Coping in the Economic Downturn: Financing family firms in a time of frenzy

It's been more than a year since the wars in the Middle East were driven from the front pages by the hurricane of economic and financial trouble. Here's a report on the character-building experiences ten family-owned firms I know have had during that time.

1. Money-management firm

A money-management boutique in the New York City area had been exploring combining with another firm. Firm A's experienced second generation ran the place day to day; the founder, nearing age 70, held the reins loosely. The leader of firm B, age 60 and without a successor, had to hold his key professionals, who were valued assets.

As their Wall Street world imploded, customers fled, margins shrank and the staffs worried. They firms decided not to wed yet but, in modern tradition, to live together. A had empty offices, and B and his professional group moved in. B agreed to outsource his back-office operations to A. Two of B's support people then were hired by A; the other two were let go. Both are operating profitably in snug quarters.

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2. Car wash

This well-capitalized operation, still in startup mode, features a state-of-the-art, highly automated, inviting facility requiring very little labor in a good location. It had agreements with nearby auto dealers to wash every car they sell or service for a lower price than the dealer could. That was its primary customer base. On top of that, service directly to consumers added the cream. As unemployment rose, consumer car washing vanished. Volume from dealers plummeted. The company reduced all prices 50%, and business returned quickly to positive cash flow. Says the GM: “We're going for the fast nickel instead of the slow dime.”

3. Auto dealer

In 2000 the owner of this business told me, “General Motors and Chrysler will never make it, and Ford is a long shot.” He had come to this conclusion in 1990, when he owned three American dealerships. From 1990 to 2005, he added six more stores featuring Asian or European brands.

The firm is operating profitably, but every month is a squeaker. New car sales have been a loss leader for more than two years. Service work is profitable and parts are about break-even. Used car sales and extra traffic owing to strong web marketing produce the profit.

The disappearance of financing for buyers created great difficulty. Loss or reduction of financing help from the factories has raised inventory costs. Advertising and sales staff have been slashed. The skilled non-family executives, led by a third-generation nephew, have been creative in generating sales and in cost reductions. Two American brand stores are expected to close eventually. The remainder are expected to be back to robust health by 2012.

4. Heavy and highway construction

This company moves earth, prepares building sites and constructs airports, highways, office parks and factories. The owners are used to seasonal work, demanding project schedules and equipment-intensive crews. They understand the value of planning.

For this firm, planning is paying off. The company has had heavy reverses in the current climate. Business in its home market in 2008 declined from the volume in 2007. A big drop in new orders for 2009 gave early warning. The company began to prepare for a tough 2009-10. A sister division (similar business) in a fast-developing area in a neighboring state was hard hit in 2008 and closed abruptly.

The company is well financed. Much of its heavy equipment is rented rather than owned. Most of the premium paid for rentals can be recovered in good times if purchase options are exercised. Thanks to a third unit that provides industrial maintenance and plant repairs, the company is cash-flow-positive; a low-profit year is the worst scenario.

5. Developer

This third-generation firm, working in the suburbs and exurbs of a major metro area, had three live developments in its pipeline in late 2007 when red flags began to fly on condo markets. One was about 90% sold; a second was under way with the third of six 36-unit, three-story buildings complete; and site preparation was in progress for another development.

The company's local banks disappeared to merger or failure, and Wachovia emerged as an aggressive lender to the business. The firm went wild with ambitious plans in 2008 despite growing signs of trouble all around. Early in 2009 Wachovia (North Carolina) disappeared into Wells Fargo (California). A month later, the bank seized the family company's cash. Days after that, the company filed for bankruptcy protection. It's a 50:50 bet that its Chapter 11 (reorganization) will convert to chapter 7 (liquidation). Management errors cannot be ignored. The bank looked out for its own interests, but the firm was already weak before the bank took action.

6. Ethnic food supplier

A couple, immigrants from India, launched a business six years ago. The wife and a kitchen crew prepare delicious Indian specialties that they sell in a retail shop in the same building. The husband and another crew handle catering and sell these and other products at a farmer's market stall in an upscale neighborhood. Their older daughter, age 12, works in the business after school and loves it. Their bootstrap financing, supported by a home equity line, was sufficient until rising unemployment in the area reduced catering and retail sales. Their income for now is whatever is left after expenses. They are smart and committed and likely to succeed as the economy improves.

7. Industrial distributor

This firm, with a huge central warehouse and nine branches, needs lots of capital for inventory and receivables. It sells equipment and supplies to commercial and industrial accounts (40%), direct retail to consumers (10%) and to contractors (50%). Banks were lending 60% to 80% against receivables and inventory to customers with long relationships and good records. This family was at 80%. After Lehman Brothers and Bear Stearns went bust, the bank proposal for 2009 was for 50%.

Through October and November 2008 the young second-generation owners weeded out 10% of the customers considered unacceptable risks by a tighter standard. A dozen of the 200 employees were discharged; 50 more had their hours reduced. Less expensive benefits were arranged. The company reduced inventory and instead pays premiums for overnight freight when a high-cost item is needed quickly. Suppliers were also cutting credit terms, and the second-generation management team negotiated extended terms for specific jobs in which the factories had a special interest.

Armed with these results, the second-generation members went back to the bank. The lenders were impressed with these actions as well as the firm's readily available detailed information and proposed reporting system. The leaders' deep knowledge of customers' finances (especially contractors') and long history of attention to credit and collections (including documenting the liens on construction jobs) led the bank to agree to 75%.

The company's current strategy is to run a tight ship and watch for opportunities to develop as weaker competitors struggle.

8. Materials producer

This 75-year-old provider of stone, sand, blocks, cement and allied products operates over a five-state area. The business is seasonal. Production employees, many of whom are long-tenured, usually have some weeks on layoff and quite a few on overtime. The company is very conservatively managed, with consistent attention to many operating, financial and safety concerns.

During early 2009, volume was down. A few failures among smaller customers produced accounts-receivable losses, and more staffers than usual were on layoff. In an effort to avoid still more layoffs, production crews spent a lot of time on maintenance and cleanup in late 2008. The company's facilities now look splendid.

With a strong balance sheet, a profitable history, and a competent third-generation group teamed with excellent non-family executives, this firm has no serious problems and is on the hunt for acquisitions.

9. Body shop

In 2006 the owners of this business concluded that the future belonged to industry players who were modern, high-tech, well regarded by auto insurance companies, and well managed. By 2008 the business had moved into a brand-new, state-of-the-art facility. The highly experienced and motivated manager was performing well, and business was growing. The business is still profitable, though profits declined as economic activity lessened.

A key to its continued profitability is the fact that it invested plenty of capital in the remodeling, with terms on the long-term debt that left room to breathe during the economic decline. As struggling competitors collapse, this business will grow.

10. Professional design and installation services

This 25-year-old, award-winning firm with a national reputation operates in a ten-state area. Managed by professionals and highly seasonal in nature, it struggles continuously. The addition of an excellent controller a year ago has helped a lot, but the root problem is undercapitalization. Every hiccough leads to a mini-crisis.

The firm's founder—the lender of last resort—personally guarantees bank financing for the company. In 2004 a term loan was negotiated. That extra capital was a huge help, and the business grew. Some benefit was lost because the design and project work and marketing efforts led to further neglect of the management function. Loyal, repeat clients provide excellent future prospects, and staff turnover is lower than normal in the industry.

Term loan payments to the bank have been sent on time, and the relationship is good. However, the firm does not qualify for more money or a renewal of its loan. Other banks have declined to lend. Before the arrival of the new controller, a pattern had developed. The company would issue checks without sufficient funds. The bank would pay these overdrafts and charge $25 per check. Within a couple of weeks money could be deposited to cover.

When the new controller arrived he surveyed the situation. He went to the bank and confirmed that the branch manager supported the firm. He also made a professional presentation for more money, but the higher division office refused the loan. So he negotiated a lower overdraft fee. This has continued for months. I've labeled this “the don't ask, don't tell financing approach.”

The bottom line

If your firm is undercapitalized, undermanaged or highly leveraged, you're in mortal danger this year of falling into trouble that could wreck the firm.

If you are well capitalized, have strong planning and controls in use and are leveraged conservatively, this is a time of great opportunity.

If you're between these two extremes, 2009-10 will be difficult and tense.

There's a silver lining in these clouds. Older family firm owners and veteran advisers have long worried because younger owner-managers lacked the experience of running things during a severe economic downturn. Now the younger generation is getting all they need. That'll do it for the next four decades!

James E. Barrett (jebcmc99@comcast.net) heads the family business practice of Cresheim Inc. in Philadelphia.

 


Panel: Cost reduction must be sustainable

In a program on managing privately held businesses through the downturn, held on March 25 in New York, a panel of advisers from PricewaterhouseCoopers noted that cost reductions must be made with business sustainability in mind.

“There's clearly a reduced appetite right now for investing in capital expenditures,” said David Zimmerman, the firm's Private Company Services tax leader for the New York metro area. “[But] the fact remains that if you're going to come out of this even stronger, there is a recognition that you're going to need to continue to invest in research and development.”

Zimmerman said companies are implementing tax strategies to enhance their liquidity. “They're looking for something that they can do today that will immediately enhance their liquidity by reducing the current tax liability or creating opportunities for refunds,” he said. “You're seeing tax strategies and tax savings right now, not only at the federal level but also on the state level.” Such strategies include taking advantage of incentives for creating or retaining jobs as well as seeking reductions in property tax assessments and state taxes, he said.

Companies are searching for ways to bring cash into the business quickly, noted Dave Pittman, a partner and national leader for sustainable cost reduction at PwC. A way to conserve cash, he said, is to eliminate the need for spending where possible. He also suggested reducing the number of employees with authority to spend money.

For highly leveraged companies, there is little benefit in attempting to get customers to pay more quickly, Pittman noted. “[If] I'm already leveraged 85 cents on the dollar, to reduce the receivables doesn't really help me, because I only get 15 cents,” he explained. A better strategy, he suggested, is to go after past-due receivables. “Banks don't lend on receivables past due 60 days,” he pointed out.

Companies reducing inventory must do so with caution, Pitt-man said. “If I don't have that inventory, my customer service can suffer,” he said.

Alterations in the business model could result in cost reduction, Pittman advised. When times were good, companies may have added brands or models that “created a lot of complexity in the organization, which is driving a lot of costs,” he said.

Many companies are learning from the cost-cutting mistakes they made during the last recession, Pittman noted. “As soon as the cycle turned, within a couple years, those costs came back,” he said. Today, business leaders are seeking management information that sheds light not only on profit-and-loss figures, but also on the factors that are driving the costs, Pittman said. Rather than creating an annual budget by simply adding or subtracting 2% or 3% from last year's figures, executives are asking, “What should I have spent?”

Seeking sustainable savings requires a cultural change in the organization, Pittman acknowledged. Communication and accountability are essential, he said.

—Barbara Spector

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