Most family business owners know they have to spend money to make money. But too often, they don’t spend money on long-term, strategic projects that can catapult the company ahead, out of fear that the added expense might violate covenants of loan agreements or simply anger family shareholders by reducing expected dividends. A simple tool that is part accounting technique, part management technique, can help.
Strategic investments are particularly critical right now. The competitive landscape is changing rapidly, with new demands from e-commerce, customers, and suppliers. Many of the best responses are intensive projects such as starting an e-commerce site to acquire new customers, hiring outside executives, altering product and service lines, and training employees to use new technology.
However, family owners often don’t exploit these projects because of two strong disincentives. Although the payoff typically accumulates over several years, the expense must be taken in the current year, since there are no tangible assets such as buildings that can be depreciated over time. That means the company will take a big hit, killing profits for the current year. If the business is living in part off borrowed money, loan covenants may prohibit the company from lowering its cash balance below a certain threshold. And family shareholders who are accustomed to receiving dividends might not get any that year. I don’t have to explain the contention that may cause.
As a result of these pressures, many owners put off strategic spending. They know instinctively that they should invest the money, and they are uncomfortable not doing so, but in the end they don’t. At best, they squeak one or two projects through, in stop-go fashion, disguising the expenses inside other budget categories.
The tool to reverse the situation is “planned strategic spending.” It is a different way of presenting financial information to lenders and shareholders. In effect, it is an extra report attached to standard documents that show operating expenses, and it explains the costs and payoffs of strategic projects as something different from the norm. If prepared properly and explained, the planned strategic spending report may well inspire lenders to adjust loan covenants, and prompt family shareholders not only to refrain from complaining about lower dividends, but even rally behind the projects’ promise for long-term gain.
Damn the rules
Planned strategic spending (PSS) gives owners a way around accounting limitations. Most of the cost of strategic projects is usually for labor, information, special services, and travel. The accounting rules charge all of these costs against current operations, making them ineligible for classification as “investment” because if they fail, there is no residual value—unlike “investment” in a building.
But this view is absurd. The sales project that resulted in no new customers this year but will generate new accounts next year; the manager who was developed for promotion next year; the service enhancement readied this year for introduction next year—all are initiatives that will produce returns for years to come. Failing to credit these as investments puts pressure on executives not to pursue them, but rather to save the cash and show better profits and ratios. But this is a recipe for disaster. Rarely a week goes by when we don’t read about yet another company that fell behind in such spending on information systems, market and product development, research, or training, and now can’t afford to catch up.
The best way to manage these necessary projects is to group them into a special category, explained in a PSS report. The PSS brings them out into the open, making lender and shareholder support much more likely. The PSS makes it clear that there is a higher level of risk in these projects, but that the company will put more effort into planning, managing, and measuring them. With more detail, open communication, careful constructive reviews, and lack of scapegoats, owners can develop needed confidence among shareholders, board members, and lenders.
Setting up PSS
There’s not a lot of rocket science to a PSS report. The finance departments may grumble because they’ll have to do a bit of project accounting. Otherwise, the best approach is to have the manager of the intended project set up the report, have a forward-looking accountant create the financial details, and have the CEO or CFO oversee how the values are set on the eventual tangible and intangible payoffs. Once this team is established, it can take the following steps.
1. Identify what has to be done to change the business, either because of good opportunity, the need to respond to some outside entity, or because the company has fallen behind in some area.
2. Develop a detailed project plan for each change. Each plan should include material describing the situation (where we are), the defined need (where we need to be), specific targets (what will be delivered), and the general strategy (how we’ll get there)—including how much will be done by the company’s own people and what will be contracted for, rented, or purchased. Detailed tactical plans are not necessary at this stage.
3. Define the leadership and staffing requirements: Who should do this? Is this an opportunity to groom someone for bigger things? How many employees need to be involved? Do they want to be?
4. Specify time and money: When should this be done? How long can it wait without creating problems? Is it big enough to require phases? What is the preliminary budget and work schedule?
Owners take note: Few family businesses have the discipline to carry out items 2, 3, and 4, much less the steps that follow. There is a strong tendency to handle this verbally and skip a lot of detail. This is a mistake. A rigorous, written report that properly lays out all the aspects of the project will be needed to garner lenders’ and shareholders’ support. Anything less will only reduce confidence, add delay, and lead to dissatisfaction.
5. Check the value. Get a different group of employees, board members, or advisers to work up a page on the value of this project. What will the benefits be? How much money will this bring in? How much less can go out? There is room for honest differences about assumptions and payoffs. Consider using a tri-level forecast of increased revenue or reduced expenses, in which column 1 is “pessimistic,” column 2 is “realistic,” and column 3 is “optimistic.”
First assess tangible benefits and expenses. Then try to get specific about soft tangibles—new procedures that improve productivity, reduce waste, use space better, or allow more efficient team interaction.
Finally, take a shot at intangible benefits, which can be very important to employees or customers even though they often are seen by managers as marginal. One example is the reduction of small, daily aggravations in the life of an employee. I’ve seen hundreds of these cleaned up inexpensively as part of a bigger project. Often, managers pooh-pooh these measures because they’ve forgotten how much small things can matter when you’re grinding the work out day after day. Ask others for input to complete this exercise.
6. Develop careful measures of the project’s various payoffs. If, for example, you claim a project will improve intangibles that will create greater customer satisfaction, describe how that satisfaction will be measured. Again, add fresh faces for this step—someone farther down in the organization, or a friendly customer or supplier. They’ll bring useful ideas.
With this level of preparation, pull the strategic projects together on a spreadsheet to see how much money will be required by when. With your PSS report in hand, begin to educate senior managers if they were not involved, outside directors and advisers, your lenders, and your shareholders. The thoroughness of the PSS work, and the broad involvement of people, will impress them. Listen carefully to their reactions, fine-tune the plan, and continue to improve their understanding until you feel their confidence.
Then move forward. Ask the lender to alter a loan covenant. Ask shareholders to defer a dividend. They will most likely be happy to do so, knowing they will benefit even more in the end. Then ask your employees to work their tails off and present ongoing written reports of progress, which you can present to the bankers and stockholders to maintain their enthusiasm.
James E. Barrett heads the family business practice of Cresheim Consultants in Philadelphia (jebcmc99@att.net).
Examples of strategic projects
- Organizing and improving information databases.
- Customer acquisition work.
- Product/service improvements.
- Web page, e-commerce startups.
- Employee training.
- Moving from paper to electronic records system.
Benefits of planned strategic planning
- Identifies investments now charged to daily operations.
- Measurement requirements improve project plans.
- Reduces stop-and-go spending, which damages projects.
- Helps reduce internal arguments.
- Gives CEO confidence to persist.
- Helps raise board confidence.