Small Business Working Capital Tug of War

Small Businesses today are caught in a Working Capital Tug-of-War with there larger big brothers.  Small and Medium businesses are further disadvantaged as they have had a smaller share of limited capital funding over the past several years.  



The following are top Working Capital Challenges faced by small businesses:

1.  Squeezing Cash Out of the business.  There aren't too many more areas left to cut.  Any growth has been fueled more from ongoing operations than borrowing or equity financing.  Businesses of all sizes are holding finance staff more accountable with increased focused on margins, Days Sales Outstanding (DSO), and Days Payable Outstanding (DPO) versus top line growth.

2.  Pent up Demand.  Large businesses are expected to start spending again.  More than 55% of small and medium businesses surveyed expect top line growth in 2011.  This growth will come from large business customers.

3.  Working Capital is the New Credit Reality.  Credit remains scarce.  More than 300 banks have closed their doors since 2008.  Bank lending showed the largest drop since the great depression.  More than 75% of small and medium business had their bank lines cancelled or restricted during this economic contraction.  We will not likely return to 2008 funding levels any time soon.


4.  Liquidity Gap needs to be closed.  We have a large capital divide between large and small businesses.  Debt is becoming more available and cheaper for larger businesses while small and medium business borrowing continues to be restricted.  For many Small and Medium business customers, their  customers are larger than they are.  Most small businesses are reporting DSO's are at all time highs.  The challenge is that large company customers are seeking to lengthen DPO's to manage their cash flow while small businesses are on the other side trying to reduce DSO's, on the other side/

Small and Medium business need to adopt with this financing challenge and secure a new mix of capital if they cannot realign DSO.  In addition to the usual capital sources, a new option is available to businesses with Business Receivables.  Receivables Auctions are becoming more economic viable financing options relative to bank Accounts Receivable financing and Accounts Receivable factoring.


How has your business been dealing with this Working Capital tug-of-war?

Financing: 8 Considerations for Taking Other People's Money

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Congratulations, you now have the proceeds from your financing efforts and survived the financing gauntlet.  You feel relieved and relaxed, but in reality that’s when the work and the pressure starts. Now, for the first time, you really have a boss, or several bosses, and often very demanding ones at that. Having participated in several venture capital fund meetings for Sprint's Pension Fund and helping small and start-up businesses develop business plans for venture capital financing, I've had a chance to see this in action from both sides.

Angel and venture capital investors rarely just give a small business or a start-up cash, and stand back to wait for you to spend it the way you want. First of all, they are generally experienced in your own domain, so they have strong views on what it takes to succeed.  Secondly, they likely didn’t give all the money up front, but made part of it contingent on meeting some measurable milestones. Your start-up is now part of a portfolio that is expecting high risk adjusted returns.  Here are a few of the ways you should expect to be monitored by your investors:

1. One or more seats on the Board. Maybe you had an informal Advisory Board before, but now you have a formal Board of Directors. This means you shouldn’t expect to make any strategic decisions without their approval. You should now plan for formal presentations to the board, with communications in between. Key business decisions that could be immediately executed after reaching agreement between you and another party now need additional approvals.
2. Manage to documented milestones. A normal part of a funding agreement is a set of accomplishments, with dates, that you are expected to achieve in order to remain in good standing and qualify for remaining cash distributions. These covenants can be either financial like cash flow, operating profit, etc. or operational such as customer counts, transaction volumes, etc.  Treat them as management objectives that will get you fired if you don’t perform. You will also need processes to routinely track and predict these measures and be able to explain variances.
3. Visits from key investors. Both angel investors and venture capital partners like to make personal visits to your facility or a regular basis, sometimes unannounced, to see how the business is running. You should expect to personally host these visits, and openly answer any questions or concerns that are raised. Do not delegate these visits.  You always should be able to speak to your key measurements.
4. Number of  contacts from you. Every investor expects to be contacted and updated proactively on key decisions or issues. A quick way to lose investor confidence is to always wait for the investor to call, or inversely to call the investor for every minor decision. It is a balancing act that needs to be managed.
5. Access to operational information. All investors have information rights which are detailed in your contracts. They generally expect you to share key operational data, such as the sales pipeline, developmental efforts, vendor discussions, and quality issues, at any time. Don’t keep secrets from your investors.
6. Extra focus on cash flow. Remember, it’s their cash, so treat it like gold. Because you now have money in the bank, now is not the time to upgrade to Class A office space, or travel around the world first-class on company business. Pinching pennies and bootstrapping like you did in the early days is still the only approach.
7. You are now graded.  Also realize that you are now being "graded" compared to other companies in their portfolio. It is to your advantage to keep track of how your company performance compares to others in the investor’s portfolio. You may think you are doing well, but if your numbers put you at the bottom of the ranking, you may need to decide that taking more risk is better than the risk of being cut from the source of financing.  On the other end of the spectrum, if you are one of the top performers, a venture capitalist may encourage you to take big risks and swing for a home run, even when a base hit or double would be a smarter move from your perspective.
8. You have more paperwork.  You will now have firm dates to turn in financial and planning information that your processes must now meet and they will likely vary from the ones you used.  Comparison to your documented milestones is key.

You no longer have full control, and you don’t need any surprises, just like the investor doesn’t want any.  The simple fact is that your whole world as an entrepreneur changes when you take someone’s else’s money. Do it with your eyes open.

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More Interesting Factoids

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I enjoy looking at numbers and look at interesting number lists from a variety of sources.  I found the following interesting factoids in the October 16, 2010 edition of Human Resource Executive magazine that was compiled by John Kador.  They give you varying perspectives of the impact of our economic slump and implications for financial planning.

• 75%  Percent of candidates who had five or more interviews per month since the beginning of their job search who have not received a single offer based on a survey of 79,000 job seekers.

• $400,000  The expected amount of money that the average worker in a 401K retirement is expected to amass given ideal conditions, over 30 years.  The actual average to to 401K "leaks" (withdrawals, missed contributions, hardship borrowing, etc.) over 30 years brings the total to $60,000.

• 42%  Percent of employers in 2010 who believe that the recession has increased the quantity and quality of candidates they recruit.

• $8.25  Wage per hour paid by the Mid-Atlantic Regional Council of Governments, a union, to hire nonunion picketers to protest the hiring of nonunion help.

• 3.7  Number of years the average adult over 18 with solid social relationships outlives those with few or no friends.

• 5  Number of states whose public pensions were fully funded at the beginning of 2010.  In 2000, 26 states were fully funded.

• 72%  Percent of workers in small companies not covered by a retirement plan.

• 59% Percent of workers who expect to receive a pension upon retirement.  But only 41 percent can identify a pension to which they are entitled.

What interesting numbers have you come across?

Business Pricing Strategies

One of the toughest decisions for a small business or start up is pricing their product or service. When we launched Sprint PCS, we had 21 major pricing elements to evaluate for our initial launch pricing positioning. We had to determine what was bundled, what was free, and what was individually priced.  We also had to make sure that the overall yield was consistent with the business plan that supported billions of dollars of investment.  Today for start ups, the choices range from giving it away for free, to pricing based on costs, to charging what the market will bear. The implications of the decision you make are huge, defining your image, your funding requirements, and your long-term business viability.  Your revenue model is the key to your business strategy.  Doing it right the first time is important since making mid course changes can be disruptive to your business.

 Here is a summary of common revenue models used by businesses today, with some of the pros and cons or special considerations for each:

1. Product or service is free, revenue from ads and critical mass. This is a common model used by Internet start ups today, the so-called Facebook model, where the service is free, and the revenue comes from click-through advertising. It’s great for customers, but not for start ups, unless you have deep pockets and can convince investors of future revenue generation capabilities. If you have real guts, try the Twitter model of no revenue, counting on the critical mass value from millions of customers to generate revenues down the road.  Ning, a social network platform tried this with a and had to transition to a "freemium model" to a tiered paid model.
2. Product is free, but you pay for services. In this model, the product is given away for free and the customers are charged for installation, customization, training or other recurring services. This is a good model for getting your foot in the door, but this is basically a services business with the product as a marketing cost.
   
3. “Freemium” model. In this variation on the free model, used by LinkedIn and many other Internet offerings, the basic services are free, but premium services are available for an additional fee. LinkedIn's advantage is that they have been able to attract a segment willing to pay these fees. This also requires a huge investment to get to critical mass, and real work to differentiate and sell premium services to users locked-in as free.
   
4. Cost-based model. In this more traditional product pricing model, the price is set at a multiple of the product cost. If your product is a commodity, the margin may be thin. Use it when your new technology gives you a tremendous cost improvement. Skip it where there are many competitors.  A lot of contractors use this approach.  A key here is to monitor the appropriate multiple as cost structures do change over time.
   
5. Value model. If you can quantify a large value or cost savings to the customer, charge a price commensurate with the value delivered. This doesn’t work well with “nice to have” offerings, like social networks, but does work for products that uniquely solve critical needs.
6. Portfolio pricing. This model is relevant only if you have multiple products and services, each with a different cost and utility. Here your objective is to make money with the portfolio, some with high markups and some with low, depending on competition, lock-in, value delivered, and loyal customers. This one takes expert management and ongoing analysis to work.
   
7. Tiered or volume pricing. In certain product environments, where a given enterprise product may have one user or hundreds of thousands, a common approach is to price by user group ranges, or volume usage ranges. Keep the number of tiers small for manageability and make sure you have a good sense of your products economics with various volumes.
8. Competitive positioning. In heavily competitive environments, the price has to be competitive, no matter what the cost or volume. This model is often a euphemism for pricing low in certain areas to drive competitors out, and high where competition is low. Competing on price alone is a good way to kill your start up. It is important to have strong elements such as service and quality.
   
9. Feature pricing. This approach works if your product can be sold “bare-bones” for a low price, and price increments added for additional desirable features. It can be a very competitive approach, but the product must be designed and built to provide good utility at many levels. This is a very costly development, testing, documentation, and support challenge. At Sprint PCS, we did the first inbound minute free at launch to make customers comfortable in receiving calls and giving out there PCS phone number to generate traffic and awareness since the existing analog cellular service was mostly outbound calling.
10. Razor blade model. In this model, like cheap printers with expensive ink cartridges, the base unit is often sold below cost or with minimal margins, with the anticipation of recurring revenue from expensive supplies. This model that requires deep cash pockets to start, so is normally not an option for start ups.

Your business model interacts closely with your marketing model.  Marketing is required to get visibility and access to the opportunity, but pricing defines how you will actually make money over the long term and drives your cash flow. Your challenge is to set the right price to match value perceived by the customer, with a proper return for you.

I received the inspiration for this post from Martin Zwillings Startup Professionals Musings blog.

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