Tuesday, July 28, 2009

Inequity Among Business Partners with Debt Guarantees

 Here is a real situation that has a partnership of four up-in-arms:

Each partner owns 25% of the business.  Three of the four partners have stellar credit and decent net worth.  The fourth partner had a bankruptcy 4 years ago and does not have much net worth, other than the value of the business, to speak of.
The company has a customer present an opportunity to them to double their business in 12 months.  The catch - they will need to buy over $1,000,000 of equipment to capitalize on the lucrative opportunity.  Even though the credit markets are tough, this company is able to secure the financing it needs under one condition - the three partners with good credit have to guarantee the loans, but the fourth partner cannot.
The three partners have exposed themselves to more risk than the fourth.  So, is the partnership still actually equal?  Not in terms of risk.
In this scenario, the three partners are fine to expose themselves to this additional risk to give the company a chance to grow.  They do wonder, however, if they should in some way receive compensation for taking on more risk than the fourth partner.  If for some reason the company defaults on the loans, then the  three who signed personal guarantees will have to resolve the issue eventually with the creditors.  The fourth partner gets to walk away without these issues.
I have seen some interesting ways to handle this issue, and I would welcome additional feedback on how to best handle this.  Any and all ideas are welcome.
One last thought - if anyone is considering taking on one or more partners in their business, this is an issue that should be considered and can even get in the way of financing your business.  If your partner owns at least 20% of the company, some lending institutions will require that they run a credit check on them - and if their credit is bad, the lender will probably decline the loan!
I received some great feedback on a social networks that I wanted to add:
Mark McLeod says:
Interesting situation Ken. You could approach this a few ways: 
1.) Risk adjusted return on the leverage the 3 partners are taking on: some additional premium either as a % of the loan or non equal distribution of profits from the incremental business
2.) Separating the legacy and new business on paper and again having non-equal profit split on the new piece.
3.) Re-evaluating whether this 4th partner is necessary for the future of the business. Will he drag them down or can he be an equal and full contributor?
Peter Towle says:
Another option to explore IF the other partners want to keep the 'bad-credit' partner in as an equal profit participant (or try to keep it equitable) is to create a side agreement between the partners that encumbers the 'bad-credit' partners assets, future assets, or share of the business should there be a problem.
Richard Wong says:
Some good answers from Mark and Peter, I would also add the possibility of another:
Since this new business will result in a major change in the net assets of the company and I am under the assumption the partners like working with each other and that's the reasons they're still partners that they revise the partnership agreement to show the new partnership percentage based on this, otherwise it may be time to incorporate.
They have a holding company, where 3 of the 4 are given a larger %ge of the shares, a subsidiary (the main operating co.) and then based on some measure ie. net profits of the added customer business dividends could be given to the 3 shareholders who took the credit risk, until the loan is repaid, then based on some sort of gentleman's agreement that the 4th partner earn his way to an equal shareholder percentage. 
Now the above could all be thrown out the window if say the 4th partner is the one who brought in the customer and negotiated the extra business because let's say he's a better salesperson than the other 3? 
Hope you can facilitate a paper solution to this Ken.
Great feedback so far...I'm open to more ideas, thoughts, and suggestions!

Thursday, July 23, 2009

The Pleasant Nuisance Theory of Collections

Every economic downturn is marked by extended receivables collection.  More businesses need to rely on their vendors, suppliers, and contractors to finance the increased time and effort required to collect their receivables - this creates a significant tightening of cash flow through and entire supply chain in each industry.

The tightening credit markets have only accentuated the problem as most businesses are not able to rely on traditional banks for to finance their working capital - which is defined as the difference between the time a business needs to pay its payables and the the time it takes to collects from its customers.

We subscribe to and teach the Pleasant Nuisance Theory.  In its simplicity, it uses consistent yet pleasant messaging to be just annoying enough but pleasant and professional enough to ensure that we are first in line to receive any payments being sent by our customers.  Here is more detail on how it works (we will assume that all customers in this example are invoices on a net 30 basis).

First, someone in the firm needs to fill the role of "pleasant nuisance."  This individual needs to devote a specific amount of time every week to contacting customers that owe money.  Sometimes 1 or 2 hours is all it takes.  The entrepreneurs, founders, CEO, and anyone involved in sales and marketing should NEVER fill this role.

Second, the "pleasant nuisance" should contact every customer within 15 days of when the customer receives an invoice from the company.  The call (yes, an actual phone call, which should not be confused with an email, text message, tweet, or status update on FaceBook) should go something like this: "Tammy, this is Steve with the XYZ Company.  I wanted to thank you again for paying our last invoice so promptly.  Also, I was calling to make sure that you received our invoice #15224 dated June 1st.  Have you seen it yet?"  If Tammy says yes, then respond with something like this: "Great.  Thanks for confirming that.  Do you have any questions or concerns with it?"  If she says no, then say something like this: "Oh, I would have thought you would have it by now.  May I email or fax it to you right now?"

The third step comes with a phone call within about 1-10 of the invoices due date.  The call may go someting like this: "Tammy, this is Steve from XYZ Company.  We discussed invoice #15524 a little while ago and you were able to confirm receipt of that invoice with you at that time.  Are there any concerns or hesitations with paying it by its due date next week, June 30th?"

I hope you can sense the pleasant part of this process.  It isn't really much of a nuisance.

Fourth, if we call have not received the payment on the due date, we might have a phone call like this: "Tammy, this is Steve.  Today is the due date for invoice #15224 and we have not yet received payment - we were expecting it today.  Could you confirm that the payment has been issued to us?  What date was the check mailed?"

If the customer does not confirm payment, then we step up our pleasant nuisance efforts by seeking commitments and then holding them to those commitments.  Our leverage points may be finance charges, late fees, or termination of their credit terms altogether.  We'll save those parts of the pleasant nuisance theory for a future blog post.

Conclusion - you will be surprised that two things happen.  First, you will start getting paid on-time and sometimes even early more often.  Second, you will train the AP clerk or accountant at your customer to expect your follow-up and want to give you good news each time you call.  You may even establish a good relationship with them!

Tuesday, July 21, 2009

Giving Has a Tangible ROI

I just finished reading one of the best articles of the year.  Perhaps I enjoyed it so much because it validated at least some of my core beliefs and the way I try to operate.  The article was published in the BYU Magazine from a speech given by Arthur C. Brooks titled: "Why Giving Matters."

Focus on giving, and the getting will take care of itself.  I have always tried to live by this, and it was the theme for the speech I gave at my graduation from MBA school.  I especially appreciate Mr. Brooks' recognition of how his research has validated many of the principles taught within the Servant Leadership movement.

"The study concludes that when people see strangers giving charitably, they recognize a leadership quality in those strangers.  If people witness you as a giver, they will see a leader.  When people see you giving and cooperating and serving others, they will see in you a leader, or a future leader, and they cannot help but help you."

The most powerful part of the information Mr. Brooks presents is that he tried to dis-prove and invalidate all of his findings.  His data and research have passed much scrutiny and the facts just do not lie...those who give of their time and resources are better off, from both a financial and overall happiness perspective!