgit it owes you. Also, tighten up payment terms and run regular credit checks on even the most trusted international customers.
Step two: exploit opportunities. With asset prices in Asia in a nosedive, small companies looking to establish a physical beachhead there can now do so on the cheap. Nor has there ever been a better time to form a joint venture or strategic alliance abroad, says Farok J. Contractor, a professor of international business at Rutgers University. "Foreign firms want financial help, and they want credit," he says. "This is a great time to ask for tougher terms."
Perhaps the best international opportunity of the moment has nothing to do with exporting at all. "We've had a lot more companies looking to get into importing," says Jeffrey Meyer, who counsels many small companies as director for international trade programs in the College of Business and Administration at Wright State University, in Dayton. Thanks to depreciating currencies, many foreign goods can be had at a bargain, causing some exporters simply to reverse the flow of goods. "When you sell abroad," notes Czinkota, "what you get is not export expertise per se, but international marketing expertise. And you can apply that same experience to importing."
Of course, small companies are still especially vulnerable to the whiplash of foreign-currency fluctuations. When currencies abroad lose value, exporters are faced with the choice of raising their prices overseas to maintain their revenues or letting them drop to maintain market share. Deep-pocketed corporations will often take the market share route, but for resource-strapped businesses, Czinkota says, "the question very quickly becomes, How long can you hold your breath? A year? Three years?"
Then too, adds Yaprak, "larger companies are more likely to read possible political changes with greater sophistication." As foreign governments react to the crisis with policy measures--import and export controls, raised tariffs, new rules on repatriation of earnings--small companies, with fewer on-the-ground contacts, are more hard-pressed to anticipate and respond to those developments. All the more reason, says Meyer, to develop on-the-ground relationships now. "And now more than ever, you have to understand what your local customers' needs are," he adds. "If they're starting to think of your hand soap as a luxury good, you'd better start thinking about retargeting your product."
The last step, Meyer says, is not to panic. "It's a world of crises. It's about how to manage them when they hit," he says. --Jerry Useem
Are there opportunities here I might be missing?
If it comes down to a recession, many of us have been through at least one before (most recently 1990-1991). But if we also begin to experience deflation--that is, falling prices--we'll be in a deflationary recession for the first time since the 1930s. That is unknown territory for most managers. Few people remember which '30s business tactics worked when prices were falling and the economy was contracting.
Before you rush for your history books, though, there are role models around today that are worthy of your attention. Certain high-tech companies, like producers of peripherals, component assemblers, and chip manufacturers, have grown so accustomed to falling prices that they have become part of the corporate culture. Fortunately, those companies generally work in expanding markets, so the rate of growth of unit sales continues to rise quickly even if that of total revenues doesn't. But they use some general tactics that all small companies, even low-tech ones, can adopt in turbulent times.
- They all invest heavily in research and development. R&D spending is not just for new products. It also covers analyzing customers' needs, developing proprietary sales techniques, and enhancing customer satisfaction, all of which lead to lower support costs and greater customer retention.
- They also spend generously on internal information systems infrastructure to support more sales at a lower cost. They reengineer their business processes (such as invoicing, doing performance reviews, and preparing tax returns) as assiduously as they do their products or services. A better process is not a "nice-to-have" but a "must-have."
- They use those investments to reduce prices before markets demand it so that their customers are pleasantly surprised--no sticker shock here. They have evolved a culture that anticipates price reduction, just as companies once counted on inflation to strengthen balance sheets.
- They plan marketing strategies around growing the number of units sold, not top-line revenue growth--a subtle but critical distinction. They assume their products will cost less in the future and therefore will be more attractive to people who are not now customers. Their focus is on how to get those people to become new customers as opposed to how to get their current customers to pay more. That approach tends to fundamentally expand market demand.
If the economy hits an even bumpier road ahead, look to high-tech role models to demonstrate the best way to survive. --Eric Kriss
Jill Andresky Fraser is Inc.'s finance editor. Eric Kriss is CEO of Workmode Inc., which provides Web-integration services to growing companies. He is the former CEO of MediVision Inc. and MediQual Inc., both Inc. 500 companies. Jerry Useem is a senior writer at Inc.
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