In my consulting practice I witness the struggles of small business on a daily basis. Cash flow and undercapitalization are the main culprits and often there is a definitive path towards the proverbial financial cliff. Starting a small business is no easy feat. If one considers the risk, particularly in this economy, and the impact on the livelihood of those entrepreneurs who dare take that leap of faith, it is truly amazing that so many small businesses are created daily. However, as our website warns,
According to Dun & Bradstreet in the next 60 minutes, 12 businesses will file for bankruptcy and another 317 will have suits, liens, or judgments file against them.
Let me add to the above. According to Bloomberg, 8 of 10 businesses fail within 18 months. How real are these figures?
Our firm is based in St. Louis, Missouri, which is the 19th ranked Metropolitan Statistical Area (MSA). There are roughly 55 MSA with a population of 1 million or more. In a typical month, there are probably 100-150 civil suits brought against businesses in my MSA that consist of breach of contracts or similar contractual suits. That does not include civil litigation in other classifications. I am also not counting litigation that occurs in the adjoining counties in the State of Illinois that are also part of the MSA. In the most recent issue of the St. Louis Business Journal (a weekly publication), there were 50 entities facing Federal tax liens and 30 facing State tax liens. It is fair to suggest that in any given month there are actions numbering in the hundreds against businesses in my part of the country.
Of course, the aforementioned statistics do not describe the outcome of litigation or tax liens. Some of these cases result in judgments against businesses while others may be settled. A small business facing litigation has several choices. Sometimes a business simply ignores the suit hoping it will go away – it won’t. The outcome of this choice will likely be a default judgment against the business.
Many will simply act reflexively and hire an attorney. It probably does not send the best message to a creditor that you have enough money to hire an attorney but not pay a debt. Here is an often ignored point about hiring an attorney for these types of civil litigation. The courts recognize that frequently there are no substantive legal points to discuss. Creditors have no other legal recourse to getting paid than initiating a law suit. There often is no disagreement that a) money is owed and b) the amount owed. If a business chooses to go to court under these conditions, they need to understand what a loss entails. A loss means liability for the original debt and potentially plaintiff attorney fees, interest charges, court costs and interest on unpaid balances that can be as high as 18% per annum. Add to this sum your own attorney fees. Such an outcome can be a death knell and eventually lead to bankruptcy.
Some business will try to deal with a creditor directly or negotiate with the creditor attorney. This is often an emotional proposition for a small business debtor. Negotiations are difficult and potentially time consuming. Small business owners often lack the expertise to settle such matters on their own.
Another path is to use the services of a business restructuring firm that will holistically evaluate the small business debt situation, arrange for new sources of capital and settle litigation out of court. Depending on the age of the debt, creditors welcome out of court settlements since it means getting cash sooner and with greater certainty. The expedient resolution will mean reduced attorney fees for the creditor. At the end of this process, the goal is to have a viable company with the capacity to employ workers.
Hopefully a business does not face legal challenges and can remain healthy. This gets back to my initial point about cash flow and capitalization. Credit facilitates both of these. As I have written often, credit = confidence. How a business manages its credit is directly proportional to the confidence a creditor will have. Consider the following for managing business credit:
1. Does the business have a credit file?
2. Did the business establish a credit history?
3. Be timely with bill payment.
4. Monitor the business credit file.
5. Monitor the credit of customers and vendors.
Even during prosperous economic times, a business may fall behind with debts. If I had to describe an anatomy of small business path to litigation it occurs something like this:
1. 1/3 of accounts payable are overdue by more than 90 days
2. Debt payments skipped to meet payroll
3. Collection letters from suppliers
There are a myriad of reasons why businesses fall into this track. Some of these reasons can be personal. Some we can attribute to unforeseen circumstances. Sometimes it may be the fault of a customer or a supplier. I remember a conversation with a paving company that was being sued by its supplier. The owner mentioned that this supplier almost put him out of business. The supplier’s product did not perform as advertised and the business owner was involved in significant remediation work.
If I had to identify managerial reasons that affect cash flow, I can point to a couple of factors. I believe the market tells you what it needs but you have to ask and listen. I find the story behind Zappos, the online shoe retailer, fascinating. The founders had an idea to sell shoes over the internet but the voice of the market had not spoken to them. To get the market to speak, they threw up an online store with shoe images (ask) and gauged the response (listen). Their initial fulfillment came from purchasing just-in-time inventory at retail prices. Granted, this was not profitable but they knew shoe sales on the internet garnered interest. The interest in online shoe sales on its own did not imply a successful business.
The business also has to define and articulate its value proposition. The first time I shopped at Zappos, I noticed I could get a variety of shoes in size 14. The largest size I usually found in most bricks and mortar stores was 13. It was easy to navigate Zappos.com. Perhaps more importantly a customer could try the shoes in their home and return them without charge if they were not satisfactory. In other words, Zappos created the in store experience without having to venture to the mall. I have no doubt that Zappos spent much time listening after they constructed their web site.
Not many small business ventures develop into a Zappos. Businesses such as restaurants and retail stores experience high failure rates. While I certainly see those types of business experiencing litigation or tax issues, there is another industry that recently captured my attention. Small trucking firms that lease their vehicles are experiencing a noticeable amount of litigation. I’m not certain if there is a broader economic implication though the movement of goods is obviously central to our economy.
Small business failures don’t make the nightly news. At a minimum, small business comprises some of the pistons of the economy’s engine. We should root for the small entrepreneur. Remember that big companies were once little companies.