How Did Your Mid-Market Company Run Out of Money?

Posted on May 11, 2012

When a mid-market company is in need of a transfusion of cash, nothing else seems to matter. This article looks at the high cost of a cash crash.  It also addresses some best practices best implemented long before trouble arises that will minimize the pain and give you a better chance to survive.

When a mid-market company is in need of a transfusion of cash, nothing else seems to matter.  That’s why lack of funding forms one of the key chapters in Deadly Diversions, my upcoming book.  Have you been the CEO or CFO of a mid-market firm that ran out of cash or got awfully close?  If so, I’d like to interview you confidentially over the coming months—please contact me.  I continue my intensive research of the many ways “running out of money” can occur, and best practices in avoiding this particular diversion.

Getting very low on cash is a deadly diversion because it forces us to change the course of the business’s activities.  We backburner the plans most important for medium and long term health, and divert all our resources into getting cash now.  Even more troublesome, being in desperate need of cash makes it harder to get cash:  funders worry about the viability of the company.  Worse yet, it reflects badly on the quality of the leadership who allowed the company to get in such desperate shape.  If you’ve been in a serious cash crunch, you know exactly what I mean.

The fight against a zero bank balance can be divided into two phases:  early prevention and near-death last stands.  Early prevention has the greatest leverage for self-funding operating companies.  The key is leaving room and time to fix the problems, which generally means stepping on the spending brakes earlier. Strong financial controls (and listening to cautionary counsel) allows for a set of triggers that push you to act incrementally- slowing the cash drain or reversing it early – without having to take dramatic action. When liquidity ratios are excellent and thickening, companies have plenty of latitude. But at some trigger point, fiscal discipline must dictate that the most risky, most cash draining activities stop. Many other forward thinking projects can still be funded, but if you make cuts early enough, you won’t have to sacrifice as much. Too many companies miss the right trigger. They have passion and hope that things will “work out” and that their “big break” is right around the corner. Then they breach the second trigger point; then the third. Usually the running out of money moment is the fifth or sixth trigger point.

One of the aspects I want to focus on in my research is how best to help shift the mindset of the CEO earlier in the negative cash flow slide, to reduce the severity of the cash meltdown.

It will help to think of your balance sheet as a series of crash barriers, like the freeway barriers for a runaway truck with failed brakes. If your firm encounters problems with a strong balance sheet, it can decelerate first by “crashing” into short term bank debt, then if needed, payables, then by slimming inventory and receivables, then by using some cash, and so on. But as you use up each crash barrier, your crash velocity had better be slowing, which means you’re turning the company around.

The 2008 downturn was a massive test of nearly all companies’ crash barriers.  Many had what appeared to be low risk, defensive positions.  Yet when sales dropped by 40% overnight, and banks went from being liberal with credit to be highly conservative, the cash balance alarms sounded one after another in an incredibly short period of time.  A scary ride to be sure.

Some companies survive the impact of a cash crash, but it becomes critical to re-build the crash barriers on the balance sheet as quickly as possible, because it can happen again. This is a critical message in the current slow-recovery environment.  This strategy means running the business in a careful, conservative fashion until you’ve generated enough positive cash flow to re-build the balance sheet. I found that running a company at such times was not as much fun. I could not jump in and be creative, or reach for the big wins (which entailed big risks). But that’s life.

For example, one company I know of was purchased in early 2007 at a high valuation and some leverage.  The timing could not have been worse.  This firm was hit particularly hard in the downturn, but the CEO clamped down on expenses, focused the business, began increasing efficiency and looking for new opportunities.  He showed true grit, and the business is recovering one step at a time.

Earlier stage, investor-funded companies are different. They spend on development, relying on their board and investors to keep the next tranche flowing with each series of investment rounds arriving just in time.  But greed for higher valuations can temp current investors and management to postpone fund raising, avoiding excessive dilution at the risk of hitting the end of the runway.  A balance must be found between critical elements:  business risk, confidence in the company and its management, the health of the board, the capacity of involved investors to participate in upcoming rounds and the ability to attract other investors.  Pressure to hit milestones can be positive and motivating, but what isn’t discussed enough is that too much pressure and uncertainly can become a destructive diversion.  If you’re thinking about taking outside money for the first time, read this now.

I’m looking forward to a lunch I have scheduled to do more research with Paul White, a serial CEO leading many earlier stage venture backed companies.  Our last discussion yielded this article: Leading with Other People’s Money, which discusses the challenges of fundraising and some keys to making it more productive.

The CEO’s responsibility for avoiding cash crunches and demonstrating leadership in low liquidity situations is a complex subject, and one that I’ll delving into deeply over the upcoming months.  If you’ve got some scars from your experience leading companies through severe cash crunches, please contact me at 925-829-8190 or e-mail me at r.sher@ceotoceo.biz.