By Ian Borman, Partner, Winston & Strawn London
Ian Borman has a wealth of experience in business through two decades of helping his clients face all manners of issues. In this article, he addresses some of the less obvious problems that can set a downwards – or even terminal – trajectory, even when the business model is sound
The statistics for businesses in the UK are astounding with 660,000 new companies registered every year – that equates to 70 new businesses every single hour. It is not surprising, then, that a significant proportion of these businesses fail – 60% will go under in their first three years of trading, with 20% shutting up shop within their first year.
Despite these odds – and an uncertain economy – starting a new business continues to be an attractive prospect. Between 2018 and 2019, the total business population grew by 200,000 (3.5%), according to the Federation of Small Businesses, and there is no reason for the trend to slow down.
After two decades of helping clients buy and sell businesses and working on restructurings, I have seen a fair few go wrong – and not always for the reasons you might expect. In the current climate, there is not an industry that isn’t disrupted by technology and we are seeing financial restructuring in companies across practically all sectors. Technological advances are transforming entire sections of the economy, and from that there are some winners and some losers. Some of these challenges cannot be predicted, but often the negative impacts could have been mitigated with more attention and focus.
Businesses fail for many reasons. Some may not find a market for their product or service or they run out of funding. Regrettably, there are frauds, which can become overwhelming if they are masked and not properly addressed – which they almost always can be, if captured early enough. Changing fashion can also play a significant part in the success or failure of restaurant and retail concepts.
However, more often than you would think the seeds of destruction are in the business itself. This is where the issue is not about protecting businesses from competitive forces, a flawed business model or being left behind when technology moves on. So, what should entrepreneurs and business owners watch out for?
Recently, I was involved with a successful restaurant chain, which was in aggressive expansion with strong like for like sales. It had invested in a dedicated supply chain and was in a strong position to continue rolling out its business and capitalise on economies of scale. But the leadership team was highly entrepreneurial and wasn’t satisfied with replicating a single restaurant model, instead choosing to branch out into new concepts. This sucked investment out of the main business on top of the supply chain investment and choked off the ability of the company to invest in the core, profitable business.
While dynamism in itself is good, in this case the investment in new concepts cost the owner a substantial part of the business and – had it continued any longer – could have cost him his entire business. In another example, I worked with an entrepreneur who owned a significant telecoms business and wanted to expand to own a satellite. This would have been a sound decision, but immediately after committing to the investment the value of satellite bandwidth collapsed, leaving the core business overcommitted. Vertical integration and diversification are sound business principles, but this investment cost him control of a successful core business.
In these situations, it is easy for individuals to overlook the time investment they are making in new projects and the impact it is having on their existing business.
Another way that businesses can fail is when their operators take their eye off the ball. I worked with two entrepreneurs with a successful waste business who were looking to sell. They had actively promoted and developed their business throughout their careers and were on the point of retirement. Looking for a way to support their future life, they found a buyer and began to invest in property whilst completing the sale, anticipating the fruits of their hard work.
But, while the sale was dragging on, they took their eye away from the businesses. The financial results dipped significantly, causing the buyer’s backers to question the transaction. Each time the transaction was ready to complete, a set of worse results emerged. This was exacerbated by the owners started to take out cash to fund their new investments, again to the detriment of a potential sale.
Maintaining focus on the business in this case would not only have maximised the value of the business but also have significantly sped up the transaction, which may now never complete. If an individual can no longer commit the necessary time to their core business, then the solution can be bringing in expert management to run an established business. This route will cost money and take time in sourcing and training but will be significantly less expensive than dealing with a failing business. There are some obvious high-profile examples of this in Silicon Valley.
I often see a similar lack of focus in people trying to raise funds to invest in a business. A key issue in early stage investment proposals is that the proposition changes in ways that investors can’t follow or understand. Investors need basic, key information to decide whether they want to spend time on a proposal. They need to understand the size of the proposition, have confidence that it will be fully funded and know which part (or parts) of the structure they are being asked to provide. Those seeking funding also miss the fact that the business will need different investors at different stages of development and fail to focus on the stage in front of them.
Entrepreneurs increasingly want to bring together a number of businesses and consolidate an industry or invest in a scalable business. They identify a range of targets or investments and then try to raise capital without having decided which targets are in the initial plan, how fast they will roll out the proposition or how the capital stack will be put together.
The damage this does is two-fold. As the plan changes, potential investors may drop away; and the failure to focus on a single plan means that no investor is able to commit to working on the plan. The entrepreneur is then forced to keep adjusting the plan to fit changing investor demand. What seems to the entrepreneur as a business plan with flexibility is, in fact, a fatal flaw, and these propositions rarely progress beyond a few meetings until the business plan becomes committed.
While innovation and development are the lifeblood of business, these lessons show that it is equally important for business leaders to ensure that their core business is nurtured, if necessary by investing in people, and for developments to be ring-fenced in a way that doesn’t threaten the core proposition.