Rahul (not his real name) is a successful business owner with a problem: He has established three businesses ranging in size from $1-million to $8-million in revenues. Each of his companies has a general manager with stock options, so if Rahul sells any the businesses, its manager will benefit financially.
One of Rahul’s managers – let’s call her Diane – has been building a promising product that has required Rahul to invest a lot of his excess cash to bring it to commercialization. Rahul has already lent the company more than $700,000, and Diane estimates it will cost another $500,000 to become cash-flow positive.
Diane would like Rahul to lend the $500,000 at prime plus three, but Rahul is not comfortable pouring another half-million dollars into the business. The business could never qualify for traditional bank financing, and it is too early to attract an outside investor, yet Diane continues to treat Rahul like a bank with an open door and a bottomless supply of money.
Now Rahul is in a tight spot: If he lends the money, he risks becoming overextended. If he refuses, the business will likely go bankrupt before rounding the corner to profitability, and Rahul will lose both his start-up investment and the $700,000 he has lent the business.
One of the problems, in my opinion, is that Rahul has given Diane only one side of the entrepreneurial equation – options that will make her rich if Rahul sells – but not the other side (other than being out of a job if the company goes bankrupt) for sucking up Rahul’s cash.
I think it’s a common problem for entrepreneurs with multiple businesses and general managers who lack a basic understanding of cash flow.
Cash flow is like oxygen. If it runs out, nothing else matters. Smart operators, using their own money, have a funny way of being able to stretch every dollar. They ask customers to pay up front, extend their suppliers, tighten their manufacturing process to build on demand – just about anything to preserve their cash.
But Diane is not acting as though it’s her money. She could have asked a prospect to pay in advance for an unfinished product in return for the opportunity to influence the product’s design. In this kind of arrangement, the customer gets a product that is designed to meet its specs, and the entrepreneur gets the cash needed to commercialize the product.
It’s how Bill Gates got the money to get the first Microsoft Corp. operating system off the ground. He agreed to develop the product that would evolve into Microsoft Windows, with International Business Machines Corp. as the financier and first customer. IBM got its operating system, but Microsoft retained the copyright, and the rest is history.
Being responsible for cash flow has a way of sharpening a manager’s focus and turning the game of business into real life.
This is why I use a cash-flow statement to mark the edges of the playing field for a general manager running a business for me. I have a cash-flow statement generated each week and make sure the operator maintains an agreed-to minimum cash balance.
Cash flow is not the manager’s goal – usually I tie a goal to profitability or client retention – but it marks the outer limits of the playing field. Cross the line, and the game stops. I state clearly that if the operator goes outside the lines, it is grounds for immediate dismissal.
That might sound harsh, but it is no more cruel than the real world, where the owner who runs out of cash is out of business (and probably homeless). There is no second chance when it’s your own company.
By making your general manager responsible for both profits and cash flow, you align your interests – both the upside and the down – as closely as possible.
Special to The Globe and Mail
John Warrillow is a writer, speaker and angel investor in a number of start-up companies. He is the author of Built To Sell: Creating a Business That Can Thrive Without You, published by Portfolio Penguin.