10 ways to lose your business in a downturn

As the economy slows, more and more entrepreneurs are finding themselves in trouble. Watch out for these 10 ways you could lose your business. By JAMES THOMSON

As the economy slows, more and more entrepreneurs are finding themselves in trouble. There have been some spectacular high profile falls. Some have lost their shareholdings and others have been forced to shut the doors completely. Watch out for these 10 ways you could lose your business – avoid these and survive the downturn.

1. Margin Loans

Let’s start with the main reason for some of the more high-profiled collapses in recent months, such as Allco Finance Group, MFS and ABC Learning (all of which are still alive, but in a much diminished state). A big part of the reason these companies have been sold off so sharply is that their chief executives – David Coe, Michael King and Eddy Groves – had big margin loans over their personal shareholdings.

It’s great to own a big stake in a publicly listed company that is performing well. But the problem is you can’t realise any of your wealth without selling some shares – and that is generally frowned upon by investors, who see it as a sign that the chief executive lacks confidence in their company. So some chief executives took out margin loans over their shares and used the cash to buy more shares (in their own or other companies) and lifestyle assets (Michael King, for example, had an extravagant polo complex in Queensland).

When your shareholding is worth $200 million and you take out a margin loan of $20 million, it’s not such a problem. But if the share price tanks and your shares are suddenly worth $50 million, a $20 million loan is a big burden. And if you are forced to pay if off your margin loan by selling shares, then you are going to lose a lot of money – and in Coe and King’s case , your job as chief executive – very quickly.

2. Timing

The other big problem that has struck chief executives of troubled companies in recent months is the way the credit conditions changed so quickly. One minute financing was cheap and easy to obtain. The next minute – mainly because some US banks had lent money to people who should never have been given loans – the credit markets are shut and financing and re-financing became impossible to get. For many of the businesses that have run into trouble, refinancing just a few weeks earlier could have made the difference.

3. Debt

Of course, if businesses such as Allco and MFS hadn’t taken on so much debt, then they wouldn’t have been in so much trouble with re-financing.

Debt isn’t just claiming high flyers. Mark Alexander-Erber, owner of the Pubboy hotel chain, is being forced to sell up by the banks and other creditors who are owed about $20 million. It appears that Pubboy took on too much debt to expand and when interest rates rose sharply he was caught out by higher repayments.

Nick Combis, an accountant with Brisbane-based insolvency experts Vincents Charted Accountants, says business owners are struggling to adapt in the credit squeeze. “They’ve still got these large amounts of borrowings but now they are at much higher rates.”

4. Bad management

David Hambleton, partner at insolvency specialist RE Murphy & Co. says the problem that hits most companies is simple – poor management and particularly poor record keeping. “In the majority of cases you’ve got a mum and dad team who are very good at what they do but who aren’t great book keepers.” When a business starts getting into trouble, many business owners have little idea why and little idea of how to turn things around. “They just don’t know where the company is sitting from a financial point of view.” Combis agrees. “I constantly see management taking their eye of the ball.” He says it’s the little things that matter, like keeping good records and keeping up with tax office requirements.

5. Debtors

Chasing up debtors is a particular management problem for many businesses. “It’s human nature,” Hambleton says. “People just don’t like making the calls to chase money.” He says business owners must change their attitude towards debtors in the tougher business environment. Creditors are becoming more demanding as the economy slows and businesses that cannot chase debtors up in a timely fashion will develop potentially fatal cashflow problems. “You can no longer just take it for granted that people will pay.”

6. Undercapitalisation

To see why businesses end badly you sometimes need to go back to the start. Another common problem Nick Combis sees is undercapitalisation – business owners are underestimating the amount of start-up capital they need. “If you are starting a business you’ve got to understand that the first 12 to 18 months are going to be tough.” He says most companies have enough to muddle by for between one or three years, but then they get in trouble and struggle to recover. “We are seeing a lot of businesses come to us at that stage, desperate for help.”

7. Rapid expansion

Even in a downturn this can be a problem and here’s a great example. You’d think that the credit crunch would mean good times for collection agency Credit Corp. Just six months ago, the company’s shares hit a record high of $12.90 and its market capitalization was around $550 million. But after two profit warnings, the company’s stock is down to 90c mark and its market cap is just $36 million. The reason for the profit downgrades? Rapid expansion, which required new employees and the need for the company’s more experienced employees to help train the recruits. This in turn led to a dramatic loss in productivity. The business has been restructured and the chief executive and board kicked out, but Credit Corp’s future is uncertain.

8. Tax office

David Hambleton says that the Australia Taxation Office’s decision to outsource tax debt collection will hurt a lot of companies. Traditionally, the ATO has been a rather tolerant creditor, but there are fears amongst insolvency specialists that the collection agencies now operating on behalf of the ATO will be less compassionate. “And there’s a heap of tax debt out there,” Hambleton says.

9. Reliance on particular customers

It’s great to win a big account or order from a valued customer, but too often firms devote so much time and energy to servicing that customer that they fail to develop new business. The Australian car parts sector is a great example. When the four Australian car makers – Ford, Toyota, Holden and Mitsubishi – were going well, the car parts makers were loving life. But when the car makers’ sales slowed, the parts makers had nothing to fall back on – no export customers, no customers in related industries – and they began to die.

10. Naughtiness

One sure-fire way to lose your business is to do something illegal or unethical – it’s usually a sign that a business is close to collapse and its owner is becoming desperate. If you do something naughty, you’ll either get caught by the relevant authorities or destroy your reputation. Either way, you’re likely to lose your business pretty quickly.