A Syllabus for Small Business

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I was pleased to see an announcement that Goldman Sachs would put aside $500 million to seed “10,000 small businesses,” including $200 million for “practical business education and training programs.”

Goldman Sachs has established an advisory council to guide the investment, with Warren Buffet and Dr. Michael Porter of Harvard as co-chairs. In addition, the deans of both the Columbia Business School, and the Wharton School are members of the advisory council.

When I was attending Wharton, I took a course in Small Business Consulting, and as a course assignment, I was sent to help the owner of the Venice Spumoni company figure out how to expand into grocery stores. At age 22, I tried my best, but did not have a lot of experience to draw upon. I wish I could travel back in time, with what I’ve learned in the intervening thirty years; today that would be a run-of-the-mill consulting problem.

I’d be interested to know what the Goldman Sachs advisory council determines are the greatest learning needs for the 10,000 small businesses they intend to help educate, and seeing how their list compares to the learning needs I’ve witnessed. Specifically, I hope some of these items make their list:

* Decision making – too often business owners just “go with their gut” when making business decisions, when what they should be is determining the size of the opportunities, probability of success, cost to invest, return on investment if they succeed, and which course of action affords the best risk-return trade-off.

* Creating and tracking against plans – business owners should make it a point to create a solid budget at the start of each year, and then track against it monthly.

* Successful selling – something not typically taught at the leading business schools, but a key to success for every small business owner.

* Financial literacy – at two workshops I ran in November, only 10% tracked the gross margin of their small business – how much they earned on each in dollar of sales, in percentage terms, after covering their cost of goods sold. Setting the right gross margin target will inform subsequent pricing and product line decisions and help guide a business to a healthy level of profitability.

* Raising capital – With bank lending down, and equity funding also hard to get, this is obviously a critical skill in the current economy. Small business owners need to thoroughly understand the differences between debt and equity, which is right for businesses under varying circumstances, and how to tell their story in a compelling way to increase their chances of securing loans or investment capital. Comfort Restaurant in Hastings-on-Hudson, NY figured out an innovative way to raise capital for their recent expansion. Read more

Why Businesses Go Bankrupt: Mervyn’s

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Private Equity firms Cerberus Capital Management and Sun Capital Partners, along with real estate investors Lubert-Adler and Klaff Partners led a 2004 buyout of Mervyn’s discount retail chain for $1.26 billion in 2004.   Upon closing, the new owners split Mervyn’s into two companies, one owning the real estate, and the other operating the stores.   The real estate company borrowed $800 million to fund the LBO, and then dramatically raised store rents to the operating company.  In October 2008, Mervyn’s went into bankruptcy, with its remaining 149 stores liquidated, and more than 18,000 employees thrown out of work.

Lesson learned: Financial engineering often increases the risk of failure.  After the split of Mervyn’s into two companies, the retail stores were left with $674 million of assets and $664 million of liabilities and worse yet, negative working capital. According to a 11/26/08 “Business Week” article, the moves left Mervyn’s “so weak it couldn’t survive.”

The Buyout of America

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I devoured Josh Kosman’s “The Buyout of America” the day after Thanksgiving, and also took the time to listen to an audio replay of his November 16th interview with Terry Gross of WHYY’s Fresh Air.

Mr. Kosman lays out a broad indictment of private equity firms, making a case that they run down the companies they acquire for debt, with exorbitant price increases, poor customer service due to staff reductions and systematic underinvestment.

A few surprising, and unpleasant, discoveries from the book included:

  • That four of the past eight Treasury Secretaries joined the Private Equity Industry: James Baker (Carlyle), Nicholas Brady (Darby), Paul O’Neill (Blackstone) and John Snow (Cerberus), giving the industry significant influence in Washington DC.
  • The Boston Consulting Group predicted (in December 2008) that “almost 50 percent of PE-owned companies would probably default on their debt by the end of 2011.”
  • The degree to which private equity firms have been able to “create a deal-making system in which they reap profits while assuming almost no risk.”  The risk is shouldered by investors, including public pension funds.

One thing that bothered me about the book was how Kosman tarred the entire private equity industry indiscriminately, without even a hint that some private equity firms are operating with higher concern for how the companies they acquire ultimately fare, after they have carved out their special dividends and management fees.

My personal experience as part of a team doing due diligence for a NYC-based private equity firm was that they seemed strongly focused on developing strategies that would govern the expansion of the acquired firm into new markets and new product categories, creating value by building up, not tearing down the business.

Why Businesses Go Bankrupt: FairPoint Communications

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FairPoint Communications filed for bankruptcy under Chapter 11 on October 26, 2009, hampered by interest payments resulting from the excessive debt it took on in the $2.3 million acquisition of Verizon’s northern New England landlines and Internet network in early 2008.  Remarkably, FairPoint Communications CEO David Hauser was quoted as saying this about the bankruptcy filing, “From a consumer point of view, this is a nonevent.”FairPoint Communications has been plauged by complaints from retail, business and wholesale customers since changing over from Verizon computers to its own computer systems, the “New Hampshire Union Leader” recently reported.  Prior to that, in mid-2008, Vermont 911 calls were not being properly routed, with state officials assigning blame to FairPoint.

Lesson learned: A look at FairPoint’s 10-k report shows that its long term debt went from zero in 2007 (the year before the acquisition) to $2.1 billion at the end of 2008, while net income (profits after interest and tax) went from a profit of $32.8 million in 2007 to a loss of $68.5 million in 2008.  I completely agree with the many bloggers who have already opined that it is hard to understand what the regulators in Maine, New Hampshire and Vermont were thinking would happen when they approved FairPoint’s acquisition of the assets being spun off by Verizon.  Regulators should have considered the advice my friend Cotty, a financial adviser in Toronto gives his clients: you may be able to make the down payment on a fancy new house, just be sure you can also handle the “cost of ownership.”

Getting Mad about Medicare Fraud

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The “Sixty Minutes” segment last Sunday on people who file fraudulent claims for Medicaid reimbursements has me hopping mad, and if you take the time to watch it, you will be too.

What I would like to know is why someone doesn’t put in an added step in the auditing process, whereby the supposed recipients of any electric wheelchair, urine bag, artificial limb or other medical equipment over a certain a dollar amount is called at random to verify that these were actual people, and it was not just a storefront operation submitting the names, before the funds are released.

If you are concerned, please write a letter to President Obama, and Senator Schumer too, if you are a New York resident.   And thanks to “Sixty Minutes” for illuminating this troublesome issue.

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As a postscript, in the early morning of July 16, 2010, Federal agents arrested 94 individuals suspected of Medicare fraud, spanning Miami, Baton Rouge, New York, Detroit and Houston, CBS News reported.    (The above-mentioned October 2009, “Sixty Minutes” segment focused on Medicare fraud based in Southern Florida.)