Running a business is a series of decisions: where to locate, what to produce, what to charge, how to distribute. There are consequences--perhaps bad ones--to whatever decisions you make. You must take responsibility for the consequences, or you'll never learn from your mistakes.
That's why I'm reluctant to dole out advice to young entrepreneurs. Occasionally, though, I am confronted with a situation where I do offer very clear and firm advice. I ran into one recently with an entrepreneur I'll call Clarence.
His company sold a consumer product with a unique twist. (I won't be more exact, for reasons that will become obvious.) He was in dire straits when he came to see me. Clarence was being hounded by creditors and couldn't repay his $750,000 bank line of credit. When I questioned him about his sales and margins, his answers were a little too vague. I asked to see his financial statements. "But I have to meet with the bank," he said. "My lawyer says I should file for bankruptcy."
"Don't do anything now," I said. "Get me your financial statements. I'll tell you what I think."
He seemed desperate, but I didn't hear from him. Six weeks later, the person who introduced us said Clarence needed to see me urgently. He brought me his financials. I took one look at the balance sheet and said, "I hope you didn't give this to anyone else. These are fraudulent numbers."
"I gave it to the bank," he said. "I have a meeting with them Monday. What's wrong with it?"
"According to this balance sheet, your current assets exceed your current liabilities by more than a million dollars," I said. "Why don't you just pay the bank the $750,000 you owe them?" Clarence admitted that he couldn't, even though the balance sheet showed he could. I asked how much inventory he had. At first, he said $150,000 worth--the amount he claimed he could sell it for, an irrelevant number. "How much did you pay for it?" I asked.
"Sixty thousand dollars," he said. The balance sheet showed $970,000 in inventory. "That's fraud," I said. Clarence protested that the accountant had told him he had to provide a bigger number to the bank. "Did you read the first page?" I asked. "It says all the numbers come from the client and haven't been audited or verified. What about this number--prepaid expenses of $600,000?" He said that he had paid certain expenses in advance. "You paid $600,000 in advance?" I said. "Baloney. I'll bet the real number is close to zero."
Accounting rules allow you some choice about revenue recognition, inventory treatment, amortization, and the like. You can be aggressive but must be legal. In his desperation to save his business, Clarence crossed a line that could land him in jail. Failure may be humiliating, but isn't it preferable to prison? Indeed, bankruptcy is almost a rite of passage in Silicon Valley. You can rebound from a bad deal or a bankruptcy. You are unlikely to rebound from a jail cell.
Clarence was beyond my help. Get the best criminal lawyer you can find, I advised, and tell the truth. "If you meet with the bank before seeing an attorney," I said, "you're out of your mind." He left, clearly shaken. Our mutual friend later asked why I hadn't suggested that Clarence just tell the bank he'd erred, and have him produce a corrected balance sheet. "Because then I'd become part of a conspiracy to commit fraud," I said.
The lesson here is this: No matter how much pressure you're under, don't ever lie on your financial statements to your bank. I just hope Clarence can learn that lesson without having to pay a heavy price.