Growing Too Fast? Watch the Danger Signs

by Shel Horowitz

Everyone loves a fast-growing business-or do they? A banker, a lawyer, an accountant, and a venture capitalist came together at the Family Business Center’s October 15 meeting to say, “It Ain’t Necessarily So,” at a panel discussion entitled “Recognizing and Responding to Red Flags in a Growing Company.”

Moderated by UMass business professor Jim Theroux, the panel of Family Business Center sponsors included: Dale Janes, BankBoston’s commercial lending chief for western Massachusetts and Vermont; Paul Kelliher, who runs the Springfield office of PricewaterhouseCoopers (known before July as Coopers & Lybrand); Ron Weiss, chair of the business department at Bulkley, Richardson, & Gelinas-who spends much of his time acquiring businesses for publicly traded companies; and Tripp Peake of Mass Ventures..

Dale Janes said for bankers, the biggest caution flag is a cash flow problem. His biggest criterion: a business should be able to repay debts out of income generated through normal operations.

From the accounting side, management is a greater concern. Kelliher cautioned against one-person management for companies in a growth mode–but notes that such red flags are only indicators to look deeply, and don’t automatically mean problems.

Weiss, the most loquacious of the group, stressed the importance of planning for the future-and getting everything in writing. A closely held business should prepare for the day when it might be for sale, and the business will fetch its best price only if everything is in order. His long list of red flags focused on lack of proper corporate documentation, and covered a number of areas:

  • Documentation that is inconsistent with current practice
  • Poorly negotiated vendor and franchise agreements
  • Failure to document loans from shareholders or problem employees
  • Improper protection of trade secrets and intellectual property
  • Noncompliance with ERISA disclosure rules
  • Lack of buy/sell and succession agreements
  • Inability to move forward because 50/50 ownership creates a voting deadlock
  • Inadequate cash reserves to pay taxes (especially for S corporations)
  • A history of contract disputes
  • Unwillingness to grant sufficient independence to advisors or lack of follow-through on their recommendations

Peake changed the focus from problems a business faces to scenarios in which a business may seek venture capital. He mentioned several possibilities: to fuel growth; restructuring; acquisition and consolidation; buyout of the senior generation by their successors; spinning off a new division.

By using non-debt capital-in other words, equity investment-family businesses can fund these objectives, and the deals can be structured so the family remains in control. Typically, Mass Ventures gets involved in deals in the 1/2 million to $1 million range, whereas, these would “fly underneath the radar screen” in Boston, where typical deals are in the $5 million range.