Every number that has to do with your business is undeniably important. But one financial reality is of particular importance to small businesses looking to scale.
LISTEN!
For a small business or an entrepreneur, working capital can mean the difference between success and extinction.
Many entrepreneurs have a dangerously simple idea of how business works. To them, it’s very straightforward—you sell something to someone else, and you get paid. End of story.
Except that’s not even close to how things work.
Here’s an example of what I’m getting at. Let’s say an entrepreneur designs an absolutely beautiful purse—stylish and eye-catching at the same time. She takes a sample around to various high-end retail outlets, and the product is appealing enough to attract immediate attention from the store owners.
“You know what?” says one. “I’d like to carry those in my store. I’ll take thirty-six. When can you deliver them?”
That’s a problem. The entrepreneur is thrilled with the order but lacks the necessary cash to buy the materials to produce thirty-six purses. And after the purses are manufactured and delivered, the store placing the order can have a month or longer to pay for them, according to most current accounts payable standards.
That’s an issue that I see over and over again with all sorts of entrepreneurs. They expect to be paid right away, only to discover that the money they rely on to keep things operating isn’t going to arrive for a month and a half.
What do they run out of? Working capital. And in my experience, the number one reason—by far—that people don’t make it is because of working capital.
“The biggest issue that small businesses face involves working capital, because they have to pay for everything up front.”
Breaking down the topic a bit, working capital is the difference between a company’s current assets and liabilities. Current assets are those that can be turned into cash within the next twelve months; liabilities are expenses, costs, and other charges within that same twelve-month time frame.
Working capital is well named. That’s because it’s money you can put to use right away to help your business function at its peak all the time.
A company’s working capital situation is determined by a number of factors. For instance, some businesses require more working capital than others, such as manufacturers that need funds to buy supplies necessary to make products.
How long it takes to make those products is known as the business’s operating cycle—the longer the cycle, the greater the need for cash on hand. Operating cycle also refers to the situation I described earlier: the entrepreneur who makes a sale but has to wait several weeks to be paid. That’s a gap that needs to be filled.
Then there’s the sort of business in question. For example, if you have a business that’s cyclical in nature—you have certain busy seasons or have products geared to particular holidays—you’re going to need plenty of working capital. That’s money that will not only see you through leaner portions of the year but also help you gear up as you approach peak seasons.
Christmas is an ideal example. Many retail businesses experience a significant sales spike during the holiday shopping season. Yet many struggle since they don’t have the working capital necessary to stock up for the holidays.
Working capital also fuels growth. If a small-business owner or entrepreneur starts a business and wants to expand it, they’ll need lots of working capital to fund that expansion. On the other hand, someone with more modest goals may be perfectly happy to stay small, requiring less cash.
These and other issues are the sorts of things that never occur to many entrepreneurs—until the day they find they lack the necessary cash to meet even the most basic expenses, let alone have the money to grow.
If you think about it, that creates something of an uneven playing field. Many small businesses have to pay for essential expenses up front, only to find that the same sort of quick payment doesn’t happen when customers place an order. Unfair maybe, but that’s the way it is.
Sometimes the worst thing that can happen to a small business is sudden success—by success, I mean a large number of orders. On the surface that may seem like the best thing that can happen, but without working capital available to produce the products to fill those orders, all you may end up with is a rash of unfilled orders and angry, disappointed customers.
Even having a large number of assets won’t necessarily cover for a lack of ready cash. The infamous Enron story is a perfect example. Enron went under due to a lack of liquidity and working capital. They had billions in assets, which they didn’t have time to sell to pay those basic expenses I mentioned earlier. Their assets were eventually divvied up and sold off after the company went under. With billions in assets, they didn’t have to fail, but they did because they didn’t have sufficient working capital.
So, what’s the answer? Every business needs a “revolver,” meaning a revolving line of credit, such as a bridge loan or line of credit, to fill in the gap.
The trouble is, getting a line of credit or loan can be difficult, particularly for a new business. Banks have been cutting back on their financing of small businesses, particularly larger banks. And as smaller community banks are swallowed up by larger institutions, the number of choices available to borrow from is growing smaller all the time.
I know exactly what this feels like. When I was starting out, I tried to get my hands on money in every possible way I could—credit cards, you name it. (One thing I didn’t do was reach out to friends for loans. If you want to lose a friend, just ask for a loan. Nothing destroys a friendship faster.)
Add to that the fact that, at the time, the banking environment in Houston and throughout Texas was being shaken to its core as bank after bank shut its doors (a situation that, as it turned out, worked in my favor, as I describe in a later chapter), so securing working capital was nearly impossible.
Even though the banking situation is a good deal more stable now, it can still be difficult for entrepreneurs and small-business owners to get financial help from a bank. Often, new businesses have little in the way of operating history to support their credit worthiness or collateral to borrow against, so their inability to secure loans isn’t all that surprising. Many lenders will give lines of credit only to companies that have a minimum of two years’ worth of operating history.
Start by building up your cash reserves. This is separate from bank financing but is a critical step to ensure you have as much liquidity as possible. It’s important for entrepreneurs to understand that business cycles go up and down. Be prepared for the down cycle. During down cycles, use your cash to expand your business. But during boom cycles, save cash for the next downturn.
“When things are bad, eat the weak and grow your business.”
That’s not just a matter of survival. It gives you the opportunity to eat the weak and grow your business—while others are struggling mightily.
Here’s an example of what I’m getting at. Lake Charles, Louisiana, may not be a familiar city, but it’s the primary gaming market for my hometown of Houston, Texas—the oil capital of the world and fourth-largest city in the United States. Owning a casino in Lake Charles was something I had my eye on for a long, long time, because I knew I could do a bunch of business there by bringing in my unparalleled hospitality, which everyone in Houston already knew.
The problem was that no more available gaming licenses were available in Louisiana, making getting into that market very unlikely. Or so I thought.
Out of nowhere, on May 29, 2013, the Federal Trade Commission (FTC) announced that a casino in Lake Charles that was being built by Ameristar Casinos (which was being acquired by Pinnacle Entertainment) had to be sold in order to avoid an antitrust problem. I knew that the other major casino companies could do a bunch of business there. I had to separate myself from them, and fast. What did I do? I was in the middle of buying another casino, but I killed that deal and immediately got on my plane and flew to Vegas to meet with then CEO of Pinnacle, Anthony Sanfilippo. I offered him a $50 million deposit—completely nonrefundable. I told Anthony that if I didn’t close on this deal, he could take the money I put up and sell the casino to someone else.
The building was barely out of the ground, I knew I needed at least $800 million to complete the project, and I had to get the deal approved by the gaming board—all of these could have impacted my ability to close. But I knew that this might have been my only chance to get into the Lake Charles gaming market, and I was ready. Having the ability to put up $50 million and make a big bet on myself and my company is what it took to get the deal done.
Everybody blinked when I staked that amount of money! But I was in a position to do that because I had accumulated the necessary cash.
The same thing happened when I put up $100 million nonrefundable to buy the Houston Rockets, fully aware at the time that I might not be able to obtain the necessary financing. Because I never stopped thinking ahead in building up cash, I was able to fulfill the lifelong dream of buying a sports franchise in my hometown.
LISTEN!
Okay, so you’re not in position (yet!) to make those sorts of deals, but the same principle applies to any sort of business. Want to know an easy rule to make certain you always have adequate cash on hand? Never put your lifestyle ahead of the growth of your business.
I’ve seen it for years. All of a sudden, young companies start making an extra $20,000 a month, and instead of using it to help their businesses grow, the owners buy new homes and new cars. Then their business slips a little, and they end up working like hell, trying to keep up their personal lifestyle.
In fairness, I also own a nice home, boats, and planes. But those purchases never occurred before making certain that all my businesses had sufficient cash to leverage opportunities at all times. I’ve always kept the majority of my money in my company. I bitch to everyone that I never have money because I keep it all in the business!
But that’s why I’ve gone from $4 million to $4 billion in thirty years—I didn’t go out and buy $100 million Picassos like some people. I didn’t buy a house in Malibu. I used that money to buy more companies and to build buildings.
About five or six years ago, I took a big dividend out of the company—roughly $600 million in cash. I didn’t go buy a new plane. I didn’t go buy a new boat. I didn’t go buy a piece of art. I sat there with the money, knowing that times were going to get tough. I was able to make some huge acquisitions. That’s because I was liquid when there was a downturn.
“Never put your lifestyle ahead of the growth of your business.”
This comes back to something I say a lot, but it bears repeating: when things are good, we tend to forget that things can get bad. One of the biggest mistakes an entrepreneur can make is to assume the good times will always last. I’ve been through three major economic downturns, and being prepared is the only way to weather these storms. During the 2008 recession, my company wasn’t caught off guard. Our income dropped 10 percent. Fortunately, we survived by being ready in advance. We always have cash or credit capacity set aside, ready for the next downturn. And so should you.
Next, address the issue of bank financing. The first step is simple: get it before you need it. I cannot stress this enough. Work to obtain bank financing as soon as you can get it, which is generally easier to secure when the economy is strong and your business is doing well. Not only does that give you the best chance to get financing on the best possible terms, but when things take a downturn—which they inevitably will—you’re going to have cash within reach to make it through.
Additionally, pursuing bank financing when your business is doing well lets you leverage those factors that every lender looks for—positive cash flow, and solid and consistent revenue and profits, among other things.
Pay attention to your personal credit, especially if your business is new, with little or no credit activity. The biggest factor in many banks’ decisions to lend businesses money is the owners’ personal credit rating. To boost your credit score, be sure to pay personal bills on time and keep a low ratio of debt to available credit on personal credit cards and credit lines.
LISTEN!
Don’t just go into the bank and tell them you need money. Walk in there like you know how to borrow money and have a thorough business plan with you. Be sure to have a comprehensive overview of your current circumstances, specifically why you’re asking for the money, as well as a strategy that outlines your future plans. And don’t make the mistake of limiting your plan’s outlook to the next thirty days. Instead, map out plans for the next one to three years—the longer and more detailed, the more favorably a lender will view your application.
But as I like to say, don’t go so far as to start drinking your own Kool-Aid. If, by chance, the scenario you lay out to a lender is too good to be sustainable, you’re going to be out of business even if you obtain the cash you’re after. That’s because you won’t be able to meet that aggressive a level of obligation—meaning that you can’t afford the loan.
Here’s what I do and what I suggest you do as well. With every scenario and every deal, I run a best-case scenario, a likely scenario, and a worst-case scenario. If you do that—and provided your numbers work—feel free to offer the banker your best-case scenario.
However, this strategy comes with a few cautions. First and foremost, don’t lie to yourself. If the numbers say you can’t manage your best-case scenario, don’t talk yourself into it, no matter how much you may need the money. Be absolutely certain your best-case scenario is, in fact, doable. Otherwise, you’re driving your business straight off a cliff.
Additionally, don’t overlook the value of drawing up a worst-case scenario. That’s because you want to be confident that you’ll still be in business if anything and everything goes wrong. In the worst situation possible, where will you be? Everyone wants to assume that everything is going to work out, but know what numbers you’ll be looking at in the event that things turn out badly. What will you do when you have half the amount of business you thought you were going to have?
It’s perfectly fine to keep your worst-case scenario to yourself. After all, you want the money. But along the way, don’t lie to yourself (or the bank) and convince yourself that a certain plan is going to work out when the numbers say otherwise. Why? Because, sooner or later, the worst is going to happen, and you need to understand whether you’re going to be able to survive or not. Eighty percent of the time, you’re going to hit the worst-case scenario and not the best-case scenario, so make sure your business is still going to be in business under the worst-case scenario.
If you’re turned down for a loan or line of credit, don’t give up. If you don’t already have one, get a business credit card. Not only can that offer some source of necessary funds, but using it responsibly will help build your business’s credit rating and history, which, in turn, may help if you try again to obtain bank financing.
No matter the specifics, remember that working capital is everything. A business without a ready source of cash is playing with fire, day in and day out.
That was my concern with Nicole Di Rocco of NICOLITA Swimwear, a company featured on Billion Dollar Buyer. The maker of unique swimwear once had a contract to supply a department store, only to have it fall apart after the store renegotiated her contract for a net 90 arrangement. Translated: ninety days to be paid by a buyer. Meanwhile, she lacked sufficient capital to bridge the gap.
Happily, when I met Nicole, she readily acknowledged her need for working capital with which to grow her business. Over my time working with her, she was able to significantly expand her company’s line of credit to carry her through the ninety-day waiting period to get paid. It also paid off for her: she accepted a deal with me worth $175,000 for swimwear for use in my resorts as well as for retail sale. All because she quickly realized that, when it comes to growing a small business, working capital is everything.
TILMAN’S TARGETS
• Working capital is the lifeblood of any business.
• Loans and lines of credit are two excellent sources of ready cash.
• Borrow money when times are good, even if you don’t need it.
• Draw up a worst-case scenario that you can keep to yourself. If everything goes wrong, you want to be certain you can stay in business.