Just as every senator sees a President in the mirror, every new entrepreneur sees a Bill Gates or a Mary Kay Ash in the mirror also.
But a new business is a risky venture, no matter how much experience or backing the leadership team has. One need only look at the ‘dot bomb’ experience to know that knowledge and money are not going to guarantee success.
Thus, every good strategic planner will develop a worst-case scenario. When business is being conducted in the big leagues, with an IPO and lots of lawyers involved, the risks are minimized among the stockholders for financial losses, and the vendors are generally not so concerned with acquiring the ever-popular personal guarantee.
A new small company, on the other hand, has very little, if any, shared risk. In fact, for the most part, if you are going into business with a partner or two, many vendors will require personal guarantees of any credit that is extended to the company. Frequently, they will want at least one of the partners, if not all, to sign personal guarantees which will now bind their personal assets for any business debts.
Every business writer in the world will tell you not to sign a personal guarantee for corporate or llc debt. It is what those “incorporate in Nevada” seminars charge $100 to tell you. This is great advice, except for one small problem — the vendors won’t extend sizable credit to a new small company without the personal guarantee, unless you have some great leverage against them. This is highly unlikely in most cases.
Continuing with my sleep lab example. We were opening up a sleep lab, and part of the equipment we needed is diagnostic medical equipment. There are three manufacturers in the world that we would consider using. Each one has their own program for purchases and leases.
Our company uses from $80,000 to $100,000 worth of equipment, so as a start-up, I did not want to use a large part of my operating capital into equipment before I had a proven business. Therefore, I chose to pursue a lease. Each company wanted a semi-long-term lease, 12 to 24 months apiece, and I had to personally guarantee any deficiencies. But that was too long for my tastes, and if the company went under, I didn’t want to be paying for equipment that I wasn’t using.
We have management with a proven track record of developing the business model we are operating under. This proved to be our leverage with the companies. By having a proven executive at the helm of the development, we were able to pit the companies against each other, and consequently secure a month-to-month lease, which I was then comfortable personally guaranteeing.
This way, if the company went under, I was only personally liable for a month or two of the lease.
Our hotel space also required a personal guarantee, but because I knew that if we were not profitable quickly I could shut down the operation and the hotel would absorb the vacancy quickly, I knew that my losses were limited. I was also able to get the manager to agree to a short-term lease with options to extend in six-month increments, which also was a safety factor for us, when most landlords want at least a year’s lease, and in commercial spaces frequently longer if any type of major improvements are being done.
We had to review our capital expenditures. Where were we spending money that we would not be able to recover if the company tanks. Obvious categories are in the office equipment like desks, chairs and fax machines, which can be sold off at a modest loss, but the less obvious categories are cabling for phone lines, cabling for the equipment, marketing materials, phone line start-up costs, etc. These are expenses that we can never recoup if we have to move, or the company goes under.
Because costs like cabling are one-time expenses, I don’t need to be concerned about long-term exposure, but I do need to be aware that these are generally not moneymaking expenses. More importantly, they are not recoverable at an auction or by sale to a used equipment dealer. Also, I am not going to get a return on my investment in cabling. I need it to have my company operate properly, but it is certainly not something that I can show to a group of doctors and extol the virtues of and convince them to send patients to us based on the quality of our cables.
As a new company, we are not offering any fringe benefits like a retirement plan or any long-term contracts that we would have to honor past next month. This is really a third-year category of benefit that we will offer once we have achieved profitability and recouped our investment.
By being aware of the potential downside, I have been able to limit our exposure should the company fail. We will not be locked into long-term yellow page ads, office space, equipment leases and personnel contracts. This is all part of a solid exit strategy for the worst-case scenario.
The more exciting and enjoyable part of an exit plan, is what do you do if you make it big. How do you handle fast growth? And what are the possibilities for the company that is successful? More on that next week. (David Pisarra is a business development lawyer in the Santa Monica firm of Pisarra & Grist. He welcomes your questions and comments. He or 310/664-9969.)
Originally published in the Santa Monica Daily Press print edition on June 22, 2004. Read the original PDF.