"When you can’t go back, you have to worry only about the best way of moving forward."
— The Alchemist, Paul Coelho
It’s the start of the second half of 2020, pandemic-induced shutdowns are lasting longer than most businesses initially thought they would, and the rate of infection in the U.S. is getting worse, not better. Although the world will get back to “normal” at some point, it’s going to be a while.
Yes, the stock market is signaling optimism for the future and steps taken by the Fed and the government have helped, but banks and others who supply capital to privately held companies are wary. As a small- to mid-sized business owner, what do you do now?
First, here’s why we believe we are most likely still in the early phase of this downturn:
Of course, those who make predictions run the risk that history will prove them wrong. For example:
"I think there is a world market for maybe five computers" – Thomas Watson, Chairman of IBM, 1943.
"Stocks have reached what looks like a permanent plateau" – Irving Fisher, Professor of Economics, Yale University, 1929.
"We don’t like their sound, and guitar music is on the way out" – Decca Recording Co., rejecting the Beatles, 1962.
- Most companies still face dramatically lower demand for their products and services. Regardless of whether a state has imposed a “wear a mask” order, consumer behavior and consumer confidence will continue to be affected until this is largely behind us.
- Businesses have used PPP funds to keep employees on the payroll up to now, but as those funds are exhausted and demand stays muted because consumers are nervous, costs need to be cut. That means more layoffs, which further reduces demand.
- Distancing and sanitizing help, but until there is a vaccine, there is no “business as usual”.
- Most businesses are experiencing lost productivity or incurring additional costs to keep their employees safe.
Quoting the President of the Federal Reserve Bank of Richmond, Thomas Barkin, “The economy rode the elevator down but will have to climb the stairs back up.” While Q3 is likely to be better than Q2, we do not believe a “V” shaped recovery is in our sights. The recession will hit different industries unevenly – the travel and hospitality industries most significantly, followed by restaurants that operate on small margins. Commercial real estate with heavy exposure to restaurants and retail are also in for a rough time. In contrast, if European and Asian countries continue to show signs of conquering the pandemic, U.S. companies that export to those markets could benefit, depending upon tariffs.
Given that we’re in this for the long haul, it is a good idea to revisit the “Five Battlefield Directives” that we described some months ago to help businesses survive the fall-out from the pandemic. As a reminder, the five directives are:
- Cash is king.
- Your previous budgets and forecasts are wrong.
- Embrace working from home.
- Do not plan to raise capital this year.
- Look for opportunities.
While all five still apply, given that the economy is going to be challenging for the foreseeable future we are updating three of them:
Cash is (Still) King
Cash is the grease that keeps the internal workings of a business running smoothly. Since the recovery is going to be delayed and protracted, keep a close eye on your receivables – they’re close to cash, but they’re not cash. Recently, a friend told me that GNC, who owes his business a quarter of a million dollars, had just filed for bankruptcy. That receivable suddenly went bad. In many respects, a business is only as healthy as its customers’ health, so shine a bright light on your receivables, including your A/R aging schedule, and be proactive with accounts that are slipping.
If your business will need more cash soon, consider an Economic Injury Disaster Loan (EIDL), available to qualified small businesses. There had been a halt on new applications for EIDLs other than for agriculture-related businesses, but the program has reopened. Once you are approved, the money is available quickly and can be a lifesaver. EIDLs do not restrict PPP eligibility.
If you have debt and expect to have a difficult time servicing that debt in the near-term, as we discussed in our post on Cultivating Your Relationship With Your Bank, it’s a good idea to over-communicate with your lender, and with your investors. A “special situations” lender recently told me, “We're willing to be part of the solution, but we need to see that the company and its investors are participating in that solution.”
Lenders want to see that you can clearly articulate what you need. They do not look favorably on a business whose CFO or CEO says, “I have a problem. What do I do?” They want specifics, such as “We are seeking an advance of $X for the next 90 days to cover Y and Z; here's how we're going to turn things around, and here's our 13-week cash flow forecast.”
Provide hard data and forecasts that are based on reasonable assumptions. Be willing to update your cash flow forecasts every week. Also, be prepared for higher borrowing costs, tighter lending standards, greater due diligence and more restrictive covenants. If you're willing to back up your claims and show that you're taking some of your own medicine (i.e. costs cuts and or equity injection), there’s a better chance a lender will be willing to partner with you to help you succeed.
Your Previous Budgets and Forecasts are Wrong (Again)
It’s time to throw out the budget you made at the end of Q1, when lockdowns were fairly new and the assumption was that after 6-8 weeks, most businesses would reopen and business activity would rebound quickly.
Start by making a new forecast for the rest of 2020, and make a 12-month forecast that is updated every month on a rolling basis. Come up with a base case scenario (e.g., anemic growth for the rest of the year), and a worst case (e.g., lockdowns are re-imposed), and figure out what you would need to do to survive the worst case.
Reassess where your business is spending money, in every category. Take a hard look at whether you are keeping employees that you really can’t afford to keep. Examine the profitability of each product line or service.
- Is a product/service generating a return that justifies supporting it for now?
- Is the sales pipeline genuine, or have salespeople been reluctant to downgrade the probability of closing a piece of business because they fear for their own jobs?
- Could the resources used to support a marginal product be deployed more profitably elsewhere?
In other words, take this as an opportunity to reassess how your capital, your human resources and your management time and effort are allocated.
If your new base case forecast reveals that your business is in serious trouble, be realistic when determining what you would have to do to get back to profitability, or what other strategic options might be available. It may be that none of those options are particularly appealing, but it’s better to face it head-on rather than just allowing things to happen to you. You will need to find ways to extend your runway so you can execute the various strategic options. Your banker and professional team might be able to refer you to someone who can help sell your business.
Look for Opportunities
Recessions, as painful as they are, prompt innovation. They have a way of restructuring some industries and changing some types of consumer behavior permanently. Do some big picture thinking instead of just counting on things going back to the way they were in early Q1 2019For example, reassess your revenue sources – where is demand coming from now? Is that shifting?
Identify your best customers and brainstorm ways that your business can focus marketing and support on those customers, to keep them happy and to grow that segment (here’s an idea – ask them). Also, make sure your good customers are aware of your full line of products and services. We’ve seen so many cases where a customer says “we didn’t know you guys also made X…we’ve been buying that elsewhere” – ouch. That’s a missed opportunity.
Is it time for some internal renovation? Evaluate how your senior team responded to the situation over the past three months. Who was a “deer in headlights” and who rose to the occasion? If you identify people who didn't perform well, know that there is more talent on the street right now than there has been in a long time. So, there really is an opportunity to upgrade.
Think beyond the normal boundaries of your business. Even though the economy is in a tough place, you may be able to stretch in a different direction by identifying what you already do well and applying those skills in other ways (think about craft distillers who started making hand sanitizer). Identify what you need to do to keep the lights on for now, but remember that creativity and grit will lead your business to a better place a year or two from now, when this truly is behind us.
At G-Squared Partners, we have helped many companies to analyze their financial condition and identify alternatives to achieve profitability. We are helping many businesses to work through a variety of financial challenges during this time, and we invite you to contact us today for a free, no-obligation conversation about how we could help your business.