Three Reasons Your Family Business Is Stumbling

By “Advisor of the Quarter” Thomas A. Powell

  

A few years ago, I was hired by a family business to act as their short-term CFO.  They made great products, but absolutely no money and their bank had “gently suggested” that the line of credit would be renewed, provided the company secured some outside assistance.

So in I went.

After a short time, I vividly recall saying to the owners, “You guys are working like farm animals and living like monks. Something is wrong with this picture.”

The heart of the problem was a lack of useful financial information. And while the company’s long-standing and quite competent controller produced perfectly fine, GAAP-compliant audited statements, these were of no use in operating and improving the business.

We needed to know what was happening in the present and plan for what might happen in the future – the GAAP statements being produced were simply records of the past.

And so we dug in. After some analysis, it turned out there were three distinct channels for going to market – three distinct businesses, really – and the financials for all of these were hopelessly intertwined.

As we pulled them apart, allocating revenues, expenses, gross profit and other financial metrics accordingly, we were able to make sense of what was happening: One channel made lots of money, another was neutral, and the third was so unprofitable that it was threatening the very viability of the combined enterprise.

From there, it was a straightforward process to dump the losing channel while giving the profitable channel the increased attention and resources it needed to grow. Before long, the owners were driving nice cars and taking regular distributions, ultimately selling the business for 19 times its very considerable EBITDA.

Moral of the story? Improved information leads to improved strategy and execution.

Unfortunately, and in the case of family businesses in particular, this type of financial clarity and insight is often hampered by three factors:

  1. Not enough outside perspective.

    Most family businesses have long-serving, faithful employees. This represents a strength, of course, but it also represents a weakness: Typically, employees have been promoted from within, without the benefit of a broad, cross-section of experience. An outside perspective can fill this gap.

    In the story above, I had previously worked for companies that did business in each of the three channels. I also had expertise in many of the control issues involved. As in any profession, there are “tricks of the trade” that bring immediate insight and my experience with other companies (and other industries) led me to solutions without a lengthy learning curve.

    Recommendation #1: Consider outside help in solving immediate and critical problems.
  2. Not enough inside training.

    Bringing in outside expertise goes a long way. That said, the real, long-term leverage occurs when you succeed in raising the business IQ across your entire organization.

    I’ve worked with several clients, for example, in which we set up and run a “university” within the company in question. Any interested employee (including hourly workers) can join and attend the meetings at company expense.

    Folks in scrubs, hairnets and earplugs (helpfully removed for the sessions) work through issues such as what exactly is a standard deviation, why is it important in statistical process control, why does it matter in maintaining customer service levels, and how does this feed through to sales retention, etc., etc.?

    Is it worthwhile? Not only is the enthusiasm contagious, when your people are able to add analytic components to their work, you add extra eyeballs and brains and your business makes more money.

    Recommendation #2: Establish formal processes/programs for teaching employees about your business.
  3. Not enough invested in systems.

    Most companies only use a fraction of the software and system capabilities they already own. In one extreme example, we generated a $10 million cash release from inventory on a business with $45 million in sales, simply by forcing someone to take the shrink-wrap off the user’s manual for the MRP system – a system they had purchased, installed and futilely attempted to use. (I know that manuals are on-line now, but that is a very recent development.) Inventory that you can find when you need it is inventory you do not need to purchase again.

    Similarly, in the opening example above, we were able to run the company with less than 1% of sales invested in working capital (that’s less than one-tenth of the norm). We did it by coordinating sales forecasting, production scheduling, procurement and determination. We used a pedestrian, off-the-shelf product that happened to tie to the general ledger. But we used it well.

    Recommendation #3: Invest the time and effort necessary to create and operate the systems you need to run your business efficiently. 

Remember, improved information leads to improved strategy and execution – keep these three ideas in mind as you fine-tune your operation. A profitable, cash flow positive family business is as close to heaven on earth as most of us will ever get. It’s worth a little investment!

Thomas A. Powell, Principal of Professional Management Partners, assists family and closely held firms in transitioning from informal financial and operating management styles to more robust processes necessary to support growth and longevity. Tom can be reached at tpowell@ThosAPowell.com, or through de Visscher & Company.

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