STREET SMARTS

Ransom Notes

It's never a good idea to pay ransom to key employees.

Norm Brodsky is a veteran entrepreneur.

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A lot of people think they own a business because they have one, but owning and having are two different things. You may technically be the proprietor of your company. You may have invested all the money and signed for all the debts. But you don't really own the business if you're being held hostage by a key employee.

That happens more frequently than you might think. The most extreme case I know of involved a company I acquired back in the 1980s. After completing the deal, I discovered that the company's computer guy was making more money than the top executives. Why? Because they were afraid he'd sabotage the computer system if they didn't pay him off. I immediately fired him. Sure enough, the system failed shortly thereafter.

But bullies are cowards at heart. I tracked him down and told him that if he wasn't back within two hours I could call the police and have him arrested. He returned and fixed the problem.

More often, of course, hostage takers are hotshot salespeople who threaten to leave and take customers with them if the company doesn't cough up the big bucks. Unfortunately, by failing to build their own strong ties to customers, a lot of owners make themselves vulnerable to that form of extortion, as I've noted before. (See " Parting Company," March 1999.)

At times, however, owners become hostages simply because they lack the experience to recognize what's happening to them.

That was the case with a couple who came to me for advice about six months ago. (I'm going to change a few details here, to protect the innocent.) Cheryl had put up $165,000 with her husband, Dan, to start a high-end housewares store in the small suburban town where they lived. After two and a half years, sales were booming -- and the debts were piling up. Not only was the start-up capital gone, but they had exhausted a personal credit line of $25,000. In addition, they had a credit card balance of $8,000 in business expenses, and the store owed about $50,000 to various vendors, who were repeatedly calling, demanding to be paid.

Cheryl was at her wit's end. The business was soon going to need more capital, but she had no faith that additional money would turn the situation around, and Dan shared her concern.

Part of the problem, Cheryl realized, was the store's manager, a woman we'll call Doris. A salesperson with experience in specialty retailing, Doris had talked to Cheryl about the potential market for such a business. Cheryl had decided to start the store and let Doris manage it. Now Doris controlled every aspect of the operation -- from hiring employees to setting prices. She was also the person most visible to customers, promoting herself as a leading expert in housewares.

Doris didn't seem to care much about having a profitable business, however. As the losses mounted, Cheryl had tried in vain to get her to focus on the financial problems. Finally, Doris agreed to let Cheryl bring in a retailing consultant, who installed an inventory-control system and told them the store was grossly overstaffed. Doris tried the system for two months and then got rid of it. She also refused to cut payroll, although Cheryl eventually forced her to reduce it by about $1,000 a week.

Cheryl and Dan didn't know what to do. Doris insisted on running the store her way, but her way was putting them deeper and deeper in debt. They asked me what I thought. I said that before giving them my opinion I'd like to visit the store.

Cheryl was there when I arrived and introduced me to Doris, who took me to the back office. A quick look around told me what I needed to know. The office was a disaster. Here and there lay unmarked envelopes stuffed with cash-register receipts. As for financial records, the store had none that provided any useful or reliable information.

Obviously, the store wasn't being run like a business, which aroused my suspicions. Everybody needs good records to make sound business decisions. If you don't have good records, it's because you don't know how to keep them or you don't want them. In any case, I knew that Dan and Cheryl shouldn't be entrusting their money to someone who couldn't account for what she was doing with it.

On the other hand, I could also see that the store was potentially a good investment. We knew that for more than a year, at least $1,000 a week too much had been spent on payroll. Without that expenditure, the store could have paid all its bills to vendors and recorded a modest profit. Undoubtedly, money was being wasted in other ways as well. If we introduced some controls, cut out the waste, and reduced whatever shrinkage was going on, the store might turn out to be highly profitable.

I explained all that to Cheryl and Dan and told them they had three options. First, they could try to sell the store, which I thought would be difficult. Second, they could shut the store down and liquidate the assets, which would allow them to pay their bills and perhaps recoup a small portion of their investment. Or, third, they could fire Doris, and Cheryl could take over managing the store. Letting the current situation continue was not a viable option. If they invested more money, they'd lose it. If they didn't invest more money, their creditors would force them out of business, leaving them in even worse shape.

Cheryl was taken aback. She wasn't ready to give up on the store, but she wasn't ready to fire Doris, either. Could the store even survive without her? Most of the staff members were friends of Doris's. The customers knew her as well. What if they all left? Couldn't we try to get Doris to change instead?

I said the store could definitely survive without Doris and that I was skeptical of her willingness to change. But there was no need to rush. Cheryl could take a few weeks to think it over. I just wanted her to do a couple of things in the meantime. First, I suggested she drop by the store one day unannounced, about an hour or so after it opened.

Cheryl wanted to know what I thought she'd find. "Someone won't be there," I said. "You're paying people to work a whole day, but they know they don't have to. The other people will make excuses for the missing person. But if you go back a couple of days later, someone else won't be there."

In addition, I said she should close the store on Wednesdays.

"Won't we lose business?" she asked.

"That's what Doris will say," I said, "but the answer is no. You're a destination store. People shop there because no one else in the area carries your type of goods. The customers will just come another day, and you'll save about $20,000 a year."

To be sure, I had ulterior motives. In the first instance, I wanted Cheryl to see how her money was being squandered. In the second, I wanted to show her that Doris would resist any attempt to make the kinds of changes that were needed.

Sad to say, I was right on both counts. Twice Cheryl showed up unannounced, and twice scheduled employees weren't there. As for the Wednesday closing, Doris was furious about it. For three weeks, she browbeat Cheryl, who finally relented and let her reopen on Wednesdays. Meanwhile, angry vendors kept calling.

By the time Cheryl and Dan returned from vacation a few weeks later, they'd made up their minds to let Doris go. Cheryl couldn't bring herself to do the firing, so Dan made the call.

The next couple of weeks were a little chaotic, but it soon became painfully obvious why the store hadn't turned a profit in almost three years. Bills showed up for housewares that were being sent directly to Doris's niece. Customers came in demanding their usual 20% discount. Then there was the $700 end table that Doris had special-ordered and given to the electrician's wife.

Cheryl's only regret was that she hadn't acted sooner, which is almost always the case. There is never a good business reason to let an employee hold you hostage.

In the end, Cheryl lost neither staff nor customers, and, despite a slow season, the store became profitable overnight. As a result, Cheryl was able to take care of the vendors and start paying down the credit line. Today the store is doing better than ever, and Cheryl and Dan are really the owners at last.

Norm Brodsky is a veteran entrepreneur whose six businesses include an Inc 100 company and a three-time Inc 500 company. This column was coauthored by Bo Burlingham. Previous Street Smarts columns are available online at www.inc.com/incmagazine/columns/streetsmarts.


Please e-mail your comments to editors@inc.com.

Last updated: Nov 1, 2001

NORM BRODSKY | Columnist

Street Smarts columnist and senior contributing editor Norm Brodsky is a veteran entrepreneur who has founded and expanded six businesses.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.



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