Autopsies from 2017
Looking back on 2017, as we do every year (or so), we identify why failures happened and seek to do better in the future. For those of you who think we are talking about you - just because it sounds like you - we are not. We're talking about another business that had similar problems but didn't fare as well at the end of the day.
The biggest problems we encountered in 2017 (as in most years) were:
Break-ups: Personal relationships get strained in startups and sometimes they just snap. One example was a pair of women who were working well together until one decided to move out. Another example was a near break-up where one of the partners got another job (you have to be able to eat and feed your family). There are several other examples from 2017. In these cases, advisors end up becoming something like marriage counselors, seeking to help the business succeed by seeing if the folks can continue together, make changes to allow the business to continue, of if the end is inevitable.
Stress fractures: Sometimes the stress just gets to be too much. In one example, the folks running the business got sick, driven by exhaustion, and as health declined, work piled up, and they finally got to the point where they just could not go on. It's hard to admit this to yourself and each other, but eventually you end up in bed really physically ill. You discover it was from stress when you finally give up and find out that you are feeling better - sometimes within a few seconds. Sometimes a vacation can fix the problem (the business may fail as a result, but then why did you design the business this way?). Usually a long weekend helps (Friday and Monday off almost never causes calamity).
Bad paper: You may think I am talking about passing bad checks, and of course that is very bad. But the more common situation is not doing paperwork very well. Most of us hate paperwork. I came to embrace it when at Sandia National Labs. I just decided to get it done as fast as possible with minimal thought. It helped. But when you don't do the paperwork like reconciling the bank accounts with the books, you invariably find that things go bad. Checks bounce because your version of the balance isn't theirs. You get fines for non-filings as the stack of paper you promise you will get to grows and grows. Note that there is a tendency to add and remove from the top, so the bottom gets older and the fines, penalties, and problems get worse. I paid small fines on three occasions in 2017 (not too bad for running 5 legal entities) because I was too late, checked the wrong box, or some other such thing. And then there are the folks who just don't keep track, and end up not paying taxes, not accounting for investor equity, not paying bills, etc.
Lack of lawyer: I am not a fan of lawyering up for every agreement or transaction. I have fairly standard agreements I use and I have had lawyers check them from time to time. But when something important is about to happen, big money is at stake, it's something you haven't done before, etc. you need to get a proper lawyer engaged. In 2017, I had a contract go bad and some of the paperwork wasn't right, producing an excuse for non-performance by the other party. On the other hand, that party is not likely to succeed regardless, because they are not taking good advice. I am not a lawyer, and I often tell my clients that as I identify why they might really want to get one right now. Some listen, some don't, and some end up in court, or in agreements that make investors unhappy (and not invest more), or in court losing their personal possessions, or in jail where they can rest for a few years before trying again. In 2017, none of my clients ended up in jail, but at least one almost did.
Cash flow analysis failures: Most businesses that fail in my experience fail from a lack of cash flow. That's a nice way of saying they run out of money. More costs than revenues for too long. Some try to get out of it by restructuring payment terms. I give big discounts for retainer-based work and never have a collection problem or substantial billing dispute - because I have the money before they have the result. The problem comes in two areas; (1) "restructuring" ends up as really being non-payment or (2) a bad model leads to really bad results. Problem 1 ends up in a game of making little bits of payments here and there to extend the time before someone really takes you out of business. Problem 2 is often a case of losing less per transaction at increased volume. Problem 1 pissed off customers of one of our clients to the breaking point in 2017, and they are paying a real price. Problem 2 almost put one of our clients our of business in 2017, but they started using our cash flow simulator to get a better model and they are now in far better control of the real cash flow implications of terms on contracts.
What we normally do about it
These are not new or novel challenges. They happen all the time. They happen to new entrepreneurs who haven't been there before and just had no idea of what it was all about, they happen to older folks running their own business as it expands, and they happen to old hands who have seen this movie before. Some days you just get tired of the grind and have to underperform for a while. And you pay the price when you do. And it is often worth it! However...
We create and use tools to help reduce the need to fail to succeed.
We engage professional help (an accountant, a lawyer, and advisor).
We create regular processes to systematize what we do.
We hire and train people to do these jobs.
We put management people and process in place to make sure it runs even when the parts fail.
But in startups, resources tend to be thin, the people don't have a lot of personal or professional backup, and this is often a root cause of the failures.
As advisors and investors, if we only invest in and advise the high resource people and companies with lots of backup and expertise, we will end up (1) without many clients and (2) missing many of the really great opportunities.
So what we really need is professionals being paid to do the job well, but we cannot get them because of the lack of resources available. We can be more selective in our investments and miss big opportunities, or we can be less selective and get screwed. Risk and reward is what it is all about.
Our solution is increased surveillance and attention as things get more important, and a disciplined approach to investing and operating. This starts with providing tools to help startups succeed, but that also provide access to information and a methodical approach to increasing maturity over time. Startups and other companies that won't take the discipline are ultimately likely to fail. Our experience is that they almost always do. And painfully so. Here are some examples:
A reasonable investor will require access (read only) to the bank account(s) and the books. They will reconcile them or have a CPA that does so. Mismatches will be investigated.
However: The advisory board rarely has access to these things, the board of directors pre-investment is usually close to the CEO, and when you try to get the real information is when you find out it wasn't there or mismatched.
Solution We require access as part of the granting of equity, as any other shareholder would have. It's in our agreements and we have the right to information as do any other shareholder. We rarely have to push it, because executives under a disciplined approach come to accept the requirements of running a real business.
Contract details are often mismatched to optimal legal issues upon close examination.
However: Small companies and startups rarely have the resources to do legal reviews of every contract and agreement, and are often under pressure to make a deal with a 3rd party who is not willing to give on key points.
SolutionOur DD teams often include an attorney who is willing to review legal agreements. And when they don't we still review them with our novice eyes to identify things we can find.
Emails often fail to include proper disclosures, such as warnings required to meet anti-spam laws.
However: Trying to get companies to include such disclosures and trying to get due diligence reports to include such potentially liability-inducing elements are often problematic. If one DD report talks about it and another doesn't, the company with a less complete DD report looks better to the casual, or even professional investor.
SolutionWe look for these sorts of things in our internal diligence process and try to address them as risks from the beginning so the CEO has them in the report until they fix the problem. By showing the risks more clearly along the way, executives can make better decisions about them. And those who see our internal diligence reports ask others about the same issues, helping to level the playing field.
People have challenges. Running a startup is a high pressure job and many people are not used to it or have problems handling it. I have personally come to tears more than once in my life/work mix and in my businesses. And I have done the wrong thing over and over because of my stresses overriding my reason or available ideas.
However: It's hard to get an executive to deal with stress issues unless you have a real relationship with them. Because there may be nobody to talk to, they may ultimately get frustrated, act badly, and do more harm than good in their attempts to make it work.
SolutionWe find that a good relationship between a lead advisor and the CEO helps to mitigate these issues by the fact that personal issues are addressed between the individuals. There is a real need for someone who understands the issues to be available to talk to you when you face them.
Cash is sometimes king. And sometimes, you need to know what to pay when and what you can delay how far in order to make it work.
However: Knowing what you can and cannot do, and communicating with folks on the AP and AR sides, is typically critical to success in handling cash crunches. Tracking cash now and into the future with good predictions is really critical in many cases.
SolutionWe provide cash flow simulation capabilities and know how to deal with these issues effectively, honestly, and fairly to all. We advise clients in how to understand their cash flow risks clearly and in advance, and keep track of burn rate and runway in almost every meeting. Some businesses are going to fail when they run out of cash, but we should all know this in advance and understand the risks we are taking along the way.
People, including people who run businesses, are imperfect and subject to human failings. Businesses fail, and there are plenty of things that can go wrong along the way.
We believe that knowing how to survive to fight another day, having someone to talk to about things, and understanding the risks you take so you can decide when to take them how far makes it more likely for you to succeed and less painful to all if and when you fail.
Our goal is not perfection. It is being helpful in a human way. We use systems and lists and similar things to help us be systematic and not forget things, and we use these to help our clients increase the maturity of their operations and find solutions they might otherwise miss. But things fall apart, and failures happen.
The best we can hope for is to learn and help our clients learn from mistakes. Autopsies can help, but they can only go so far. We wish all of you a great year ahead, and hope you will learn from our mistakes.
Copyright(c) Fred Cohen, 2018 - All Rights Reserved