The surest way to ruin a man who doesn't know how to handle money is to give him some.· George Bernard Shaw
Monday, 31 March 2014
Billy’s Twentieth Law -- Banking Paradox Two: Just because your business is bankable, doesn’t make it viable!
Last week, we looked at banks’ lending criteria. This week, we look at the reality of a small business loans. Before the nineties, a business loan was scrutinised by a business banker. This is a time consuming process performed by a highly skilled individual. (Or so business bankers would have you believe!) Wells Fargo Bank in the Unites States made an interesting observation. The best predictive indicator for the repayment of a small business loan was not the business plan, but rather the credit worthiness of the prospective business owner. People who managed their personal finances well were more likely to repay their debts than those who did not.
This created an interesting dynamic in the small business lending arena. Personal credit history replaced the brilliance of a commercial credit officer. Personal lending criteria replaced business-lending criteria when granting smaller loans.
When this concept first came to Canada, it was revolutionary in banking circles. Banks could speed up their responses to smaller business loans simply because it is easier and faster to do a credit check than to analyse a business plan. I remember that the first loans were up to $35,000. BMO (if memory serves me) increased this to $50,000.
Over the years, this seems to have worked in Canada, as the loans are getting quite large before a commercial credit officer takes over your account. The refusal rates were lower, default rates dropped and the approval process was faster and simpler. The bank did not require a time consuming business plan, which includes the cash flow forecast. Entrepreneurs were happy and the banks were happy.
There is one problem with this situation. Many businesses are financed without the scrutiny that used to accompany a business loan application. The banks do not distinguish between a loan repaid with the proceeds of the business, the contributions of a willing spouse or even the redemption of RRSP’s, investments or sale of the house. The bank just knows that it was repaid for the loan.
In our business, we have seen many people scrambling to repay lenders using such sources. We have seen marriages come under huge financial stress, as one partner finances a business that takes all of the other partner’s time and efforts, as the enterprise sinks deeper and deeper into the financial abyss.
I cannot say that I blame financial institutions. Analysing a business proposal takes time and expertise. The cost of administering a small loan, given the small margins the bank receives on a smaller loan leads to such banking policies. Many people however are unaware of this. Some people see bank financing as an endorsement of the business or the concept.
Unfortunately, I don’t have an answer. I don’t think it is realistic to hold the bank responsible for the future of an enterprise, yet most people have no idea how to objectively evaluate a business, never mind a business concept.
So, as they say, Caveat Emptor. However, let this lesson be to you. Your financial institution really wants you to succeed, however; in the final analysis, they want repayment even more.
Tuesday, 25 March 2014
Neither a borrower nor a lender be, For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry.
Hamlet Act 1, scene 3, 75–77
This is the second of my three laws of banking. In the first banking law (Law Eight, for those of you who are keeping track) we discussed the dynamics of banking from the lender`s perspective. In this law, we examine how the credit officer (also known as the Loan Arranger) makes his or her decision. Banks often use what is called the five C`s of credit when determining whether or not to advance loan proceeds. These are:
Capacity (Cash Flow): This represents your ability to repay the loan from internally derived sources. The Cash Flow Forecast is one critical document in influencing lender`s decision.
Capital: This represents the amount of money the owners have invested, or retained in the business. We measure this by calculating the Debt to Equity Ratio. Banks don`t generally like having more at risk than the owner.
Collateral: This is the bank`s security should the loan fail. Internal security is found within the business. It can include inventory, accounts receivable and equipment. External security is pledged by the borrower from assets outside the business. This could include personally held stocks & bonds or real estate.
Conditions: These are the terms and conditions requested by the borrower. The amortization period of the loan is one example.
Character: This represents the personal characteristics of the lender or lenders. There are two distinct aspects…the management or business skills of the owners and the credit history of those same borrowers.
Notice, that the notion of business viability is absent from the decision making. Capacity (Cash Flow) measures the historic nature of the business, and possible lends itself to viability, however; the remaining criteria have little to do with the overall viability of the business concept and the ability of the owners to execute the requisite strategies.
Some businesses are not conducive to bank / debt financing. Businesses requiring a great deal of development time prior to operations (developing a computer application for example) have no security what so ever. An owner may take out a personal loan and invest it in the business, but this is very different from a true business loan where the bank grants the loan on the strength of the business.
Some entrepreneurs lack personal resources. This reduces capital, increasing the debt to equity ratio and thus making the loan more difficult to approve. Other entrepreneurs request term loans for items that quickly lose value (collateral). If you were a banker, would you rather approve a loan for a car or a computer lab? Computers lose their value very quickly, reducing the security value and thus making the loan more risky to the financial institution.
Over the years, I have worked with many entrepreneurs and ‘pre entrepreneurs’ and one recurring problem is the lack of start-up financing. It is not appropriate for the financing to all come from debt sources, including the bank. Non-traditional sources of equity such as crowd sourcing and even debt/equity hybrids are in their infancy. Until this is more common, the challenge of financing will remain difficult and therefore the borrower must understand the lender. Always remember:
It takes more than ideas to start a business, it takes capital. That’s why we call the system capitalism and not idealism!
Next time the opposite dilemma loans granted to non-viable business.
Tuesday, 18 March 2014
A business growing faster than its owner is like a little kid taking a big fast dog for a walk. Sometimes, we wonder who is walking whom.
Several years ago, I worked with Elizabeth Lake Ledoux of Denver Co. on some consulting concepts relating to business development. Elizabeth, along with her business partner Dr. Mel Wernimon developed a methodology of moving a business through seven different ‘strata’ with the ultimate goal of developing a sustainable, transferable enterprise.
When I looked at it, I thought it was great, but that it needed something. That something was the development of the entrepreneur. This later became the Entrepreneur’s Strata in their highly successful Entrepreneurial Flight™.
The eighteenth law emphasises the need for the entrepreneur to develop ahead of their enterprise. When the businesses’ development outpaces the development of the founder, the results are disastrous. The founder / owner is quickly in over his or her proverbial heads. If the ultimate goal of a business is to become transferable, then it must have the systems in place that allow it to operate successfully without the founder’s involvement. This allows for a successful succession plan… through either sale or a family member operating the business.
Businesses develop through three stages as they become ‘mature’ enterprises:
Nascent: This is the foundational stage of the business. The founder is usually an expert in the field, and is now learning about operating the business. Many founders never develop the business past the nascent stage and are happy to remain self-employed. They own a business that provides them a job.
Developmental: When the business owner begins to develop the business, they spend less time in operations or production and more time managing the business. At the same time, there are more specialist positions that develop within the company. If the business founder cannot develop managerial skills, the business often stalls in this area.
Sustainable: A sustainable business is a systems based business not dependant on any one individual…even if there are essential positions within the company. The business is often both scalable and duplicable increasing the growth potential. The founder must now develop even higher level skills called executive skills… thinking about the long term future of the business.
Matching these levels of business development are levels of entrepreneurial development. These three roles are:
Operational: In this role, the founder is an essential part of selling the product or service and producing or providing the same. She works in the store, provides the legal services or helps construction of the products. The time frame at the operational level is next week!
Managerial: In this role, the founder is actively managing the business. Although she is not necessarily producing or providing, she is actively recruiting, hiring and directing the operations of this company. This stage becomes a trap…with a larger enterprise requiring constant attention. The time frame is one month to one year.
Executive: In this role, the founder is directing the long term vision and direction of the company. She is thinking ahead, and ensuring that the development of the enterprise is consistent with her pre-determined vision and values. The executive time frame is beyond one year.
The eighteenth law is a warning… if you want to develop your business you must develop your skills before you enter the next phase. You must develop managerial skills before you leave the Nascent stage and enter the Development phase. To develop a sustainable business, you must develop your executive skills before you get there. To use a football analogy you ‘the passer must lead the receiver’ allowing him to run into the ball.
When I am working with my clients, I am constantly using the term ‘move north’. I get the owners to spend less time working on ‘today’ and more working on the future of the business. This inevitably means that others must also ‘move north’ in order to fill in the space left by the owner. This creates a chain reaction, of people moving north and fulfilling more executive and managerial positions. The result is a business reliant on positions rather than individuals.
If you want to develop your business, ask yourself, how much time you are spending on operational, managerial and executive tasks. The more time you are able to spend in managerial and executive tasks, the better ready the enterprise is poised for business growth.
If you are interested in more on the Entrepreneurial Flight, purchase Accelerate Your Entrepreneurial Flight: How to Energise Business Value and Entrepreneurial Growth, by Elizabeth Lake Ledoux and Dr. Mel Wernimont, Ph. D. It is available from Amazon. Alternatively, contact them through their website at: http://www.vnacelleconsulting.com/
Tuesday, 11 March 2014
I am the master of my fate:
I am the captain of my soul.From Invictus: by William Earnest Henley
The need to belong and the need for control are, in many ways conflicting needs. We are both communal creatures and fiercely individualistic. The control need is one of the dominant marketing messages provided in modern marketing…especially in North America.
Think about your own reaction when someone tells you what to do. Most of us hate it! An important factor that makes us adults is our independence. We want control of our lives…whether in our working lives, family lives, and financial lives human beings need a sense of control. Advertising uses the control need. Examples include Freedom 55 (financial services) and Have it your way (Burger King). In providing price choice we feed into the control need. If there is only one price , the customer has no control. If there are multiple price choices, then the perceived control reverts to the customer.
The control need is often closely associated with one of the other three needs. An increased sense of control leads to an increased sense in security. A lack of control may lead to diminishing status within the tribe. Our very individual identity provides the foundation for our control need.
Let’s consider this from another angle…the loss of control. Being a Star Trek fan, I cannot help but use the example of the Borg. The Borg would assimilate other species into the mass collective. This led the writers to create the line: “We are the Borg…You will be assimilated…Resistance is futile.” The key to creating any great villain is to play on fear. The Borg proved to be one of the great Star Trek villains as they threatened the very thing that makes us human…our individual identity. The threat to the control need hit viewers at a fundamental psychological level.
Trust messages are control messages as much as they are security messages. They allow the customer to retain control through you. A delivery date is a control message. Amazon created Amazon Prime. For a fixed annual fee, Amazon guarantees two day delivery. The competitive disadvantage for Amazon over retail stores is waiting vs. instant delivery. If I go to the book store, I get to start reading immediately. If I buy through Amazon, I don’t know when I will receive my book (lack of control). To some customers, this disadvantage might not outweigh the advantages of greater selection and better prices. When regular customers could trust a two day delivery window, they not only paid for Amazon Prime, but also ordered significantly more from Amazon.
In today’s business world, we often cede control to suppliers and take control from our customers as part of a complex supply chain. One of our manufacturing clients subcontracts a specialty service mid-way through the production process. Our client loses control of the process. Only trust makes up for this subordination of control. Likewise, this same fabricator has the trust of his customers, for whom he produces sub-components.
Control counts. Ensure you provide your customer a strong feeling of control by demonstrating that you are the kind of supplier and person, who comes through for them. Ensure you show them how they can gain a sense of control, or avoid losing that control and individuality so important to the human spirit.
Monday, 3 March 2014
If you can’t be the bride at the wedding or the corpse at the funeral, why go?
Last week, we talked about the belonging or associative need. Early humanity formed groups in order to thrive and survive. We instinctively need people. There is, however, another side to humanity and that is the importance of the individual. We are not only social animals, but we are unique … we are individuals. It is this context that brings forth the notions of the final two emotional needs, status and control.
Advertisers commonly use status as an emotional buying need. Status reflects our position, or our desired position within our group or tribe. The tribe may protect the tribe members from outside threats, but status is often a battle within the tribe. We want to know our status and, often, improve our status. We want more. To quote Abraham Maslow, “Man is a perpetually wanting animal.” (Alternatively, to quote Mick Jagger, “I can’t get no satisfaction.”)
We compete within the many tribes in which we live in modern society. I have brothers (the Family Tribe) and brothers compete. (I only have one sister, so I have no insight on how sisters compete.) We have our work tribes, our school tribes, and our social tribes. The notion of ‘keeping up with the Jones’s’ is just another manifestation of our desire to enhance our position within our various tribes. Tribes also compete with each other, often with a status method. Here in my province of British Columbia, the government proudly proclaims it. "The best place on earth."
If the first aspect of status is our position within the tribe, the second is our desired position within the tribe. This is our aspiration. Aspiration is also a huge influencer over our behaviour, including our buying behaviour. The target market for ‘Seventeen’ magazine is not the seventeen year old, but the fourteen and fifteen year old aspiring to be seventeen. The seventeen year old is perceived to have more status, and thus is desirable to emulate…at least within that demographic tribe.
Status manifests itself in many ways. Sometimes, the selection of a brand is in itself tribal. The Mac vs. PC commercials is classic examples of Mac presenting itself as the ‘cool’ group whereas PC is part of the ‘nerdy group’. As my daughter would say, “We never really left high school.”
Status is all about how we look to the outside world. Status manifests itself differently to differently people. My friends are real ‘car guys’. One drives a Mercedes SUV and the other a Porsche. I drive a Chevy Cruise. I used to drive a Saturn. For the most part, I want a sensible car that delivers good gas mileage and has a low cost per km. On the other hand, I was an early adopter of both the e-book (I had the Sony and now use a Kobo Glow) and pre ordered my IPad. I could tell you it is all about the technology, but status has a lot to do with these decisions.
Status is important in marketing. Even Wal-Mart has a campaign called the ‘second look’. The premise if the campaign is that Wal-Mart carries high-end brands such as Dyson and Samsung. The message is Wal-Mart is not as down scale as you might think. (I don’t know how effective this is, however they are certainly using a status based message rather than their usual low price message.)
Buying decisions are emotional. Status helps your customers achieve their status aspirations within their pier groups. General Motors designed brands to move their customers through these status stratums. You could start with a Chevy, move to a Buick and then eventually get to the Cadillac.
No matter your business, you should ask if it is appropriate to use a status message as a part of your overall promotional message. Next week, the fourth and final need …the need for control.