May 27, 2014
By: Neil J. Smith
We have seen a lot of companies go into bankruptcy over the years, and there are some common issues with most of them. These are issues that may not necessarily show up on the balance sheet, but in my experience they are sure signs that trouble is ahead. If some of the signs on this list apply to your company, then some major course corrections may be in order. If all of the signs apply, then your company is probably doomed.
1. The owner’s son or daughter is going to take over, no matter what, and he or she is unqualified. In a lot of family-owned businesses the company falls apart in a few generations because owners conflate a management succession plan with an estate plan. Giving Junior ownership of the family company after the founder is gone is fine, but management should only consider giving Junior the job of running the business if he or she would reasonably have been hired by an objective HR manager from among a pool of qualified candidates. Unlike good looks, managerial competence is not an inherited trait.
2. The company does basically one thing, and the way it does that one thing is basically the same way as it was done twenty-five years ago. Think for a moment about how different your life is now from life in 1989, and then reflect on how differently your company delivers to customers today than how it did in 1989. If your company delivers to customers in the exact same way as it did in 1989, then trouble is likely ahead.
Established companies that have been doing the same thing for a long time can easily get lulled into a sense of complacency, and not make needed, expensive upgrades to stay competitive until it is too late. The world is changing rapidly, and there are very few areas that have not been impacted. Example 1: Kodak just kept making film instead of fighting like mad to get into digital cameras. Then it went bankrupt. Example 2: In the 1990s Smith-Corona made a smart move by moving its typewriter factory from high cost NY to low cost Mexico. The problem? They were still making typewriters. Then it went bankrupt.
Admittedly, some companies really will never have to change. Amish farmers probably won’t go out of business because they don’t have twitter feeds. Most companies are forced to change in fundamental ways, however, or they end up on the auction block
3. The only way the company has enough money left for operations is for ownership/management to work for free. While it may be inspirational to the employees, it is a bad sign that the ownership of the company is working for free. In a lot of situations, companies’ management/owners will forego or greatly reduce their salaries and distributions in an effort to keep the company afloat. Doing this for a few weeks may just be a sign that the company is going through a temporary rough patch. Doing this for months, however, is a sign that the company operations don’t bring in enough revenue anymore. Doing this for years (and yes, that does happen) is a sign that the company is doomed.
In economic terms, the purpose of a business is to make money for its owners. If it does not make money for its owners, then what is the point of running the company?
4. The company does not make a profit from its operations. Companies are supposed to do things, and then they are supposed to make money from doing these things. This may seem obvious, but a lot of companies, both large and small, are afflicted by the deadly disease of not actually doing much of anything at all, and thereby not making any money from what they do.
Startup companies sometimes hide this by getting more cash from hapless investors and crowdfunding (i.e. Pets.com), and established firms hide this by selling assets and accumulating uncollectable receivables (i.e. Enron). Eventually the day of reckoning arrives when no one puts more money in the Kickstarter campaign, or there are no more old assets to sell. A company cannot escape the fact that it must actually do things that make money.
5. Management is clueless and lacks clear plans for the future. This ties in with Signs 1–4. If the management refuses to acknowledge critical problems like those above, then the problems won’t be fixed and the company is doomed.
Beautiful formal business plans themselves never, ever save a company. Indeed, for some companies a very simple business plan is the best thing. The real issue is whether management can answer the following question: What are the specific problems that will come up in the next five years, and what are you planning to do to fix or prevent them? If management can’t identify and fix problems then the company is going to have a tough time, regardless of the formal business plan.