There is not one single credit policy that will be perfect for each and every company. But, a well thought-out credit policy can help weigh the risks of a customer defaulting and determine whether their business is a risk worth taking.
A company looking to expand its market share may decide to extend credit to just about anyone, besides, of course, obvious bad debts. On the other hand, a company with a more mature and established market position might not be interested in taking any risks at all, and may choose to only extend credit to customers that are completely credit-worthy.
“Receivables are a big part of a company and write-offs hurt,” says Dan Bennett, an associate with Kegler, Brown, Hill & Ritter. “So it’s important to have a handle on the quality of your receivables.”
Smart Business spoke with Bennett about how the collection process works and how tweaking your credit policy can help you with it.
What are some common mistakes companies make in their credit policies?
From a legal perspective, one of the biggest mistakes companies make is not knowing their customers. Literally, you have to know exactly who your customer is. The customer may use a trade name, or it could be an individual and not an entity. Once a matter hits my desk and the client wants to proceed to suit, if I have to spend time researching what entity actually owes the debt, the entire collection process becomes much more difficult, expensive and uncertain. The worst cases I’ve seen are where the customer doesn’t actually exist from a legal perspective — in other words, the entity listed on the credit application is not an actual registered entity.
Another mistake is not maintaining the file properly. This might sound basic, but if a client wants to proceed against a debtor under its standard contract or a personal guaranty, I need to have a fully executed copy. If the creditor is secured and wants to take advantage of its remedies as a secured creditor, I need a signed Security Agreement and the security interest needs to be perfected.
From a business standpoint, the biggest mistake I see is continuing to extend credit when there are red flags associated with the account. An ounce of prevention is better than a pound of cure, and so if an institution is looking to minimize credit risk, the credit managers need to be proactive any time there is a warning sign on the account.
How does the collection process work?
Assuming we’ve done our homework on the debtor and we think collection efforts make sense, we’ll either send out a demand letter or proceed directly to suit. The claims we’ll bring and the entities we sue will depend on the facts of each case. Is the creditor secured? Does the creditor have a mortgage? Is the debt personally guaranteed? Were sales made pursuant to a contract or on an open account? Has the debtor been doing anything nefarious that might make claims against shareholders or affiliates viable? Is the debtor the type of business where we could seek to have a receiver appointed?
Once a complaint is filed, and assuming we’re unable to work out a settlement, the case proceeds to judgment and then post-judgment collection remedies. We’ll continue to attempt to collect until the judgment has been fully paid, we’re unable to identify assets to collect on, or the debtor files bankruptcy.
How long does the litigation process take?
It varies greatly. It could last a bit more than a month if the debtor fails to even defend the case. If a debtor defends the litigation all the way through trial — which would be rare, almost all collections cases end without a full-blown trial — it could last between a year and a year-and-a-half. After obtaining a judgment, forcible collection could last anywhere from a couple of months to indefinitely. It just depends on the financial health of the judgment-debtor.
Are there any solutions when the debtor has no assets?
No. You can’t get blood from a turnip. Post-judgment collection results are going to mirror the quality of the credit decision the client made in the first place. When a client comes in to us with a potential new case, the first thing we do is gather all the information we can on the debtor to determine the likelihood of collection. If, for example, we see there are four judgments already outstanding, a federal tax lien, no assets to speak of, and a home in foreclosure, the reality is we’re never going to see a dime from that debtor. We’ll advise the client not to proceed — there’s no sense in throwing good money after bad.
A company should know in advance based on how it’s structured its credit policy whether it will experience a high volume or low volume of write-offs. If it’s not matching up with their expectations, they need to revisit their credit policy.
Dan Bennett is an associate with Kegler, Brown, Hill & Ritter. Reach him at (614) 462-5448 or email@example.com.
It is a big decision to bring equity into a company. Typically, equity is brought in when debt alone is not appropriate or sufficient to satisfy the company’s needs. Equity can be minority or majority, and it can be structured in infinite ways. Regardless of the type or structure, this step also means that you are adding one or more partners. So, if you have the good fortune of being able to choose among two or more equity suitors, do your homework. The following are some things to consider:
Beware of the false minority (i.e., the devil is in the details). Minority equity often is viewed as more attractive because of the perception that “control” is retained. While this certainly can be the case, great attention must be paid to the terms of the investment, particularly to the rights of the investor in the event things don’t go as planned.
Frequently, minority capital will have performance hurdles or other identified events (like defaults under loan agreements), the failure or occurrence of which will give the minority investor greater rights and authority — sometimes control of the company. When bringing in minority capital, engage a qualified, experienced attorney and understand the rights you are giving away.
The power of the majority (i.e., it’s better to own half a watermelon than a whole grape). The remainder of this discussion will focus on investors who purchase 50 percent or more of the company. Your decision to accept equal or majority investment must also come with the acceptance that you now have a partner or partners and that there will be changes — ideally, for the better. A good equity partner can help create tremendous value. A bad equity partner can make your world miserable. At a minimum, look for these qualities in a potential partner:
Track record. Be sure that whatever you are hoping to gain from the partnership (other than capital) your potential equity partner has successfully done before. Whether it’s building a sales team, developing new products, cutting costs, developing infrastructure, going public, acquiring add-ons, franchising, etc., verify they have done it well. Study their track record, and ask the hard questions. If they are what they represent, they will respect your diligence. If they aren’t, you will, hopefully, avoid a mess.
Expectations. A good potential equity partner will spend considerable time with you and your team understanding your vision and making sure it aligns with theirs. When disputes arise between investors and their operating partners, it most often is the result of misaligned expectations. On the other hand, if done properly, the equity structure should be based upon your and the investor’s collective vision of the future.
Hands-on, hands-off. Prior to closing the investment, it is imperative that you and the potential investor agree regarding how you will work together. Some investors are only comfortable if they are deeply involved in operations. Others expect only to attend quarterly board meetings unless things go badly. We are in the middle. We like to spend significant time supporting development of the strategic plan, and then seek to support our operating partners any way we can in executing the plan.
Chemistry. Although hard to quantify, you should feel good chemistry with and trust for your potential partner. As you may be together a long time and face great challenges with your partner, this consideration should not be compromised.
A good equity partner can accelerate your growth and success and help you create and realize a vision far grander than you might otherwise have. A bad equity partner can be disastrous. Be disciplined, and choose wisely.
Dan Lubeck is founder and managing director of Solis Capital Partners, a private equity firm headquartered in Newport Beach, Calif. Solis focuses on disciplined investment in lower-middle market companies. Lubeck was a transactional attorney and has lectured at prominent universities and business schools around the world. Reach him at firstname.lastname@example.org or visit www.soliscapital.com.
Bill Ford Jr. never thought he’d see the day when Chrysler and General Motors would be forced into bankruptcy proceedings, when American automakers were in such peril that they had to look to the government for a bailout or when the entire auto industry was teetering on the brink of disaster.
Yet that’s exactly the depths to which the automotive industry sank over the past two years. As the worldwide economy slumped into a massive recession, the auto industry took one of the worst beatings of any area on the business landscape. Car sales slumped, auto component suppliers went bankrupt, Chrysler partnered with Fiat, and GM underwent a restructuring and downsizing that included the elimination of the Pontiac, Saturn and Hummer brands from its lineup.
As the executive chairman of Ford Motor Co., Ford — the great-grandson of company founder and American business icon Henry Ford — helps lead the one U.S. automaker that didn’t face bankruptcy proceedings or the humiliation of limping to Capitol Hill with its hands out. But that doesn’t mean Ford Motor Co. has emerged in 2011 unchanged or unchallenged by the events of the past two years.
In November, Ford gave a presentation at the Ernst & Young Strategic Growth Forum in Palm Desert, Calif., moderated by veteran journalist Charlie Rose. During the presentation, Ford talked about the recent past of the auto industry, where the industry is headed and what business leaders in other industries can learn from the lessons taught to automotive executives in the past couple of years.
“Every industry says they’re in a time of great change,” Ford says. “I suppose when you’re in it, you really feel like you are. But if you just look back a few years and look forward a few years, you’d be hard-pressed to find any era in any industry that will comprise more change.”
Do the right thing
When the other American automakers went to Washington seeking a federally funded lifeline, Ford figured his company would be at a disadvantage on the consumer sales front.
“We didn’t really know what a bankruptcy meant for us,” he says. “Would a customer buy a car or truck from a bankrupt company? What we didn’t realize at Ford was that it would resonate with the average person on the street that we didn’t take a bailout. We thought the average person would take the opposite stance, as in, ‘I have so much money wrapped up in this company, I’m going to buy their car or truck.’ We were worried that no one would buy from us, because they were now shareholders of sorts in GM and Chrysler.”
Instead, Ford received — and still receives — letters of support from small business owners and operators who admire Ford’s ability to get his company through the recession without the need for taxpayer dollars.
“The letters I got, and continue to get, are incredible,” Ford says. “Things like, ‘I’m a small business owner in Des Moines and no one would ever bail me out, and we’re really glad that you guys did it the right way.’ It really was heartwarming to see the response we got.”
But there was a cost for staying financially self-sufficient. Ford Motor Co. had to borrow against many of its assets to finance the research and development projects that allowed it to stay away from the jaws of bankruptcy and bailouts. The company amassed a large amount of debt, compared with GM and Chrysler, who emerged with clean balance sheets thanks to their sources of external funding.
But Ford believes a commitment to developing your business internally is one of the most reliable methods by which you can weather an economic storm. If you’re developing new products and services and finding other ways to enhance your business from within, you’ll become much more strategically diverse and self-sufficient as a company.
Ford’s emphasis on internal development is reflected in one of the first conversations he had with Alan Mulally, who succeeded Ford as the company’s president and CEO in 2006.
“One of the things I told Alan in our first meeting was, ‘There is no point in going through all of the pain we’re going to have to go through if we don’t keep investing in research and development and product development,’” Ford says. “He agreed completely. Now that we’re through and out the other side, most of our competitors, both domestic and foreign, slashed their spending during that period. Not only didn’t we do that, we actually accelerated some key areas. So when the clouds started to lift, we had the products, technology and features that made our vehicles very desirable.”
Ford and his leadership team set those wheels in motion even before Mulally came on board, working with bankers to get capital to pump back into the company’s development areas. From Mulally’s first day on the job, he began making the rounds to banks, trying to secure the loans necessary to make it all happen.
“It was a pretty dicey period,” Ford says. “You can imagine it was a pretty interesting conversation I had with the extended Ford family.”
To build the case to the other stakeholding members of his family, Ford needed to go back to the basics of good business communication from the executive level: Lay out your plan, be as forthcoming with information as possible, answer questions and seek feedback.
“I was very proud of the fact that, over the course of that discussion and over the next couple of years, when every day they’d pick up a paper that says, ‘Ford, GM and Chrysler aren’t going to make it,’ they all hung in there,” Ford says. “I had to continually sit down with them and say, ‘We do have a plan, you’re not seeing it yet, but it’s going to work.’ To their great credit, they all hung in there. And that really allowed the rest of the management team to not have to worry about the shareholders. They could focus on fixing the problem.”
The patience of the Ford family is being rewarded. Not only did the company emerge from the financial crisis without the need for federal money, but Ford says the company’s debt is being paid off much faster than either the company’s leaders or industry analysts anticipated.
“There was a disadvantage to doing it the way we did. But that disadvantage [of debt] is shrinking almost on a daily basis,” Ford says. “I wouldn’t trade places with anybody. I love where we are. I love our product, our direction and our freedom to operate without interference.”
Face the future
Before you can build something, Ford says you have to value it. You have to value the end product as a company and as a marketplace. The failure to adequately value the domestic manufacturing sector is something Ford believes the American business community will continue to face.
To increase the value of manufacturing businesses, Ford says it will take a combination of new, innovative ideas, intellectual partnerships, capital investment and an appreciation for how other countries handle their manufacturing bases.
“Manufacturing was kind of seen as yesterday’s news, brownfields, and we’re going to become a high-tech and service economy,” Ford says. “The problem is, the multiplier effects of those jobs versus manufacturing jobs is minuscule. To put it another way, every country that Ford does business in around the world will really do everything they can to help their manufacturing base. In our country, it was the opposite. The feeling in Washington, and even on Wall Street, was ‘Who cares? Shut your plants here, because we’re going to be a different kind of economy.’”
It’s taken the economic downfall of the past several years to increase awareness about the importance of maintaining a manufacturing base.
“Manufacturing has to change, and it is changing,” Ford says. “We’re making new things, high-tech things. The auto industry is one of the biggest users of high tech. We should now be building those high-tech components and clean energy components here in America. If anything good has come out of the last three years, it has been a recognition in Washington, and I think on Main Street, that manufacturing matters a lot, and we ought to have a strong manufacturing base. That recognition in and of itself is a great start.”
New avenues to maintaining the manufacturing base won’t be discovered without new ideas. And to that end, Ford sees a great deal of fertile soil in the nation’s universities. Whenever possible, the business sector needs to partner with and leverage the research capabilities of educational institutions.
“In terms of where we go forward, one of the great advantages we have in this country are our universities,” Ford says. “And we have great venture capital activity. We really need to take advantage of those great resources, both the venture capital mentality and the help that the universities can provide to all businesses in terms of R&D, partnering and I’m happy to say those are all vibrant pathways.”
But even with the external financial and intellectual avenues available to businesses, growth still boils down to what is going on under your own roof. You need to have the manpower and the brainpower to take advantage of the opportunities presented to you, which is why Ford promotes an innovative and entrepreneurial spirit among his employees.
“It’s something we struggle with every day,” Ford says. “I believe that now, we have the equation right at Ford. A few years ago, we didn’t. Part of it is you have to look at what the inhibitors are, because people really do want to be innovative. Most people want to try new things. But in our case, one of the things I did was do a deep dive into our product development system. We had a terrific R&D function, built with a couple of Nobel laureates. But somehow these great innovations weren’t making it into our vehicles.”
It demonstrated to Ford how a company’s leaders need to remove internal barriers to innovation — barriers that might exist within your company’s structure that you might not even realize.
“In our case, it was our finance system that created the barrier,” he says. “Whichever program it was — let’s say it was the new Explorer — wanted to adopt the new rear seat belt we just introduced. That program would have to take the cost of that entire innovation. So you wanted to be the second program to take the innovation, not the first.
“That is just one example of how you need to look at what the structural barriers to innovation are. People often blame the culture. People often say, ‘It’s a big company; nobody wants to take a risk.’ That can all be true, but there can also be structural inhibitors like the one that I just mentioned. You have to get those out of the way.”
The other critical component in building your business for the future is a motivated work force. You motivate employees by giving them avenues to pursue their ideas and removing roadblocks. But you also need to encourage the behaviors you want to see.
Ultimately, your internal culture needs to work in tandem with your outside resources. When a motivated work force can draw upon extensive financial and intellectual support, your company can have the tools to weather just about any circumstance that comes your way. There will still be adversity, but you’ll be prepared for it.
“You have to celebrate success,” Ford says. “That is a cultural thing. We do a lot of that, we have awards within the company for innovation. It’s great when you recognize externally. For instance, we’ve been the keynote at the consumer electronics show for the last three years. They never had an auto show up, much less give a keynote. We won the award last year for best in show. That is very reinforcing for our employees, when they’re recognized not just from an auto trade standpoint but something completely different that is seen as really cutting edge. That emboldens people to continually go further.”
How to reach: Ford Motor Co., (800) 392-3673 or www.ford.com
Ford Motor Co. Executive Chairman Bill Ford Jr. touched on a number of topics during his November presentation at the Ernst & Young Strategic Growth Forum. Here are some additional nuggets of information from one of the world’s leading automotive executives:
Ford on where the auto industry is headed: When you think about this industry, for 100 years, we had a changeable line. The Model T had an internal combustion engine and was sold through dealerships. But now we sit on the threshold of some very interesting technology coming into vehicles on the safety side, on the data management side, in terms of real-time road information, where traffic is, where the parking spaces are, all of that will be available very fast.
Ford on the future of electric cars: If you think of electric as we know it today, there are three types. There is the hybrid, there is the plug-in hybrid, and there is the pure electric. To me, the pure electric is great because it is totally clean depending on how the power is derived, which is a whole separate discussion.
If you live in San Francisco and just need to drive around town, that’s OK. But if you all of a sudden want to drive down to Los Angeles, that’s an issue. Plug-in really alleviates that. With the plug-in hybrid, you can drive on the electric motor for the first number of miles, but once the electric runs out, it will then run as a conventional engine. So that gives you a lot more versatility.
Then the current hybrids, which don’t require anything to be plugged in, we keep refining those so the batteries become more fuel-efficient. So really, it will be a three-pronged approach in terms of electric. You’ll have all three of those in the mix.
Ford on international growth: By the year 2020, there are going to be 9 billion people in this world. If you look 10 years beyond that, there are going to be 30 cities of 10 million or more. Most of those will not be in the U.S. or Western Europe, and they don’t have the infrastructure to start shoving cars into those cities. So mobility starts to become a big issue. How are people going to move in big urban areas? The answer is not going to be to put two cars in every garage. So how do we help countries and municipalities solve the urban mobility issue. That will require us to define ourselves not as a car and truck company but as a mobility company.
As leveraged buy-out professionals, debt (i.e. leverage) is fundamental to what we do. When used properly, it enables us to generate higher returns on invested equity. It also instills valuable disciplines and practices in the companies we have invested in or acquired.
Although often feared – particularly by entrepreneurs – properly used debt can provide business owners the same benefits. Some things to consider about debt are: How much is desired? How much can be supported? What type? What is the lending environment?
How much debt is desired? This depends on how the debt will be used. Most often, debt is used to fund growth or to bridge working-capital cycles. Debt also can be used to buy new facilities, fund acquisitions or provide partial realizations to business owners. Potentially, any capital needs of a business can be funded with some form of debt.
How much debt can be supported? This is the key question. For the answer, look at your company’s trailing 12-month cash flow – or earnings before interest, taxes, depreciation and amortization (EBITDA). The appropriate amount of debt typically is talked about as a multiple of EBITDA. For example, if your company is not expected to grow much but has a very high certainty of stable EBITDA, the right amount of total debt likely will range from 1.5 to 2.5 EBITDA. If your company is on a high-growth trajectory, then the right amount of debt might be as high as 4 or 4.5 times EBITDA.
However, when doing this calculation, BE CONSERVATIVE! The reason debt is feared by many business owners is that, if things go badly, the lender(s) can become very intrusive and expensive and potentially take your company. In our investing, we are far more conservative than most other professionals. It is very rare for our leverage to exceed 2.5 times EBITDA, regardless of the company’s projections. Things can go very differently than planned.
What type of debt? Essentially, there are three types of debt: senior term, senior revolver and sub.
Senior term is typically partially or completely unsecured, will have scheduled principal reduction payments, and often requires additional principal reduction based on cash flow. Because it is not wholly secured, lenders charge more for this debt (
usually at least a point or two) and want it paid off as quickly as possible.
Senior revolver, known as asset based lending (ABL) is the most commonly available debt. It is wholly secured – typically by receivables, inventory and other more liquid assets. Virtually all senior lenders offer and compete for this type of debt, and it is the most competitively priced.
Sub debt (or mezzanine debt) generally is not asset secured and is far more expensive than senior debt. Sub debt should be viewed as the middle ground between senior debt and equity.
What is the current lending environment? For the most part, lenders are cyclical “pack” actors. The availability of debt ranges from too much (like we experienced from 2004 to 2007, where debt was often more than five times EBITDA), to very little (like now, when most lenders struggle to lend over 2.5 times EBITDA). Regardless of where we are in the cycle, it will change. Because a number of lenders have done very well over the past year or so because of their low cost of funds, we are again starting to see more aggressive, competitively priced proposals.
The amount and type of debt you seek will dictate which lenders to approach.
Regardless, you probably should use some debt – but use it wisely!
Dan Lubeck is founder and managing director of Solis Capital Partners (www.soliscapital.com), a private equity firm headquartered in Newport Beach, Ca. Solis focuses on disciplined investment in lower-middle market companies. Lubeck was a transactional attorney, and has lectured at prominent universities and business schools around the world. Reach him at email@example.com.