Usha Viswanathan

Monday, 26 March 2007 20:00

Due diligence needed

For select businesses looking to expand their facilities, a novel financing mechanism allows owners to gain a 15 percent to 40 percent savings over conventional loans.

Known as industrial development bonds (IDBs), these instruments can provide up to $10 million in low-cost, tax-exempt financing. Issued by governmental agencies or authorities or a development corporation, these bonds are used to finance qualifying construction and equipment purchase. The interest paid to investors who purchase IDBs is generally tax exempt, while the borrower benefits from the lower cost of funds. The bonds can be a boon for companies, as long as requirements are met.

“We know that a business owner is focused on building a lasting and profitable enterprise, not navigating the IDB process,” says Don Starkey, senior vice president at Comerica Bank. “That’s where an experienced banker is needed: to help chart the course of a successful financing project.”

Smart Business spoke with Starkey about the banker’s role in initiating an issue of an IDB.

Are industrial development bonds more attractive to a certain class of business?

In order to be eligible, a business needs to operate as a manufacturer or processor.

IDBs can range between $2 million and $10 million, and can be used to finance the construction or purchase of industrial plants, warehouses and distribution facilities. Beyond that, the funds can also be used to purchase equipment and machinery, expand an existing facility, or even relocate. The ultimate goal of the IDB program is to benefit local economies through job creation, keeping a business in business and generating locally based revenues.

What are the benefits of industrial development bonds over other types of financing?

First and foremost, a company may see cash flow savings from 15 percent to 40 percent over conventional financing through the use of industrial development bonds. The cash flow savings is a result of the low-interest environment for IDBs in which rates are running 2.6 percent lower than the average prime rate during like periods (based on average interest rates from 1982 through 2003). Lower rates typically mean lower payments.

What role does the lender play in helping companies obtain IDBs?

Before proceeding with an industrial development bond project, it’s important to get your lender involved early to evaluate the feasibility of the project from a bank’s perspective. Bondholders don’t want to worry about whether or not a company can repay the bonds, so they typically look to a bank to provide credit enhancement for the bond issuance. This enhancement comes in the form of a letter of credit and ensures that the bondholders get their money in the event the company defaults on bond payments.

As you might suspect, most banks are going to evaluate a company’s creditworthiness before issuing a credit enhancement letter of credit. They do so by reviewing, at a minimum, three fiscal-year-end financial statements and personal financial statements of the owners.

Also, a ‘sources and uses’ summary is required to demonstrate that the funds will be used for eligible purposes. This summary includes the cost of the building, detailing land value separate from construction costs, new equipment purchases and other expenses related to the project.

Beyond that, most lenders will look for projections that demonstrate that the company has sufficient future cash flow to support the required bond payments. This might sound like a lot of information, but most of it is no different than what any prudent business owner should review prior to making a large capital investment.

In addition to the lender, who else is involved with the process?

Most companies use specialists whose sole mission is to maneuver through the differing requirements of issuing an industrial development bond. The tasks handled by this third party include processing the application with state and federal agencies, managing the bond issuance process with the public and coordinating with bond counsel.

With all of the moving parts, we find that very few banks support industrial development bonds because they can be so time-consuming, taking up to six months from the application submission to the closing of the bond issue. There is a fair amount of work that goes into these transactions but, in almost all cases, the long-term cost savings compensate a business for the short-term diligence.

How should a company proceed if it is interested in applying for an IDB?

A business owner should talk with a banker experienced in supporting IDBs who can speak in detailed terms about the application process, the underwriting requirements and an interim plan, should a business not have six months to wait for the bond issuance.

Because this is a unique process, an experienced banker should also be able to put you in contact with specialists.

DON STARKEY is senior vice president at Comerica Bank. Reach him at (619) 338-1541 or at

Monday, 26 March 2007 20:00

More than transactions

While the axiom “Never a borrower or a lender be” may have been taken as sound advice at one time, credit took on a completely different meaning as countries and economies industrialized. Businesses and bankers have long actively courted one another to establish and provide credit, which provides the grease that lubricates the engine of commercial expansion.

For middle-market companies, understanding how to present the best face to a banker is often a lesson learned through experience. Helping applicants to negotiate the process, bankers are eager to educate prospective clients on the mechanics of completing a solid loan application.

Everett Orrick, senior vice president and regional manager of San Diego and Orange County at Comerica Bank, notes that his job is to develop a solid relationship with clients in order to understand their businesses inside and out and to continue to lend to them over the long term. But what elements must a business consider when selecting with whom it will form a long-term banking relationship?

To get to the heart of the matter, Smart Business spoke with Orrick about forging a successful relationship.

How does the mindset differ between a banker and a prospective borrower?

A borrower obviously is most concerned with whether credit is available, and then secondly whether that credit is priced competitively. A banker wants to make sure that his terms are favorable to a client, but he first must be satisfied that the business he is lending to is sound.

Among the factors we consider include history of cash flow, ability to repay debt, the quality of assets securing the credit, accounts receivable, ownership of inventory and equipment, real estate holdings and, in some cases, intellectual property such as a trademark or patent.

We consider all these factors when deciding to approve a loan. And the way we do that is to get to know a business inside and out because our aim is to lend to an enterprise on an ongoing basis.

Why is relationship-building so important to a bank?

A bank that views itself as a transaction bank looks to do one deal at a time with many different customers. In effect, the lender operates a constant revolving door with customers, most of whom may never come back for banking services.

But once you become the bank of choice for a client, the number of opportunities to perform a myriad of business transactions for that customer increases. The bank now can offer value-added services because it has done its homework to gain an intimate knowledge of a customer’s business.

It can be a huge advantage to mid-sized businesses if all their banking needs are consolidated in one place. Among other things, if a bank understands the full range of a business owner’s financial needs, it can structure the best credit package. And loan approvals also can be performed faster.

How can such a lasting relationship be established?

It starts with the banker. He must know everyone at his customer’s business and understand how each element of the business functions. And the customer must be allowed the opportunity to meet as many people at the bank as he wishes.

Through delving into a business, a banker gains an intimate knowledge of its needs as well as a business owner’s personal needs. Herein lies the key difference between a transaction bank and one that sees itself as a relationship bank. The view benefits both the banker and the customer. Because the lender has become thoroughly familiar with the firm’s ins and outs, he can provide business advice and structure loans at more advantageous terms than would be possible if the business were to use a different bank for each of its needs.

Should customers worry about putting all their banking eggs into one basket?

Not necessarily. In fact, it can be a huge advantage. There are a host of intangible services associated with doing business with one bank. For example, there is continuity and consistency of credit responsiveness. Banks with large commercial lending concentrations depend on maintaining these customer relationships as their primary source of income.

Some business customers believe that spreading their lending requirements to several banks will reduce their risk of not being able to access credit in the future. Not so. The more a bank knows about your business, the more easily it can deliver a loan approval and the more efficiently it can price the right credit facility for you.

A customer’s purchasing power grows incredibly and he is able to borrow much less expensively and at better terms for everything from real estate acquisitions to working capital and for his personal needs. The benefit gain can be anywhere from 1/4 percent to 1 percent less on average for each loan. By this point, a relationship-centered bank understands the breadth of a customer’s business. It knows intimately its cash flow and the nature of its assets. It is here that the bank can make a difference by providing a better rate pledge.

EVERETT ORRICK is senior vice president and regional manager for Comerica Bank’s San Diego and Orange County offices. Reach him at (714) 435-3998 or at

Wednesday, 28 February 2007 19:00

Loan applications

The higher rewards that business ownership often promises and the yearning that many have to run their own companies have motivated thousands of Americans to join the ranks of the self-employed.

As their numbers rise, the growth of small businesses is critical to the lending business. The banks’ goal: help local businesses thrive while ensuring that depositor’s assets are safeguarded in well-run and prudent investments. Too often, however, the small business owner does not understand how to secure the credit needed to jump-start or sustain his operation.

“It comes down to understanding what a lender is looking for: the tools that he needs to make a risk assessment decision,” says Frank Briggs, senior vice president and manager of business banking at ViewPoint Bank.

Smart Business spoke with Briggs about some of the do’s and don’ts of commercial borrowing and how to obtain the right loan at the right price.

Is getting a commercial loan as simple as filling out a loan application?

That’s one part of it. Remember, banks are competitive in their desire to establish credit for their clientele, yet so many customers fail to understand what a lender is looking for.

The biggest issue is being able to demonstrate that you already have good credit. Paramount in a person’s ability to get business credit is the strength of his or her individual credit score, which is a great measure of an ability to repay a business loan.

In most owner-managed companies, the owner manages the cash flow of the business. Of course, we look at a company’s revenue, its accounts receivable, marketing strategy and other elements of the operation to determine the strength of the business.

But we also look at how the owner-manager manages the cash flow in his personal life. Does he pay his bills on time and in full? Does he live within his means? Such factors are great indicators of how well he might run his own business. If the history of performance on the personal side is satisfactory, then we look at the business’s trends in revenue, profitability and debt to equity.

How could a person who knows how to run a business not understand the elements of securing credit?

Many business owners know the nuts and bolts of their industry but are not trained in banking.

You could say that there is an entire spectrum of knowledge on how best to secure credit. Some are extremely knowledgeable about available sources of funds and how to qualify. But others are so busy concentrating on their business that they have not gained the tools to understand a lender’s mindset. A simple example is a case in which a client approaches us for a line of credit — a term he hears frequently at social gatherings, in advertisements and from his business peers. But even after counseling, he realizes that an equipment loan to buy a delivery truck is necessary. What we do is to uncover the true purpose of the need and direct a customer to the right facility, often at better rates and terms than he originally figured.

What are some of the key elements of an application package?

We look for three things: the credit history of the owner, the cash flow sufficiency of the business and collateral sufficiency or a secondary source of repayment, such as internal capital (including the owner’s personal assets) that would allow for the liquidation of the business in a downturn and make the bank whole.

Many borrowers don’t understand that the bank is lending its depositors’ money and that we need to be certain to minimize risk in order to protect our depositors’ funds.

What are some common mistakes made in loan applications?

An area that borrowers fail to address most commonly is the understanding of historical cash flow. They do not identify all their repayment sources. This could include depreciation — a noncash expense — excess personal income and excess personal income from other company owners. We help the client identify all sources of repayment in order to strengthen his application.

How does the loan application process begin?

It starts with an interview. But even before that stage, we reach out to the community to target existing customers and new prospects to see if there is a need we can satisfy. It could be that we discover that their borrowing expenses are too high, and that our products could help lower their financing costs.

FRANK BRIGGS is the senior vice president and manager of business banking at ViewPoint Bank. Reach him at (972) 801-5729 or

Friday, 24 November 2006 19:00

Global risks

Our nation’s most successful firms are ones whose financial managers understand how to raise and allocate capital as well as arbitrage and hedge risks in the global market.

Arvind Mahajan, Lamar Savings Professor of Finance at Texas A&M University, has spent decades observing how multinationals manage risk. His take: good risk management is based on a keen understanding of, and adherence to, corporate objectives. “This is a subtle point that’s often overlooked,” says Mahajan. “Risk management has to be in consonance with the identity of the firm.”

Smart Business spoke with Mahajan about how risk needs to be addressed. His proposal: view risk in a holistic way and always consider the impact of a risk management decision on the overall value of a firm.

What are some key ways that derivative instruments can aid the financial manager in achieving financial objectives?

Derivatives can help, but only if senior executives clearly plan their overarching corporate objectives to include risk management. We see an example of this in the foreign exchange arena. If an integrated currency risk management program is important to an organization, and the firm has done a fair amount of introspection to determine who they are and which risks they want to bear and which they do not, then costs associated with exchange rate hedging can be reduced. In such a case, individual units within an organization will not instigate hedging transactions without considering the existing exposure of other units. Such an approach reduces transaction costs while benefiting the company as a whole. Too often, managers hedge risk only in their functional area of responsibility without analyzing exposure across the enterprise.

Is there a convergence of prices or are there special circumstances when risk is priced differently for the same product?

Even in the U.S., where markets are more efficient, price differences can occur and these could be caused by market sentiment or participant psychology. This is corrected with time. However, in international markets, there are also imperfections that place limits on arbitrage such as transaction/information costs, or capital and foreign exchange controls and differential taxes, which are the result of government policies. While the consequences of some of these imperfections cannot be circumvented, creative organizations can find ways to successfully negotiate around them.

For example, foreigners may be restricted or find it very expensive to invest in some countries’ capital markets. To get around such constraints, clever financial intermediaries created American Depository Receipts (ADRs) and country mutual funds, which allow the U.S. investor to participate in certain foreign markets they may not otherwise be able to. Restrictions can impede foreign and domestic prices to converge in the real sector of the economy as well, providing a unique opportunity for multinational firms to profitably exploit them. Existence of such firms and astute traders, increasing awareness of international portfolio diversification benefits coupled with development of financial engineering products are expediting price convergence. A trend toward reduction in barriers and the ability to communicate and transmit information swiftly are resulting in a more integrated global market.

As American firms seek partnerships with foreign firms for the competitive advantages they offer, how can businesses better manage foreign exchange risk?

Foreign exchange risk emerges irrespective of whether you have foreign partnerships. The risk arises the moment you have potential cash inflows or outflows in a currency other than your own. When you are able to match the timing and magnitude of these flows in the same currency, you wash out the risk.

With increasing globalization, firms have to contend with foreign exchange risk. The easy solution is to match currency denominations of your inflows and outflows or insist that payment received or made be in your home currency but this is not always possible.

In that case, you can create currency hedges, and there are many ways to do this. The simplest one is a money market hedge where you hedge exposure by selling dollars and buying, say, pounds in the spot market and investing the proceeds in a bank to pay off a later pound liability. Another method is to hedge using forwards or futures: signing a contract today to transact at a set price (in this currency) at a predetermined time in the future. Alternately, you could use currency put and call options, and it’s in this area of derivatives where the greatest innovations have occurred.

ARVIND MAHAJAN is the Lamar Savings Professor of Finance at the Mays Business School at Texas A&M University. Reach him at (979) 845-4876 or

Saturday, 28 October 2006 20:00

An ounce of prevention

As the number of health care plans expands and their costs increase annually, the American worker faces a conundrum: He must select a plan that best serves his family and one that targets his income bracket.

Sally Stephens of Spectrum Health Systems, an Indianapolis-based provider of health and wellness programs, says that the answer lies in becoming an informed health care consumer. This includes understanding the health needs of all family members and the true costs of providing medical services. The key is for employers to educate their workers about the expenses the firm bears in providing health coverage and encouraging employees to more actively manage their health.

Smart Business spoke with Stephens about ways employers and their workers can protect themselves in an era of rapidly increasing medical costs.

How is health care consumerism different from more traditional health plans?
Under managed care, employer sponsored plans controlled demand by limiting employee choice and decision-making through various gatekeepers. In this model, the plan paid the majority of the cost of health care services, leaving the employee only responsible for the premiums and small out-of-pocket co-payments, creating little incentive for managing consumption.

Consumerism strategies manage demand by educating employees about health care and costs and ensuring that employees pay a more meaningful portion of the cost of care. It seeks to make employees more accountable, knowledgeable, and actively engaged in managing their health by shifting their role from passive patient to active health care partner.

How does the consumer make health care choices that are best for him and his family?
Most employers and their health plans have insulated plan participants from the true cost of their health care and the financial implications of their choices. Because most employees seldom have the tools to fully evaluate costs, quality and effectiveness of care, there are few financial incentives to choose appropriate coverage and use it effectively.

Employees must fully understand their plan choice, how it works and how to effectively use the benefits. It is not enough to simply focus on the monthly premium contributions, co-pays and deductibles. Instead they need to be informed about the necessity and advantages of one service over another. Now employees must look at budgeting health care, much as they do with other expenditures. And it means being a true partner with their physician in determining the plan of care that is right for them.

What role does the employer play?
Today, employers recognize that better consumer behavior has the potential to improve the quality of care they receive while reducing future cost increases. While employers can’t be directly involved in making health care decisions for employees, they are looking at health care consumerism as a way to change employee behavior and promote more accountability for health care management and costs.

Providing plan participants with the information, skills and tools to meet their health care needs and expectations will empower them to make informed decisions, much as they do for other purchases.

What do employers need to consider when introducing consumerism to their employees?
Research is one critical component: understanding how much employees know about the rising costs of health care and the resources available to them as they become more accountable consumers.

Information access is another. In order to respond to market signals about the differential costs of preventive, routine, life-threatening, chronic and life-enhancing services, people need access to information about the true cost and quality of services.

Employees should be educated in careful, sophisticated ways, using successful consumerism initiatives and resources. Meanwhile, employers should be more active in talking about the connection between health and productivity. That means creating a communications strategy that builds a shared understanding between employer and employees.

Employers should also provide tools and resources to assist employees in managing and maintaining healthy lifestyle practices.

Why should young or otherwise healthy people be concerned about the quality of heath care their plan provides?
In recent years, everyone is focused on the increasing cost of their own health care. They care deeply about the kind of coverage they have available to them. Unfortunately, we live in a culture of entitlement where we feel we should have access to the highest quality of care at relatively no cost.

In a health care consumer model, an individual’s overall health care expenses will be directly proportionate to his or her level of health. Those who are healthy will have lower out-of-pocket costs then those who are in poor health. The most important thing an individual can do to manage total cost is to stay healthy.

SALLY STEPHENS is the founder, owner and president of Spectrum Health Systems. Reach her at (317) 573-7600 or

Thursday, 26 October 2006 07:13

Protecting trade secrets

In business, competitors can battle to grab more than a slice of your market share. The wily rival also will make claims on your proprietary market or product information through lawsuits or the threat of suits. Must you hand over hard-won data about your enterprise to the opposition? Not necessarily, says Jonathan Ellis of Shumaker, Loop & Kendrick LLP.

“The defendant often is not even aware that confidential business information is being sought, because the requests are couched in arguments that seem to be anything but an attempt to uncover business secrets,” Ellis says. “Above all else, there must be a legitimate business interest in order for someone to request details about your operation.”

Smart Business spoke with Ellis about steps to take when sued by the competition.

Under what scenarios might a competitor ask for information that you would deem confidential?
For example, a former employee starts a business and asks for various documents alleging that, as a shareholder of your company, he needs this information to perform a valuation analysis. Or a competitor could ask for your supply contracts when you’ve hired away his key employee.

What are the general guidelines for when you must divulge information to your competition in a lawsuit?
The courts will always look for a legitimate business interest in the information being sought. For example, if you developed secret knowledge about a product or technology and nobody else has it, you can prevent sharing this information. Or, if the information is readily available in the marketplace, such as a price list that you’ve published on your Web site, then there is no reason not to give it. The key here is to ask, If the information is not readily available, why are they asking for it? What purpose does it have in the lawsuit? Is the requested information reasonably likely to lead to discovery for admissible evidence? If the answer is no, you shouldn’t be required to produce it and you object to it. If the answer is, yes, then you want to be more careful. Is it a trade secret, and does it fall under the Trade Secret Act?

How do you continue to protect your business interests and yet meet your legal obligations to the plaintiff — your competitor?
Before you just turn information over, you need to ask yourself if you can protect the material from other parties or whether you can provide only part of the information that’s requested — and then only for the attorneys’ eyes.

For example, if the plaintiff asks for production costs from your enterprise, you could suggest that he review the raw numbers from your consolidated financial statements to arrive at a figure. If he asks for your customer list, you need to determine whether that is relevant to the litigation. Keep asking yourself, What’s at stake if I provide this information? Will it bust the company if I continue with a lawsuit? Is it worth the money to continue meeting these document requests and responding to demand letters? Is it worth it to settle up front, or should I fight the claim and go to trial?

Are many of these requests for information from a competitor legitimate?
There seem to be more cases coming up in which the ultimate goal behind the litigation is not what’s on the face of the lawsuit. There are suits that are brought undercover to determine confidential business information. And sometimes that is realized only in the middle of a lawsuit during the discovery phase.

In one case, a group of employees left to start a competing business and demanded a majority of their former company’s documents, such as accounting records and major contracts. The defendant asked why these records were necessary. The plaintiffs answered that they had to determine the value of the shares they held in the firm, and the contracts (which spelled out the dollar value of purchase agreements) were the only way to get at a true figure.

Our answer would be: Get the numbers from the firm’s balance sheet. If that doesn’t work, we make sure that confidential data is provided for review only by the opposing attorney and not his clients. If we do provide information or trade secrets to the opposing party, we want to include provisions that confidential data is not filed in public records, that it is kept under seal and not released to the public at large. This could include client lists, contact books, Social Security numbers or other financial information.

JONATHAN ELLIS is a partner in the Tampa office of Shumaker, Loop & Kendrick LLP. Reach him at (813) 229-7600 or at

Thursday, 26 October 2006 02:11

Dore v. Arnold Worldwide Inc.

Among lawyers, words are more than tools of persuasion. They are the glue that hold people to agreements. Correct usage is never more important than when writing contracts. For proof, look at court dockets, which are filled with cases that pit litigants in battle for rights presumed but never clearly expressed in writing.

In August, the California Supreme Court addressed the words that should be used to create “at-will employment” and provided some long-awaited guidance to employers who wish to create and preserve at-will employment relationships with their employees.

Smart Business spoke with Tom Reilly, an employment attorney at Newmeyer & Dillon LLP, about the Court’s ruling and the precautions employers should take when informing new hires and employees that their employment is “at will.”

What is at-will employment and why is it important to employers?
At-will employment means the employer retains the right to terminate the employment relationship with or without cause and that the employee has no recourse against the employer for breach of contract based upon the termination. There may still be other statutory or common-law claims arising from the termination of an at-will employee, such as claims for illegal discrimination or discharge in violation of public policy, but not breach of contract.

Have California employers experienced problems in maintaining at-will employment relationships with their employees?
Yes. California Labor Code Section 2922 provides that an ‘employment having no specified term may be terminated at the will of either party on notice to the other.’ In the 1980s, however, California courts ruled that Sec. 2922 created a mere presumption of at-will status which — in the absence of an express, written at-will agreement — may be overcome by oral assurances of continued employment or an implied-in-fact contract requiring good cause for termination. As a result, diligent employers made sure their employees signed written at-will employment agreements, imbedded in employment applications, offer letters, employee handbook acknowledgments, and other documents.

Some employers struggled with the language used in such documents. They felt that telling an employee or applicant he or she could be terminated without cause was too harsh. They attempted to construct softer sounding at-will provisions, such as, ‘You retain the option to terminate your employment at any time and the company retains the same right.’ Employers who failed to state clearly that at-will employment could be terminated without cause were often unsuccessful when they attempted to enforce their at-will agreements in defense of wrongful termination claims.

What affect will Dore v. Arnold Worldwide Inc. have on the ability of an employer to create and enforce at-will employment agreements?
In Dore v. Arnold Wordwide Inc., the Supreme Court ruled that a provision in an employer’s offer letter describing the employment as at will and explaining that the employer retained ‘the right to terminate ... employment at any time,’ was sufficient to preserve the employer’s prerogative to terminate the employment with or without cause. This is a positive development for California employers because the Supreme Court demonstrated a willingness to enforce at-will agreements that are worded with reasonable clarity. The case also firmly established that a properly worded at-will agreement will bar claims for breach of contract and, in some cases, fraudulent inducement.

Can companies continue to use softer language in their offer letters and other employment documents?
In Dore, the court ruled that that it was sufficient for an employee to acknowledge in writing that the employment was at will and could be terminated at any time. However, we do not recommend soft-pedaling an issue as important as at-will employment. In his concurring opinion in Dore, Justice Moreno intimated that merely saying the employment could be terminated upon notice would be insufficient to create an at-will employment. No employer wants to be the next test case. It is always better for an employer to explain that ‘at will’ means the employment relationship may be terminated at any time, with or without cause.

Employers who want to create and maintain at-will employment relationships should also assure that their clearly worded at-will statements are presented consistently in employment documents signed by their employees, e.g., employment applications, offer letters and employee handbook sign-off sheets. Moreover, agreements regarding at-will employment should specify that they are intended to be the parties’ final agreement on the subject and that they can be amended only by another written agreement signed by the employee and an officer of the company.

TOM REILLY is a partner in the Newport Beach office of Newmeyer & Dillon LLP. Reach him at or (949) 854-7000.

Wednesday, 25 October 2006 08:34

Addressing corporate ethics

American business took a beating in recent years as a rash of high-profile court cases unwound operations at once-vaunted firms and sent key executives to an ignoble future of lengthy prison terms.

As news stories mined the details of shady accounting and management greed, the nation’s business schools vowed to step up efforts to better instruct the next generation of managers of the fundamental importance of ethical corporate behavior.

Bala Shetty of Texas A&M University concluded that the lack of ethical guideposts among now-fallen industry majors is a sign that many (although not all) businesses no longer value the once-unquestioned tenet of practicing corporate responsibility.

Smart Business spoke with Shetty about corporate ethics and how Texas A&M University is poised to address the way shareholder wealth is really created: through the practice of integrity.

What lessons can MBA students glean from these recent cases so that they can positively affect corporate practices?
There’s an increasing awareness since Enron and other high-profile firms sank into ignominy, that more instruction about ethical behavior is needed. As the economist Milton Friedman has said, a company’s ultimate goal is to increase shareholder wealth through profit maximization.

At the end of the day, unethical behavior destroys wealth and causes a firm to lose significant value. It’s not profit maximization if you don’t act ethically. The two are not mutually exclusive. Long-term value creation results from the ethical behavior of your executives, and if they don’t behave ethically, investors lose trust and will not invest in the company. It makes good business sense to operate with a moral compass.

Do these recent stories reflect a general diminishment of ethical behavior in corporate America, or are they aberrations from the norm?
Many things happened in the ‘80s and the ‘90s that gave rise to infectious greed and served as the catalyst for what happened. Between 1998 and 2002, there were 658 accounting restatements by public companies. Before that, there were only 92 in 1997 and 3 in 1983.

The business climate with its unprecedented economic growth and investors’ demand for immediate returns on investments were responsible for many corporate boards realigning management incentives to meet short-term expectations of their investors. As a result, there was an astronomical increase in CEO compensation in 1990s. For example, in 1980, the ratio between a CEO’s compensation and the average worker was 42 to 1. By 2000, that number was, on average, 600 to 1.

Although there are many honest, decent and hard-working people in the upper echelons of many firms, our excessive focus as a society on maximizing wealth gave young graduates the wrong message about corporate stewardship.

Should more be done in MBA programs that address corporate ethics?
Yes. Graduate programs should emphasize the values of integrity and corporate responsibility as vital for adding long-term value to a corporation, and this should be done throughout the curriculum.

Social projects should be emphasized as a way for students to connect with ethical principles. By their involvement in such projects while in school, they will be less susceptible to irresponsible corporate behavior later.

MBA students should engage in several fund-raising events during the year for local charities. Students who help elevate standards of business practice should be given credit hours and scholarships.

There are so many great stories about what ordinary citizens in every corner of this nation are doing to make lives better for others. Unfortunately, our kids read and hear very few of those in the mass media. As a society, we need to rethink our priorities.

Can American business recover from these recent scandals and regain the trust of workers and the public alike?
Yes, if we as a society — teachers, parents and institutions, take to heart the old adage that dishonesty does not pay. We can rebound from recent excesses if we work with legislators, the media and the legal system to stop corporate malfeasance. Sure, no executive in any of these cases killed anyone, but they hurt the most vulnerable among us. There needs to be more severe punishment, and we need to make sure those indicted do not profit from their crimes through books or publicity.

Also, the AACSB (The Association to Advance Collegiate Schools of Business) needs to develop more vigorous criteria for teaching ethics in business school curricula. It needs to put in place an assessment mechanism to ensure the schools are teaching the right things to our students.

BALA SHETTY, Ph.D., is the Jenna & Calvin R. Guest Professor and associate dean for Graduate Programs at the Mays Business School at Texas A&M University. Reach him at (979) 845-0361 or at

Wednesday, 20 September 2006 13:11

An ocean away?

When your fiercest competitor lives not across town or even in the same country, but a continent or two away, what pressures bear on your ability to build and sustain a business?

According to Michael Hitt, a leading management consultant and distinguished professor of business at Texas A&M University, globalization forces businesses to continually develop new competitive advantages in order to go head-to-head with rivals an ocean away. Sophisticated in every way as an American operation, these firms bring to the table ready access to the same skills and materials that domestic firms market. As a result, U.S. companies need to develop a fresh paradigm for viewing competition, says Hitt. This means developing strategic alliances and partnerships globally in an effort to reach more markets and to continually improve on customer service and product delivery.

Smart Business spoke with Hitt about the challenges facing American industry in a globalized economy.

Why has the term ‘competitive advantage’ become so popular?
Competition has really changed in the last 10 years, and we truly are a global marketplace. The work of Michael Potter at Harvard caught the eyes of many managers when he wrote about competition and the implications of designing the best strategy.

Other recent works including that by New York Times journalist Thomas Friedman have addressed how a firm can no longer consider itself a solely domestic company when the entire businesses environment has become globally focused. Today, you no longer sell in a regular (protected) domestic market. And firms realize they need to develop unique strategies to remain competitive.

Can you cite recent examples of firms that have failed to adapt to the new competitive landscape?
Levi Strauss comes to mind. As recently as 20 years ago, this American icon was the top brand in its category. Today, it’s struggling to survive because it failed to address customers’ needs. And as it faltered, others quickly brought out the kinds of products that consumers desired.

Polaroid is another example. It once was one of the country’s top 50 companies. Today, it’s no longer in business because it failed to quickly bring out a digital camera, which a slew of rivals did.

What role can outsourcing play in developing a competitive strategy?
A lot of business activity has shifted to countries such as China and India, either because of the cheap labor or for the access to a wide pool of high-skilled people than is available domestically.

Figuring out what should be outsourced is part of the new competitive strategy. A large firm typically forms about 140 strategic alliances in a three- to five-year period. In doing so, it’s getting something valuable from its partners — a constellation of networks in which they share a knowledge base; an entre into a new market with seasoned operators; and the kind of partnership that’s needed to manage local relationships.

Should a firm sign up the lowest cost provider of a product or service?
You should never go for the cheapest bid. Some people assume that companies outsource their work because it costs less to get work done someplace else. Maybe the talent that’s needed is not available locally or because, in order to enter a new market, you need local partners.

Regardless of the decision to farm out a function, it’s critical that you manage your human capital.

It seems as if a businessperson today cannot afford the luxury of sleep.

You cannot relax as an individual or as a firm. You’ve got to be aware of many different elements of your business, including your own strengths and weaknesses. You’ve also got to know who your customers are and always keep a line of communication open with them. You need to know what your competitors are doing to beat you at your game, and you’ve got be able to predict your customers’ future needs.

If you do all this, are you sure to succeed?
A number of strategic mistakes are made when a business becomes too arrogant. It’s why you see businesses entering industries they shouldn’t and then failing. Know your strengths and focus on them. At the same time, maintain a dynamic equilibrium in which you pursue, diversify and build new strengths in your business. It’s why developing a competitive advantage through strategic alliances with other firms becomes important. Having access to their resources can help overcome your weaknesses.

MICHAEL HITT is a Distinguished Professor and the Joe B. Foster chair in business leadership and the C.W. and Dorothy Conn chair in new ventures in the Department of Management at the Mays Business School at Texas A&M University. Reach him at (979) 458-3393 or

Monday, 26 March 2007 20:00

Standing at the ready

Visits to venture capitalists (VCs) are among the first order of business for entrepreneurs seeking to get a business off the ground.

These seasoned investors with an eye for the next home run often are the initial source of funding for neophyte businesses seeking to take a novel idea and morph it into a marketplace behemoth. As savvy pros in the high-stakes seed-financing arena, the investors also hold back subsequent rounds of funding until they see progress on a business plan.

Often, the business owner needs additional funds to tide him over during the period between one round of funding and another. This is where a commercial bank can assist with venture debt financing.

Smart Business spoke with Phil Koblis, first vice president of the Technology and Life Sciences Division at Comerica Bank, about how venture debt financing helps provide the “additional runway” to firms waiting to tap the next round of capital from their major investors.

What is venture debt?

It basically is a cheaper cost of capital. Less expensive than raising money from a venture capitalist, venture debt helps businesses continue to hit their major milestones as money from an earlier round of financing is depleted. Venture debt loans are loans made against a company’s assets and typically provide the runway between a first and a second round of financing.

Most start-ups need to do business with a commercial bank at some point, even if they have venture capital backing, because they usually are in an infancy stage and have very little cash flow. They depend on their venture capitalist for nearly all their operating needs. Our loans help supplement their burn rate for one to two years until the VC steps in with additional dollars.

How do you assess the creditworthiness of a start-up company?

We usually come in only after a business has secured the commitment of a major institutional venture capitalist. The factors we evaluate include who is providing the venture capital; the individuals who form the management team at the company, their track record and their history of business success; and finally, the business idea itself.

The original equity investor already has done a lot of due diligence before committing his money. And we hold their decisions very highly because they typically make good investments. But we also meet with a company’s management several times to discuss their business plan, ensure that they are on track in hitting their milestones and we review all their financial statements.

One of the keys in providing these loans is understanding the quality of the VC firm. We need to know that the VC has a certain amount already allocated to the business for its next round of financing. We know which of these firms will go through thick and thin for a company by following through on initial investments.

There is a bit of a process of educating both the business owner and the bank about the expectations one has for the other. How will a venture debt loan help push the business plan along and how confident is the owner that he can raise additional funds from the VC? Ultimately, we believe that the strength of our business lies in our ability to actively partner with both the business owner and the venture capitalist to help ensure that their expectations of the business can realistically be met.

How long does the process take to secure a venture loan and how is it secured?

It might take between three and eight weeks on average to close a loan. During this time, we ensure that the business is plugging along in the right direction, that the VC is still interested in the business and that we have sufficient security in the firm if we need to claim its assets.

Our loans on average range from $1 million to $5 million. For biotech firms, the amount is about $5 million to $10 million. On average, a loan is amortized over three to five years. Once a business finishes drawing down its loan, it has about 36 to 48 months to repay the loan amount.

From our perspective, we should have the confidence that the VC will come in with its financing once our amortization schedule kicks in. We also take a little bit of stake in the company through warrants to buy shares at a future date, and this can help the firm in getting a better price on the loan.

At the end of the day, we take a risk in providing a loan. We are not gaining equity in a firm and expecting to make money once a business is sold.

Why has it become such an attractive option for companies lately?

A couple things make it so popular. First, the availability of venture debt has grown as new providers and more dollars have entered the market. Second, the cost of this form of capital is still very low as compared to equity. At the end of the day, if the companies and venture investors involved in those companies use the venture debt in the proper way, they should be able better maximize their investment returns upon a liquidity event.

PHIL KOBLIS is first vice president, Technology and Life Sciences Division, at Comerica Bank. Reach him at (415) 477-32622 or a

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