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LEVERAGED CAPITAL NEWSLETTER Leveraged Capital, is a free monthly newsletter that presents growth and strategy issues effecting entrepreneurs and owners of small to medium size enterprises (SME's). Leveraged Capital is published and delivered electronically to subscribers. Your privacy is strictly respected and we do not share or sell subscriber email addresses to anyone outside of Graham Financial Corporation. If you enjoy what we present, please forward a copy of Leveraged Capital to clients and associates. They can subscribe to Leveraged Capital, by clicking on this link: http://www.GrahamFinancial.com/newsLetter.htm and filling out the quick form.
What a year - what a month! Markets are back, Saddam's behind bars, a new PM that actually seems to want to step out and lead Canada, and an economy that is headed in the right direction - not much left on my business Christmas list. This has been a tremendous year of renewed opportunity and growth and I am thankful once again for my family, my business partners, and our clients. Merry Christmas to all; may you and your families experience rich blessings at this most wonderful time of year as we celebrate Christ's birth. Much (long-term) success to you,
In This Months Issue: (Click on the Article Title To Go To The Full Story.)
Quote Of The Month: Investment Hindsight:
A lot of ink gets spilled about entrepreneurial leadership and vision, but let's face it: the real test of business reality comes every two weeks or so when employees expect a sum of money to materialize in their bank accounts. The amount of that sum, and how much it increases over time, has a lot to do with a team member's attitude, ambition, and overall commitment to the company. Entrepreneurs face the challenge of deciding how much to pay as soon as the first employee is hired. However, the stakes get higher if the company gears itself for growth by bringing aboard outside equity investors. Having third-party oversight often results in significant change; a company may acquire a board of directors, and, as revenue grows over $10 million, it may also acquire an increasing amount of fiscal discipline in the form of an actual budget to which executives are held accountable. Awareness of the compensation strategies used by companies fitting this growth profile is a useful reference point for all entrepreneurs, including those running earlier stage companies. As headcount grows beyond 100 employees, companies tend to expand both wide and deep; new departments open up to focus on high impact functions, while layers of management spring up with an increasing span of control. As founder and CEO of TriNet Group, Inc., a provider of outsourced benefits, payroll, and human resources, I've wrestled with how a company in this position should approach compensation planning. I feel that there are two givens in regards to compensation when set against the framework of third-party oversight and tighter fiscal discipline. The first is that there must be money available to spend on proposed changes to the compensation structure. The second is an awareness of how key jobs in the organization become de facto benchmarks that drive compensation decisions for all positions. Money in the Bank. There is a high correlation between the amount of resources devoted to determining a compensation strategy and the trends in a company's cash flow. If the balance sheet is flush with working capital, and you're generating cash on or ahead of your targets, it's easier (and imperative) to be proactive about the issue. After all, when a company's executives sit down to talk about changes to the compensation structure, the pressures are oriented toward how and where to increase pay levels. There's simply a lot less discussion about compensation when revenues are below forecast. TriNet joined many other companies in facing declining revenues in the years 2001 and 2002, and none of us were clamoring to raise people's salaries with dollars we didn't have. With revenues and cash flow now back on the rise (we project a 30% increase in net income this year), our management team has already begun to increase our involvement in compensation planning. But even as we do, we will keep a careful eye on how well we meet and exceed budgeted goals. Competitive Pressure for Key Positions. If you're achieving your cash flow targets, then you can begin to consider the details of your compensation strategy – and certain jobs in your organization will be the drivers. When a top performer leaves a key position for compensation reasons, it's a flag that gets management attention, as does any difficulty in finding a qualified replacement willing to accept the available compensation. These situations create changes in compensation structures that reverberate throughout the entire organization. The jobs that affect compensation structures across the company possess three attributes: they require extensive training, they have a noted impact on the company's performance when vacated, and they are difficult to recruit for due to a small supply of qualified candidates. Such positions may be high level, such as vice president, but they also might include anything from a salesperson to a java engineer. As compensation for these positions get fixed, other positions in the organization get evaluated or ranked in comparison with the key positions for purposes of internal equity. Strategies for Fair Pay. For the company that is enjoying the fruits of growth and has benchmarked its compensation for key jobs, the next steps involve developing and communicating the company's formal compensation structure. Distribute Unequally. In entrepreneurial companies of the kind we're discussing here, the "all-for-one and one-for-all" approach to compensation isn't ideal. In our annual budgeting at TriNet, we do set a flat percentage of the total payroll for across-the-board pay increases. However, we do not distribute an equal percentage to each individual employee. Instead, because we are committed to paying for performance, we ask department heads to divvy up the salary pot and work with directors and managers to distribute according to individual performance. An employee who makes a significant impact will receive a much higher percentage than one who is merely meeting expectations. The challenge here is to define what performance elements are critical for an individual position, creating objective measurements that can be used as factors in compensation decisions. Create Internal Equity. No, this second strategy doesn't contradict the former. While it is necessary to distribute unequally to motivate top performers, it is just as necessary to ensure that the method or process for compensating is equal across functions and departments. The larger the company, the more managers and executives are involved in the actual decision-making process – and with a wider decision-making audience comes the likelihood of inconsistent standards being applied. It's necessary to decide the timing of when increases will be awarded, how well the top and average performers will be treated, and how jobs of comparable responsibility will be ranked across the compensation structure. Setting these standards will help ensure an equitable distribution of increases across the company. Internal equity, as we call this concept, in theory leads to higher morale and protects against legal retaliation by dissatisfied employees. I say "in theory" because internal equity is a moving target rather than a goal that's ultimately achieved. Both the content of jobs and the performance of people are always changing, which causes compensation levels to change as well. Even at the best of companies, there's bound to be some tension in regards to internal equity and how employees perceive it. Use Perks to Supplement Cash. At entrepreneurial companies, the judicious use of perks and other non-cash compensation can be a motivating supplement. The rule of thumb is that you shouldn't ratchet down cash for perks—for the company does need to remain competitive—but that you should take perks into account to create the full package. At TriNet, for example, we offer a competitive benefits package, as well as scheduling flexibility for a work force that is increasingly concerned about balancing work and family considerations. Non-cash factors can help influence whether an individual accepts – or continues in – a position at any given company. Another form of non-cash award, stock options, may also comprise a portion of the package at fast-growth companies. Because options can turn into cash, this perk acts as a particularly powerful motivator. At TriNet, we set aside about 10 percent of total equity for options that are broadly disbursed to employees at all ranks, a high percentage for a transaction processing and service company. Educate to Get Buy In. Founders and owners of companies that have passed the threshold into equity-financed revenue growth are likely being held accountable for setting fiscal expectations and producing results on budget. In terms of communicating this process to the workforce, it's easy to slip into a lazy pattern of sugarcoating the finances when times are bad and overestimating successes when times are good. The better strategy is to help employees themselves see the big picture—namely, how their jobs fit into the company's overall objectives, and the necessity of adhering to a budget to get there. Employees won't grasp the full facts of your company's financial situation by reading the income statement and balance sheet. Understanding comes only with a significant investment of management time in disclosures that come through company meetings and all employee communications. Those that have been there will tell you that an informed work force will commit more fully to critical company goals than one that is being kept in the dark – especially during the bad times. Always Ready for Conflict. There's always a reason for companies to put off developing a compensation strategy in order to focus on more pressing business issues. But since building a compensation framework is an iterative process and will not be done overnight, companies that start investing some resources now will avoid having to be reactive when their key performers hear the siren song of pay opportunities elsewhere. A compensation strategy is a crucial piece of firepower, and it should be kept loaded well in advance of the next war for talent. Martin Babinec is the founder, president and CEO of
an outsourcer of human resource services that has grown into a $32-million-plus
operation. Visit www.trinet.com.
Michael was the logical choice as CEO with his business and legal background and Keren says there is no-one else she would rather trust in the job. Our mother wanted to scale back her involvement in the business and Keren was planning to have more children. Despite having founded the business, Keren didn't want the day-to-day stresses of running the company. She was already feeling "torn" by the conflicting demands and family values have always been extremely important to us. So, while it was a difficult decision for her to let go of this "other baby," the family unit always comes first. Keren is still very involved in the business as Director, Business Analysis and has a say in all decisions as a member of the Board. As CEO, Michael was responsible for setting all the wage levels in the business. Unfortunately, this included all the family members - including himself. Deciding what we should earn was not a fun job. As a son, brother, and husband, he wanted to pay everyone far more money than they were earning. As the boss, he obviously wanted to pay them a lot less. And of course with his own wage, he felt that he could never win. In other people's eyes he was being paid too much. In his own and probably his wife's eyes, Michael's salary was never enough. Outside Help. It was these sorts of issues that led us to the realization that we needed outside help. A few years earlier we had adopted a similar strategy when we appointed non-family members to some key senior management roles. We felt these people brought additional skills and knowledge to the business that we were not able to provide. We also came to the conclusion that we needed to have structures in place to enable honest discussion and resolution of family issues within the business. The appointment of an external Chairman of the Board was one of the best decisions we have ever made. The first thing the Chairman did, was to take on the role of overseeing remuneration and setting all the family's wages at the appropriate level. Some of us were probably happier than others but we all now agree that the new system is fair and meets current market levels, with a slight family bias. As a result, everyone is a lot more comfortable with the process. Michael may not be with Kez's Kitchen today if we had not appointed the independent Chairman because having a professionally run business and happy family is extremely important to him. In fact we would all close the doors on the business tomorrow rather than risk our family relationships. The Chairman has overseen the introduction of corporate governance structures for the business and also acts as a mentor to Michael. We all see the benefits to the business of Michael having a non-family member as an advisor and sounding board. Having an independent Chairman does not mean we have completely avoided family problems within the business. But it has meant that we have been able to face up to issues early on so we have been able to avoid the damaging family rifts you often read and hear about elsewhere with people sniping behind the backs of others. Whilst we've had to make the hard decision to terminate a couple of employees over the years, we haven't had to fire a family member of the business. But, it is reassuring to know that there is a process in place to deal with this hopefully unlikely event! Keren and our mother Helen do not like dealing with employee termination issues. Both are happy to hire people but Keren says firing employees makes her feel "sick" even when she knows the decision is correct. Michael doesn't enjoy the process but has a more business focused approach. Family Council. The Board comprises a large number of family members but we also have a separate Family Council which meets regularly to deal with issues that are family related and not necessarily part of the everyday running of the business. We wanted to give family members an opportunity to speak their mind and raise issues without taking the time of the Board. In the early days of the company we'd find a position for any family member who wanted a job. That's not the case any more. Several years ago when Michael's wife wanted to join the business, her employment was first raised at the Family Council before being formally voted on at Board level. While it would have been awkward if the Board had voted against her employment, she was more comfortable in the knowledge that her job prospects were being discussed openly and honestly. As a result, she is much happier as an employee. She knows that she was hired with open eyes; everyone knows her skills and the role that she was hired to fill, and all members of the Board have confidence in her ability to do the job. Despite the family involvement in the business we don't believe other employees see any of us as an impediment to their own career within the business. Our mother is the Director of Business Development and Marketing but the other three senior jobs reporting to Michael are all non-family members - a National Sales Manager, a Financial Controller and a Manufacturing Manager. We have always been very open about the fact that we see no reason why in the future, the CEO's role must be filled by a family member. That view is also supported by the Board. Non-family Employees. The senior management team knows that there's technically nothing stopping them obtaining any position in the company. We think any negative thoughts they may have are considerably outweighed by the fact that they enjoy working in a family business. In our environment, decisions can be made far more quickly than in many other companies and managers have as much direct access to Michael as CEO, and the Board as they require. We have deliberately set out to surround ourselves with people who know far more in their specific fields than we do. To deny these managers the authority to make the day-to-day strategic decisions to do their work effectively would be very silly. In the last six months we've all started to realize that we need to look to the future of the business without necessarily as much family involvement. One of the benefits of the senior management team is that all family members are now able to spend more time outside the business. For example, Michael has recently joined a CEO Forum Group through the auspices of Family Business Australia. Through this Group, he is able to meet with nine CEOs of leading companies for a minimum of half a day every month to swap thoughts and ideas. Keren gets to spend all the time she wants with her kids and is able to work from home a fair bit if she needs to do more than her three days a week. These opportunities don't arise unless you sit down and ask yourself what you need to do to be able to look and think strategically. If you're not doing that, you're getting bogged down in the day-to-day management issues and it just makes it far more difficult to succeed. This includes all the human resource issues associated with working as a family business. If you have the plans and processes in place early you can avoid potential problems down the track. This not only makes a better business but also a happy family. Located in Melbourne Australia, Kez’s Kitchen
started with both Helen and Keren baking from the kitchen at home in the morning
and then hitting the streets in the afternoon to sell the product. Kez's Kitchen
now employs approximately 100 people in a large custom built factory. Current
revenues are about $7 million. Michael Carp joined Australian gourmet biscuit and gift producer, Kez's Kitchen, in 1994 and has been its Chief Executive Officer since 1996. Keren Ludski is the Director of Business Analysis at gourmet biscuit and gift producer Kez's Kitchen in Melbourne, Australia. She co - founded the company with her mother Helen in 1991.
By the time I get involved, the banks want their money because they're worried. Vendors want their money because they haven't been paid in two, four, six months. You have employees looking for accrued vacation pay and the bonus they thought they were getting - again, the money. And then there's me: I want my fee. All of those people are trying to chase you for the money. It's the uphill battle for a company growing so rapidly that it doesn't have enough cash to fund expansion. Or -- and far more typically -- the downhill slide for an enterprise whose fortunes are fading fast, whose sales have slowed and whose accounts receivables and payables are mounting. Either way, that's where I come in. I'm an entrepreneur who is now working as a turnaround specialist, consultant - some prefer "artist." For the past decade, as co-founder and founder, respectively, of two Boston-based "workout" firms, I've helped companies as diverse as a go-go technology company that ran out of too much venture funding and an old-line New Hampshire metals manufacturer. (The technology company was gracefully liquidated, while the metals manufacturer was successfully turned around and saved.) Cash Is King. So I am writing this article for you, the entrepreneur, because I don't ever want you to have to call on me. Keep in mind that I've also been in your shoes. After graduating from college in 1969, I joined my brother in running my family's construction company. We increased revenue 25-fold to $50 million over 15 years and added three new divisions. After a brief corporate interlude (as a vice president for Rockport Shoe Co., which was eventually sold to Reebok International), I again turned to a venture of my own. With the people who founded Rockport, I set up a private equity company, investing in businesses as diverse as a hotel and a fledgling salmon farm. Throughout my career - from the enterprises I operated or in which I invested to the picking up of the pieces that I do today for others - it has become clear to me that the single most important tool for building new companies or saving dying ones is the deft management of cash flow, that stream of money pouring continually in and out of your company. In other words, your accountant may say your business is profitable. But he or she could be assessing only the profit-and loss statement (which tracks non-cash items as well as dollars) or the balance sheet (a snapshot of a company's assets and liabilities at one point in time). Just because you are making a profit does not mean you will be successful unless you are generating cash or have access to cash. It's as fundamental as that. Entrepreneurial Delusion. All of which raises another fundamental: that entrepreneurs - or at least the ones I tend to work with -- are unlikely to accept the fact that cash is, in fact, king. As people who are good at building companies, entrepreneurs are impatient with the methodical task of tracking the dollars that come in and go out. In small companies, moreover, owners are unlikely to employ a controller or financial officer whose job it is to do that. It's an ego thing, too. When cash is short (either because of fast growth or slowing sales), an entrepreneur takes the problem personally. The company, after all, is his or her baby. As optimists, they are also likely to think, just wait until next month or next quarter when things will surely improve, right? Taking action to confront and correct a cash-flow imbalance isn't something that comes naturally. Add to this the tight web of relationships upon which entrepreneurs build companies - the people who helped them get started, their employees and vendors. You've played golf with your biggest vendor for years, had him to your house and to your family functions. How do you look him in the eye and say he won't be getting paid? You don't. If entrepreneurs don't take this reality to heart and get past the delusions that "things will just work out," they might find themselves with a company in big trouble. Someone like me will deliver the hard dose of reality, getting a handle on which of the people clamoring to be paid will get paid when there isn't enough money to go around. Often, it's late. The banks are threatening to call the loans and vowing never to lend again. Sometimes, the board recognizes that there are problems. On rare occasions - I've seen two or three in the past decade - it's the entrepreneur who makes the call for help. Putting Out Fires . In the recent past, cash-flow issues have been exacerbated by a shift in business thinking toward spending to build market share at the expense of profit. In the case of the go-go technology company that I was called in to help, the entrepreneur actually had a brilliant idea that could have been the foundation for a new business model in the insurance industry. He had technology designed that seamlessly linked customers and insurers, enabling policies to be sold in one step. Sales were made in discount retailers. Predictably, the idea caught fire among venture capitalists. The VCs poured $100 million into the company, which I would argue was entirely too much money. The entrepreneur used the money to build his work force to 500; he began running out of cash before selling enough policies to turn a profit and cover those costs. By the time I came in, it was too late to attract other investors, and the company was ultimately liquidated. But it isn't only those companies with the trendy spend-at-all-costs mentality that suffer from inept cash-flow management. Take the old-line New Hampshire manufacturer, in which I took an equity stake. When I stepped in, it was bleeding cash. I had to restructure $8 million in debt, settle a Department of Labor lawsuit and motivate a demoralized work force before I was able to turn the company around. I was able to sell my interest within nine months for a 22% return on equity. Managing Cash by the
Fundamentals. A potentially lethal combination for a company is at
work. Cash is king. But many entrepreneurs do not accept or act on that
principal. Avoid having to turn to me by taking stock of a few good
fundamentals:
Then take a step up on the cash-management ladder:
At all of these junctures, ask for help. If you don't have a financial professional on staff, go to your board of advisors. Or call a turnaround specialist to take a quick pulse of your business. In short, what you need to do is avoid what I call the "spiral": the thinking that next month or next quarter the business will get better, and so you can spend now and hold off paying vendors. Whether yours is a growing company or one that is troubled, you might think that you can't run it by the numbers. But be assured: you need the numbers to keep it running. As I've said, just a few good fundamentals. Robert Wexler, 54, is president of The Tron Group, a Boston-based private equity firm, providing management and capital to private companies. Previously, he was a partner in an international turnaround firm. He has also owned and operated a $50 million construction company, a manufacturing company and a real-estate firm. He has extensive experience in corporate reorganizations, having restructured more than $500 million of real estate and corporate debt. He also has served as managing director of a $100 million private equity firm with holdings in fish farming, hospitality and real estate. Earlier in his career, Wexler was vice president, corporate development, at The Rockport Shoe Co., a $550 million division of Reebok International. He is a 1969 graduate of the University of Vermont and holds an engineering degree from Northeastern University.
Peter Drucker is arguably one of the most influential management thinkers of our time. The Claremont Graduate University’s Peter F. Drucker Graduate School of Management has compiled a collection of over 6 decades of his papers, writings, and other materials. Definitely worth spending some reading time over the holidays. Click here for the Drucker Archives.
Feel free to forward a copy of Leveraged Capital to clients and associates. It is free to subscribe by clicking on this link: Click Here For Your Free Subscription To Leveraged Capital. To Unsubscribe from Leveraged Capital: If you wish to removed from our mailing list, send an email to us at: ezine@GrahamFinancial.com with the word "Unsubscribe" in the subject field. © 2003 Graham Financial Corporation, All Rights Reserved. |
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