Editor’s note: Jim Verdonik and Benji Jones of Innovate Capital Law are regular contributors to WRAL TechWire
RALEIGH – Are you worried about how events outside your control are affecting your business?
Who can prepare for something so unpredictable?
Let me ask you this question:
What do the following years have in common?
Major Recent Crises
In 1987, the federal agency that insured Savings & Loans became insolvent. The crisis forced the closure or consolidation of many small to mid-sized financial institutions. Reckless lending propped up by government insured bank accounts created a real estate bubble. Lenders simply financed many more projects than the market needed. Empty buildings were everywhere.
In 1991, during the first Gulf War many people stopped working and watched American technology blow up Iraq. People stopped doing deals, because of uncertainty. But it was a short war. Everyone went back to doing what they usually do, and the economic damage was limited.
In 2000, the Internet bubble popped. Hundreds of overvalued dot.com companies went out of business. Paper millionaires had to become waiters. But most of the other parts of the economy kept chugging along. And later a dot.com named Amazon became the most valuable company on the world.
In 2001, 9/11’s World Trade Center attack threatened to shut down the economy. The Government shut down the airlines. People were fearful there would be a wave of terrorist attacks wherever people gathered. President Bush told Americans they could fight terrorism by going shopping. We did. The economy suffered only minor damage outside the airline industry.
In 2008, major financial institutions went under due to over speculation. Businesses faced a liquidity crisis. Stock markets crashed. Bankruptcies spread. Unemployment skyrocketed.
It’s too early to know the 2020’s pandemics enduring effect on the economy. All we know now is that business activity across a wide range of industries has slowed or halted and we have had the fastest unemployment increase in modern history.
Will the Government keep restaurants and shopping malls closed or restricted?
Will Americans go shopping again once stores reopen? Or will Americans hunker down in fear despite reopenings?
If Americans go shopping again as we did after 9/11, will the virus strike them down?
This important part of the 2020 story remains unwritten.
If you are looking for answers to these questions, you will not find them here.
This article is not primarily about the current crisis. It’s about how we build the unexpected into our businesses to deal with this and future crises.
What do all these crises have in common?
- All have had major stock market crashes and sharp drops in business activity.
- Uncertainty and fear threatened to spread the economic damage far beyond the cause of crisis.
- Many businesses that did not cause the problem suffered
- Businesses and consumers had to adapt to new circumstances.
Dealing with Certain Uncertainty Moving Forward
So, how do you deal with these problems that are not caused by your business?
The first principle is that you should always expect that something unexpected will happen. Over a period of thirty-three years a crisis has occurred at 6 to 7-year intervals on average. It is not rational to ignore something that happens so often.
The second principle is that its irrelevant that these crises were started by many different causes. War, disease, terrorism and speculation are all outside the control of most businesses and often sneak up on people “out of the blue,” because we are all so busy doing other things. And then we become scared. So, how people react in any crisis is usually a much bigger issue than the events that triggered the crisis.
Given these two principles, how do you protect yourself?
Investors often say they would rather invest in a Grade A management team with a Grade B idea than a Grade B management team with a Grade A idea. Grade A management teams change their plans to minimize damage from unforeseen threats and quickly redeploy resources to maximize the upside of new opportunities. They do not panic when they face new threats. They also are not so tied to their business plan that they miss opportunities.
Team Buy In
One of the signs of great management is the extent to which their team members understand their roles in fulfilling the business’ overall strategy and are dedicated to playing these roles. Needs change during crises. So, roles also often change. That requires new buy-in.
Decision Making Processes and Implementation
Crises require fast action because time is money. You must cut the bleeding quickly to save the patient. How long does it take your business to make decisions and implement them?
Beware of leverage. Debt is a great tool during smooth economic times with rapidly growing revenue and high margins. But debt in a downturn is deadly. Imagine a restaurant chain that borrowed money last year to open 20 new stores. Debt service obligations based on perpetual growth and high margins kill businesses on a regular basis.
Balance your business’ fixed costs and marginal expenses. It takes money to make money. So, you must spend money. But its dangerous to lock yourself into high fixed costs that you cannot cut rapidly. So, try to have a Plan B that allows you to shed expenses quickly. You will probably pay more per year on average for the privilege of having an escape hatch, because other businesses will give you discounts if you make long term commitments to them. Think of that extra cost as the price you pay for an insurance policy. Businesses should always price risk.
Risk Reward Ratio
Each transaction you enter into has its own risk reward ratio. Do not assume high risks unless the rewards are high.
Contracts and Legal Advice
Contracts play a big role in your business. Each contract allocates rights and rewards and obligations and risks. Leases generally assign to the tenant the risk that a pandemic will shut down your business and cut off the revenue you need to pay rent. Other contract terms limit damages. Force majeure provisions allow one party to delay performance when things they cannot control make performance impossible. Do you know how your business’ contracts balance your risks and rewards?
Business interruption insurance can insulate you from the effects of some risks. But pandemic insurance is likely either unavailable or very expensive.
People talk a lot about building sustainable businesses.
Building crisis coping mechanisms into your business is a critical sustainability requirement.
Every six years or so you’ll be glad you did.
(C) Innovate Capital Law