One of my favorite clients was Allen, a young man who built a very successful commercial landscape and maintenance business. He started out in high school mowing lawns. He did such a good job and was so industrious that he built a $3 million business providing the landscaping and maintenance for commercial office centers, industrial complexes and home owners associations. Although still in his thirties, without a college degree, Allen was one of the most industrious, hard working and creative clients that I have ever met.
When I first met him, he was experiencing some difficulties in his growth process and struggling with how to finance that growth. Any new contract or customer was welcomed with great, open arms. Unfortunately, his cash was in awfully short supply, and he couldn’t figure out why he was doing so well in growing the business but so cash-poor.
One of the little known truths
in business is that growth
requires cash.
Allen saw a lot of growth in the business and less and less
cash available, which was contradictory to him. He knew
that his growth required increased payrolls, increased
purchasing and increased expenses. But he expected that the
increased revenues would more than cover those expenses. He
was very careful in bidding new work to make sure that it
would be profitable.
Allen was right about increased revenues coming with added
volume, but he failed to look at the timing of the cash.
Although growth increased sales, the collections were 30-60
days after he had to pay for the labor, materials and
overhead of earning those revenues. He had to pay up front
for all of the costs of earning the revenues, and then wait
to collect for them. If he couldn’t pay today’s labor, he
couldn’t collect tomorrow’s revenues.
And those were just the operating expense problems. He also
had the capital costs of supporting this growth.
In the case of landscaping and maintenance, there is a
tremendous capital investment in equipment to put another
crew into the field. A truck with a trailer full of
industrial mowing and maintenance equipment may run
$50-60,000, so there is a significant investment associated
with growth. As he added customers and hired crews to
service those new customers, he had to also secure the
essential equipment.
Being a young business, strapped for cash, Allen’s
borrowing capabilities were quite limited, although the
leasing companies were very glad to deal with him.
Accordingly, he was obtaining his equipment with the
highest interest rate financing available – leasing
companies.
Until one Thursday night, when he called me in panic. The
controller had been sick for a few days and when he went
into the office, the accounting mail had stacked up in the
bin for the controller. Casually, he thumbed the mail, and
noticed a number of colored envelopes from the telephone
company and the newspapers. He opened these, only to see
that they were threatening to cut off phone service and
cease running ads if his bills weren’t brought current
immediately!
Our first step was to structure a complex re-financing of
the leases. In effect, he “bought out” the leases by
borrowing from a bank at lower loan rates and buying the
equipment that he already had under lease. The effective
interest rate on his financing took a significant drop,
which is why the bank was willing to make the loan.
Our analysis also found that when he brought in new
equipment, he had only short-term customer commitments. In
other words, he would buy a piece of equipment with a 3-5
year life and pay for it over 3 years, but have only a
one-year customer agreement. So, every time he took on a
new one-year customer, he found himself making 3-5 year
equipment commitments to serve them.
Allen discovered that he was making long term financial
commitments to those leasing companies even though he had
no long term commitments from his customers. As we analyzed
his situation, we concluded that he was undertaking a
tremendous amount of risk in leasing the equipment just to
get new customers. We also observed that his profit margin
was stunningly thin on the new work coming on.
This lead to seeing the risk/reward relationship of all his
new business. In other words, he was making a commitment of
his own every time he took on a new customer. He was taking
on a financial risk in order to serve that customer. This
was a true revelation for him. He had never thought that
when he gained a new customer, he simultaneously took on a
liability or risk. Obviously, if he could serve a new
customer without any capital outlay, he would be taking
much less risk. He would be getting better utilization out
of existing equipment, and incurring only the risk of
payment for services.
Ultimately, Allen decided that he could not afford to
blindly accept every new customer who came his way. Rather,
he decided to go a little more slowly and “pre-qualify”
each new customer while cementing relationships with
existing customers.
The overall effect was that, within six months, while the
volume had not grown significantly, he had cut his debt
service, his profitability had grown tremendously, he had
solidified relationships with his new clientele and he
reduced his risk with respect to the new equipment. Since
then, Allen has always maintained a critical eye when
soliciting and accepting new work. He realized how
important it is to have a long-standing relationship with
the customer and so he evaluates their track record of
vender-shifting to assess the expected stability with him.
In the end, the controller was replaced, and my
Brother-In-Law tried to open a channel to the successor –
to have a dialogue with that stranger so that he would hear
about problems as they came along. Naturally, he had to
also not close off those lines of communication so that he
would hear about the problems before they approached a
fatal point. A few years later, he sold the business to a
new public “consolidator” of “mom and pop businesses” but
that is an entirely different story.
POINT: Like the Marines “Looking for a few good men,”
businesses need to be looking for good customers, not
customers at all costs.