Money: That’s What I Want. Sources of Capital for a Growing Business

If your only business is snowboarding, you need money for three reasons. First, your business should grow at least as fast as the industry, and that growth translates into more cash tied up in the business. Second, extreme seasonality and the extended dating customers are demanding requires more working capital. Finally, tough competitive conditions are probably reducing margins, leaving less cash flow for each unit of product.

Adequate working capital is never enough to make a company succeed. Survive and continue, yes- but not succeed. On the other hand, not having enough capital has destroyed many businesses that were otherwise viable. Another time we’ll talk about determining how much working capital you need. For the moment, let’s assume that’s done. The subject for today is where to find it.
Two general comments about raising money. First, the only thing we know for sure about your estimate of capital requirements is that it’s wrong. We don’t know it you’ll do better or worse than projected, but either way, your capital need is usually greater than anticipated. Most investors, when looking at a new business, assume that twice the capital projected will be needed. Allocating an additional 15 percent for surprises may make sense if you’re budgeting a project for an ongoing, established business, but it’s wildly optimistic for a startup or fast growth.
The second thing to recognize about raising money is that it takes longer than you expect and requires your continuous attention, especially if you’re raising equity. Plan to be distracted from running your business.
The smaller and less established your company is, the tougher it is to find capital unless it comes out of your pocket. Profitable, established companies have an easier time of it, but the options are essentially the same.
There are only seven places I know of where you can find capital.
·         Your pocket
·         Your friends’ and relatives’ pockets
·         The bank (including bank like entities like the Small Business Administration)
·         Asset Based Lenders
·         Third party private investors
·         Your customers and suppliers
·         The public markets
Let’s look briefly at each one.
Your Pocket
Nobody is going to invest in your business unless you do. As a result, most small businesses get started with the owner’s personal capital. It can be a home equity loan, savings account or an advance from your credit card, but it’s going to be your money.
Your Friends’ and Relatives’ Pocket
“Joe’s starting a business!” I’m putting up $5,000 and we’re all going to get rich!” People you know well are the easiest to approach, and the most likely to be supportive. Nobody likes rejection, and you get a lot when you’re raising money.
People who love and trust you may not ask the hard questions a banker or third party investor would ask. As a result, your expectations and theirs may not converge. Especially when taking money from friends and relatives, make sure the relationship is defined as rigorously as it would be with somebody you didn’t know.
Is the money a loan or equity? Do they expect dividends? A job? Are they really prepared for the possibility of losing all or part of the money? Can they truly afford it? How do they propose to get their money out of the business? By when? It’s hard not to accept cash when you are enthusiastic about your business and it is offered with so few strings attached. But spelling out the relationship now will save you money, time, headaches and friends latter.
A client of mine has an exciting new product. His partner is contributing his time, professional expertise and reputation, and some cash for a stake in the business. The agreement they’ve got calls for him to receive 25% of the “net profit” after allocation of direct expenses and “appropriate overhead.” It isn’t clear if he continues to receive such compensation after he leaves the company. We’re rewriting the agreement to eliminate the ambiguities. Imagine all the fun the lawyers could have arguing over what “net profit” and “appropriate overhead” means.
The Bank
Banks are in business to earn some interest and a little fee income. They aren’t interested in sharing the risk of your business with you. The wise person who said “Banks will only lend you money when you don’t need it” was basically right.
What a bank will do is look at your company’s performance for stability and consistency. But even a small business that’s consistently profitable and been around for a while isn’t typically going to get an unsecured line of credit. The bank will require a security interest in inventory and receivables. They will probably also insist on a personal guarantee. From their perspective, a small business owner and his business are the same entity because the owner controls and flow of money between the company and himself.
A startup or company that isn’t stable and established won’t get a bank loan, though that doesn’t mean they can’t get money from a bank based on the owner’s personal assets.
Asset Based Lenders
An asset based lender functions much like a bank, but is willing to take more risk. They compensate for this by charging higher fees and interest, controlling access to the money according to a carefully defined formula, and tracking the assets they control as collateral very carefully. A bank looks at your cash flow as a primary source of repayment. That is, they analyze your company as a continuing entity. An asset-based lender is less concerned about profitability than about their ability to liquidate the company’s assets for at least as much as they have lent to you. Your business may collapse, but the asset based lender still feels they will get every cent they have coming to them.
Third Party Investors
The good news about a professional investor is that they will put you through a more rigorous legal, business, financial and market evaluation before making an investment. At their best, they will provide you with skills and experience that will help you build your business in addition to access to capital. The possible downside is that they will take control out of your hands, may have active involvement in the company, and will be looking for a big return. They will be in your business to make money.
It seems that everybody who knows the term venture capitalist thinks they are the place to go to finance a new business. But venture capitalists invest in, say, ten businesses expecting eight of them to fail to live up to expectations. That means they are only interested in you if you can demonstrate the potential for rapid growth with a clear competitive advantage or unique product. It also means they generally aren’t interested in investing $50,000. At a couple of million you may get their attention.
The reason is simple. The time and effort they put into making an investment is expensive. It represents too big a percentage of a small investment. Nor can they expect the returns they want to aim for on smaller deals.
Your Customers and Suppliers
A larger company who wants to work with you may be willing to provide some up front payments to get your product. Suppliers often offer terms to companies they hope to expand their business with if required by the competitive situation. At its best, you get terms from your suppliers such that you collect from your customers before you have to pay the supplier.
These business cycle dynamics can be an often overlooked source of working capital.
A client of mine that is producing interactive conference calls (almost like talk radio over the telephone) has found its large corporate customers so anxious to use the service that they are being paid in advance. Essentially, they can grow without raising any outside capital by utilizing the business cycle they have created.
The Public Market
The advantages of going public are that you get a higher valuation of your company, access to future funding, and liquidity for your personal equity in the business. The disadvantages are the reporting requirements of a public company, the fact that your company is something of an open book, the loss of flexibility, and the expense. I understand somebody else is doing an entire article on going public in this issue, so that’s enough said by me on the subject. 
Those are your choices. Which one is right for you depends on how much capital you want to raise, what you want it for, the history of your business, and its prospects.



Getting In Deep Trouble; Why Companies Get There, and What it Takes To Recover

It doesn’t matter if you’re a retailer, distributor or manufacturer. It doesn’t even matter if you’re in the snowboard business. In every industry, companies get in trouble for the same basic reasons, and require the same things to recover

All businesses in trouble share two characteristics: denial and perseverance in the face of inescapable change. It’s easy to believe in what worked in the past, and hard to step outside our comfort zone and do things differently.
Businesses suffer from information overload, just as individuals do. Big surprise since businesses are made up of people. When companies get into trouble, day-to-day management of immediate crises (like finding enough cash for payroll) consume managers. Their ability to identify opportunities and problem solutions decline because they can’t see past the next phone call from an irate creditor or reluctant supplier. Pretty soon, they’re paralyzed by action. Managers and staff alike are frantic, but nobody addresses the fundamental changes that get companies in trouble in the first place.
A business owner once looked me straight in the eye as he told me that he had to sell his product for under what it cost to produce it. Why? Because that’s what his competition was doing, he said. Denial and perseverance. The fact that he was liquidating his net worth a little at a time and working for less than he could have made at McDonalds wasn’t really something he’d focused on.
The owner of a business can’t afford to shut out critical information just because there doesn’t seem to be time to consider its significance. Ignorance can kill.
Like the frog that won’t hop out of water if the temperature is raised slowly to boiling, many companies seem all too willing to cook rather than change with the business environment.
There are a lot of reasons businesses boil rather than hop out. The five most common ones that I’ve seen in my work with troubled companies include:
Failure to answer the question “What’s the Goal?”
Seems like a simple question, right? What are your goals for your business? Can you measure them? By when do you want to achieve them?
Think about it. How do you know if you’re succeeding if you don’t have tools to measure success and keep you focused on where you want to go? Most businesses that get into trouble have never answered this question and companies jumping into the snowboard business today are often prime example.
Business goals are measurable and realistic. They can always be quantified; an increase in sales, gross profit percentage or dollar sales per employee. Don’t be constrained by traditional measures. If it meets the criteria, works for your business, and keeps you focused, it can be a goal.
Failure to respond to a change in the market
Does anybody doubt that IBM could have dominated the PC market if they had decided to do it early enough? Bill Gates offered them a chance to buy the rights to MS-DOS and they turned him down. Oops.
It’s easy to keep doing what has worked for you in the past. Everybody likes to stay in their comfort zone. A dramatic change in the way your business operates involves perceived risk and is inevitably disruptive and messy. Building an organization that is receptive to change, so that change is ongoing and incremental instead of chaotic, is a critical ingredient of business success.
A character flaw in the owner/chief executive
No, we’re not talking a crook or a psychopath. Like all of us, business executives have strengths and weaknesses. The strengths that allowed Steve Jobs to establish and build Apple Computer became, in the judgment of some, liabilities when it was time to manage the larger, corporate organization that Apple became.
Perhaps individuals who establish and build companies come to believe in and depend on themselves too much. They are often right to think that they can do anything in the organization better than anybody else. Trouble is, they can only do one thing at a time, and this hands-on-everything approach creates a bottleneck at their door and discourages other employees from taking the initiative to solve problems.
Inadequate control systems
“Inadequate Accounting System Scuttles Company” isn’t the kind of headline that boosts circulation, but it should be obvious that you can’t run a business without current, accurate information.
A company I was hired to turn around was operating two businesses on one accounting system. “Nothing wrong with that!” you say. True enough, unless you use one data base for both companies. You credit one business and debit the other. At the end of the month, the books balance, but the numbers are meaningless.
As a result, monumental adjustments were required to create good, meaningful data and they were months behind in doing it. The owner, by the way, was a CPA. Before I ever got there, he’d invested close to $1 million in the venture and ended up losing most of it. Go figure.
Growing too fast
Remember the business cycle; especially in a highly seasonal business like snowboarding. You have to invest money (for salaries, advertising, inventory, whatever) before you can sell anything. The more you sell, the more money you have to invest to keep the business running. It’s called working capital. Profit is an accounting concept. Nobody ever pays their bills with profit. Companies run on cash. If you grow faster than your financial capabilities allow, you can be profitable, but still broke.
If your business is growing (even if it’s not, but especially if it is), do a simple cash projection. It can be as easy as beginning cash balance, plus sources of cash during the month, less itemized expenses for the month, equal cash balance at the end of the month. That number becomes the starting place for the next month. Make it as simple or as complex as you like; whatever works for you.
You know two things for sure about a cash projection. First, that it’s never right. Hey, it’s a projection! Second, that the more you use it, the more valuable it becomes. It’s your money. You must understand the financial dynamics of your business no matter how much you’d like to leave it to your accountant.
Find some quiet time to evaluate your business with regards to these five issues. Better still, have an objective third party whose business acumen you trust evaluate them with you. However hard it is to correct any deficiencies you discover, it’s easier to do now than after the business is in decline.
Company Already In Trouble?
What Does it Take To Climb Out?
·         A viable business
Evaluate your competitive position. Why are customers going to buy your product instead of somebody else’s? If you don’t have a good answer, ask yourself if the risk you’re taking is worth the potential return.
·         Bridge capital
There’s always a shortage of capital, though it’s typically a symptom rather than a cause of the company’s problems. There has to be cash from some source to keep the business going while the problems are fixed.
·         Management
Managing a turnaround requires a different set of skills than managing a healthy company. Often the individuals who were at the helm as the business declined are the wrong ones to rebuilt it, if only because their credibility and confidence is poor.
·         A little time
If creditors have judgments and are attaching bank accounts, the bank has called the loan, and the IRS is padlocking the place for failure to pay withholding taxes, an organized liquidation or bankruptcy filing may be your only choice. Positive changes take time to have an impact. Options decline with circumstances.
·         A plan
You have to convince yourself, your employees, customers, suppliers banker and other stakeholders that you can recover.



Dr. Jekyll or Mr. Hyde; The Dilemma of the Skateboard Factory Owner

“Blanks are killing the industry.” “Yeah, but they give the skater a good deal.” “But pros are what builds the industry, and we can’t support pros on blank margins.” “The problem is that we have too many pros to support.” Etc., etc., etc.

In this highly emotional debate, there’s some truth to everybody’s position. A lot of people seem to feel very strongly both ways from time to time, and it’s an unfortunate source of friction in the industry at a time when it would be nice if there could be a little more cooperation.
It’s a Numbers Thing
Once you get past the strong feelings and the concern for the industry that, hopefully, drives them the dilemma for people with skateboard factories comes down to the numbers. There are two basic business models skateboard factories (or any factory, for that matter) can follow that theoretically make sense. One is higher margin, lower volume. The other is lower margin, higher volume. For companies with factories and brand names, there’s also the internal tug of war between wanting to keep the factory running and maintaining the brand’s position in the market.
Let’s look at two factories- one owned by Dr. Jekyll and the other by Mr. Hyde- and see how the operating perspectives and financial circumstances of these theoretical businesses differ.
Dr. Jekyll
Dr. Jekyll doesn’t own a brand. Just a big old money eating factory that needs to be fed. Whether he makes a single deck or not, wages, insurance, utilities, telephone, interest, and a hoard of other expenses all have to be paid. He’ll make decks for anybody who can pay him his normal price.
Let’s say his overhead (the money he has to pay every month whether or not he makes a single deck) is $50,000. Notice that he doesn’t have to support a team or pay for any ads. He’s making twenty thousand decks a month and the materials and direct labor for each one is about nine dollars.   He sells each of those decks to whoever is going to resell them for, say, fourteen dollars. Here’s how his monthly income statement looks
Revenue                       $280,000           (20,000 decks times 14 dollars each)
Cost of Goods Sold      $180,000           (20,000 decks times 9 dollars materials and direct labor)
Gross Profit                  $100,000
Overhead Expense        $ 50,000
Pretax Income               $ 50,000
Great business. If I believed these numbers were real I’d dump consulting and writing and open my own skateboard factory, which is just what the industry needs.
Mr. Hyde
Mr. Hyde has not only a factory, but also a successful skateboarding brand. It’s not that he wouldn’t accept some shop or blank or export orders, but just for the moment let’s assume he doesn’t need to.
His overhead is the same $50,000 a month as Dr. Jekyll. It costs him the same nine bucks to make a deck. But his deepest darkest secret, contrary to his advertising, is that his decks are fundamentally no different from those of his competitors. So he’s justifiably concerned with protecting his brand name, because the perception of that brand name is really the only competitive advantage he has.
He doesn’t want to flood the market with decks, because that would weaken his brand name. Let’s say he makes 10,000 decks a month.[1] Because the brand name demands a higher price, he can sell them to retailers for $30. Here’s his monthly income statement so far.
Revenue                       $300,000           (10,000 decks times $30 a deck)
Cost of Goods Sold      $ 90,000
Gross Profit                  $ 210,000
Overhead Expense        $  50,000
So far, this is an even better business than Dr. Jekyll’s is. If the expenses stopped right here, Mr. Hyde would have a pretax profit of $160,000 compared to $50,000. I want to be in the business even worse than the first one.
But the expenses don’t stop here, so let’s keep going. There are going to be operating expenses other than overhead. He’s got more customers to deal with and more selling expenses. In additional to what I’ll call administrative selling expenses, there are the advertising and promotional expenses to support the brand; team, trade shows, stickers, advertisements, giveaway product, sponsorships, printed selling materials, the web site…. Quite a list.
Just for fun, let’s say that those costs total another $60,000 a month, bringing the pretax profit of Mr. Hyde’s business to $100,000. Without claiming that these models really represent existing reality in the skateboard manufacturing business, let’s see what we can learn from them.
By the Book
The textbooks say both of these business models- higher volume, lower margin and lower volume, higher margin- should be viable in the same industry at the same time.
The first, utilizing a price leadership strategy, makes money by spreading costs over a larger volume and eliminating most traditional selling expenses. If Dr. Jekyll can sell 10,000 decks a month, and assuming his overhead remains constant at $50,000, he breaks even that month. Every additional deck he sells in excess of 10,000 generates $5.00 (The selling price of $14 minus the direct costs of $9) that falls right to the bottom line. In our simplified model, he should be theoretically willing to accept any order (after 10,000 decks) that pays him more than $9 a deck.   The factory is sitting there anyway with fixed overhead of $50,000 a month and if he sells a deck for $9.01 that’s an extra penny in his pocket.
Mr. Hyde’s breakeven point is 5,238 decks a month even though his expenses below the gross profit line are much higher than Dr. Jekyll’s. Shows you the power of a higher gross margin, and value of maintaining the market position of your brand doesn’t it?
Mr. Hyde has a factory to feed too and even with a successful brand, he isn’t immune to the thought that every deck he makes for more than $9.00 puts some money in his pocket once he’s past his breakeven point. He realizes of course, that he’s essentially competing against himself by making OEM decks and maybe hurting the market position of his own brand, but there’s that factory to feed
It seems at the end of the day that there’s a little Dr. Jekyll in Mr. Hyde.
The Real World
Putting the textbooks on microeconomics back on the shelf (maybe in the section marked “fantasy”), we rejoin Dr. Jekyll and Mr. Hyde in the real world.
You see, lots of other people saw those numbers in the textbook and thought they could have a business like that too. They started factories and brands. When potential customers come to see Dr. Jekyll, and he quotes them $12.00 a deck, they mention that down the street it’s only $11.50 a deck, or maybe that there’s some quantity discounts, or possibly some terms, or an extra deck thrown in for every ten you buy, or something. Well $11.50 isn’t that much different from $12.00 Dr. Jekyll reasons. He still gets a good gross margin. Of course, his break even just went up some decks, but that’s okay. He can accept a couple of shop orders he’d been turning away.
Could be that more than one customer asks for lower prices. Maybe he has to go even lower than $11.50. That breakeven volume of decks keeps going up, and the margin declines further. The lower margin means he has to invest more cash in the business. Getting more volume, from anybody who wants a deck, becomes his purpose in life.
A funny thing happens on the way to higher volume. At some point, he’s got to buy more equipment. Maybe he has to pay overtime wages to support the production volume. His beautiful business model has gotten ugly. Margin is down and overhead expense is up. What’s he supposed to do?
Maybe he can start a brand.
Back at Mr. Hyde’s place, he notices there are lots of new brands, and that it’s getting really cheap to get decks made in small quantities with or without graphics. Determined to defend his brand name and market position, he hires some more team riders, runs some more ads, or whatever. In spite of these efforts, his volume drops a little because there’s an awfully lot of product out there and it’s awfully alike. So his total gross profit is down because he’s now spreading his constant overhead over fewer decks. His expenses have increased because of the new advertising and promotional expenses.
He suddenly remembers the guys he threw out of the place because they wanted him to make OEM decks and scurries to try and find their business cards.
Dr. Jekyll and Mr. Hyde are both to be congratulated on the logical business decisions they have both made. How come things just keep getting worse? What can they do to fix this? Could it be that their existing business models don’t work under emerging competitive conditions and that focusing only on competing in the hard goods market for core (whatever that means) skaters isn’t the answer?
Tune in next issue for the continuing adventures of Dr. Jekyll and Mr. Hyde.

[1] In practice, of course, a brand with a factory doesn’t just sell decks, and its costs aren’t just those associated with the decks. Margins also vary depending on whether or not sales are to distributors or direct to retailers.   But I’m trying to make a point here, so give me a little leeway and let me keep it simple.



Cash Flow Revisited; Why Hardly Any Successful Business is Just Snowboarding Anymore

I know it’s because of crossover, and the mainstreaming of action sports, and because we’re selling to parents as much as to kids. I know all that. Largely, I believe it. I just did my occasional and not nearly frequent enough sojourn into a bunch of local snowboard retail stores, big and small, and looked at what they’re selling. Snowboards and snowboarding equipment, apparel and accessories- sure. But they are also selling skateboarding, surfing, skiing, wakeboarding, bikes, roller blades, tennis and/or some others depending on the time of year.

Have they become as diversified as they are because of “the market?” Yes, “the market” demands it. But lurking in the lichens is the financial requirement of businesses that are highly competitive and selling products that are awfully similar to each other in a given product category, differentiated largely by the brand marketing strategy. Bottom line is that the less seasonal your business is, the more money you can expect to make.
Let’s take a journey into fantasy land and take a look at a couple of hypothetical business that are in snowboarding (retailers or manufacturers- makes no difference) and see how their financial equations differ with the seasonality of their sales. I know you already know that it’s bad to be seasonal, and good to sell all year around. But the extent of the difference on the two company’s financial results-especially the return on investment- may surprise you.
Meet the Contestants
Seasonal Enterprises (SE) and Year Around Ventures (YAV) both sell snowboard hard and soft goods. But while SE sells almost exclusively snowboarding and snowboard related products, YAV has diversified into other action sports.
Both SE and YAV sell $12 million a year. SE does all its business in five months. YAV boringly sells $2 million a month, month in and month out. 
At the end of the year their income statements, down to the Income before Interest and Taxes Line, look identical.
Net Sales                                                                   $12,000,000
Cost of Goods Sold                                                 $ 7,800,000
Gross Profit                                                               $ 4,200,000 
Operating Expenses                                               $ 3,600,000
Income Before Interest and Taxes                        $     600,000 
Now, $12 million is kind of an awkward revenue number. It’s much more than your typical specialty shop sells, and it’s probably less than a snowboarding brand needs to do in revenue to break even (I think that number is maybe a little north of $20 million unless you have a very well established brand and market niche).
Just for your information, in their most recent complete years, Vans, K2, and Pacific Sunwear had gross profit margins of, respectively, 43.5%, 31.1%, and 33.5% of sales. Operating expenses, respectively, were 35.7%, 25.3%, and 22.7%. Unfortunately, no specialty shops publish their financial results.
This hypothetical income statement is kind of a cross between a retailer and a brand. The goal, however, is to make a point so allow me a little creative license as I set the stage to make it.
Balance Sheets and Working Capital
Working capital is the money you have invested in a business so that it can operate.   Rent, salaries, product costs all of which are incurred before you sell anything represent working capital invested in the business. To the extent that you can get terms from the supplier of the product or service you are using, your working capital requirements can be reduced.
The balance sheet shows, as a point in time, the financial viability of a company and its ability to finance itself. Let’s compare the working capital and balance sheet situation of SE and YAV.
Seasonal Enterprises
SE, you will recall, does all its business in five months. But it has to operate for twelve months, and buy the product it sells in a way that it has product to ship during its selling window. Assume its total expenses of $3.6 million are spent evenly over the year- $300,000 a month. In practice, selling and marketing expenses would be weighted towards its selling season.
It’s got to buy its product for a total of $7.8 million. Remember SE is getting some terms from its suppliers, but it may also be giving some terms to its customers. Where does that all net out in the real world?    Obviously it’s different depending on whether you’re a retailer or a manufacturer.
SE’s going to spend $300,000 a month for seven months before it sells a thing. It will probably collect some money from the previous season during this period, but it will also have some expenses that go out during its selling season before much comes in the door. If, then, it has to borrow $300,000 a month for seven months it will have $2.1 million in loans just for operating expenses by the time it starts selling. And of course you won’t pay it all off the day you start selling.
Then there’s the $7.8 million in cost of goods sold SE has had to finance. For how long? Shall we say four months?
The last prime lending rate cut was to 6.5 percent on August 22nd. Just to make my calculations easier, let’s say you are borrowing at 10 per cent. I know that may be high for some borrowers, but if we think about credit card fees (which I consider basically financing costs) letter of credit fees, commitment fees, etc. maybe it’s not too far off when you look at your real cost of borrowed capital- especially for smaller businesses.
If you assume you pay off the loan for operating costs completely literally the day you start selling, your interest charge would be $70,000. It’s more realistic to say you pay it off over a couple of months at best, so let’s say it’s really $90,000.
At 10% for four months, financing the cost of goods sold comes to $240,000. Total interest expense, then, is $350,000.
After interest, pretax income is $250,000. Assuming a 30% tax rate, the business earned $175,000 for the year, or 1.46 percent of sales.
Year Around Ventures
This is a little easier to explain. They just do $2 million in business each month. No big inventory buildup. No operating expenses to finance without any income.  They get some terms from their suppliers, and, with luck and depending on the type of business it is, may even collect before they have to pay. They don’t need millions of dollars in temporary working capital just to get through the business cycle. All they have to finance, more or less, is a month’s worth of expenses or maybe a little more. Their interest expense? Hardly anything. Maybe if they’ve got any sort of balance sheet at all, nothing. If that’s the case, and with the same 30 percent tax rate their net income for the year is $420,000, or 3.5% of sales.
Balance Sheets and Rates of Return
Income statements don’t happen in isolation from balance sheets. On your balance sheet, you (hopefully) show some equity- the total of the investment in the business plus the profit you’ve made, less any losses you’ve incurred, and less any dividends you’ve paid out. The larger the number is, the stronger the business is, and the less money you should have to borrow. So, you can truthfully exclaim, “If I’ve got a whole bunch of equity in my business I don’t have to borrow squat and I’ll have no interest expense! My return on sales will be the same whether I’m SE or YAV.”
True, but that’s a misleading and incomplete analysis. The financial issue is always what are you earning on the money you have invested (the equity in the company, more or less) and how much risk are you taking? Most simply stated, return on investment is net income divided by total equity. YAV, due to its year around sales, doesn’t need much equity to have basically no interest expense. It’s probably got a great return on equity, and because of the diversification that allows it to sell the same amount each month, it’s risk is lower.
SE, on the other hand, has to have a pile of equity if it’s going to eliminate its need to borrow money. If it does that, it will have the same net income at YAV, but it’s return on equity will be much, much lower. And its seasonality makes its risk higher.
As you consider your return on equity, be aware that if you’d invested your equity in an intermediate term bond fund for five years, you would have earned around eight percent a year before taxes. Over the last twelve months, with the Fed cutting rates, you would have earned something like thirteen percent. We can probably agree that the risk in an intermediate term bond fund is less than the risk of an action sports business.
In the market we’re in right now, is there any competitive advantage to being a “snowboarding only” business? I can think of a couple of possible exceptions but generally, I’d say probably not. If there was, it would be financially rewarding from a return on investment point of view. Isn’t it interesting how the industry’s requirements for success from a marketing and a financial perspective have come together?



Swell Raises $2 Million

Almost as soon as my article on surf industry internet models was finished, Swell shut down its Crossrocket site and then, on May 3rd, announced it had raised $2 million in bridge financing. I hate it when that happens.

Rather than just throw up a press release that created more questions than it answered (see it below) Surf Biz asked me to track down new Swell Chairman and CEO Bob Allison and ask him what was up. It required a fairly impressive game of phone tag, but we manage to connect. Hopefully you’ll agree that the additional information was worth the wait.
The headline on the press release was about a $2 million bridge, so the first question was “Bridge to what?”
The $2 million is a loan convertible to equity. Mr. Allison confirmed that Swell had burned through most of the capital it had raised (most recently, $8 million raised last October). The $2 million “gives the investors time to evaluate how to move forward with the appropriate plan,” said Mr. Allison. He indicated that investors had committed to invest an additional $5 million in Swell consistent with the company demonstrating to them a viable business plan and revenue model.
So the additional $5 million is “committed” but not in the bank. It’s hardly surprising to learn that investors won’t throw money at a company until they understand the business model. 
The money raised towards the end of last October lasted six months or a little longer. That’s a burn rate of something like $1.3 million per month. Obviously, Swell has moved to reduce that. Part of that is the moving of the Swell media business to Huntington Beach, which Mr. Allison confirmed.
Swell’s actions in containing costs are consistent with what other surviving dot coms have had to do and, in any event, just make good business sense. But of course, no matter how much you reduce costs, you also have to grow revenue to demonstrate a viable business.
That business, according to Mr. Allison, will focus around the catalogue and ecommerce business. Brick and mortar may still be in the picture, but only in the longer term. Since launch, Swell had generated more than $1.5 million in revenue in spite of having essentially missed the Christmas season. $400,000 of that was in the last month, so it appears that revenue growth is accelerating. Their four catalogues have had a combined circulation of 1.6 million, and Swell has shipped more than 25,000 orders.
Still, they clearly have to grow revenue, reduce expenses and raise more money for the business model to succeed. The alternative is to make a deal.
Like with Surfing, for example.
Mr. Allison pointed out that Primedia, the owner of Surfing, had been an investor in Swell since its inception. He said that the two companies see significant potential synergies between what Swell is doing on line and what Surfing is doing off line. He acknowledged that there were discussions ongoing, but that no deal had been reached as of this time (May 11th). He expects a conclusion to those discussions in the next couple of weeks.



Sell!? Maybe It’s Time to Think About It

Here we all are, back from ASR and boy are we excited. More brands, more excitement, hype, orders, deals, three page ads in Skate Biz. People can’t get enough of skateboarding There’s nowhere for business to go but up, and it’s got to be even better next year.

Unless, of course, it’s not.
As a business owner, you have (or you ought to have) some goals that go beyond running your business every day. They may include spending more time with your family, buying an island in the Caribbean, working less hours, diversifying your financial position, or just getting off the damn personal guarantee for the bank loan. Clearly, these aren’t all financial goals, but they have a big financial component to them. Someday, it’s going to be time to sell your business, though it may not be now. If you were to decide that this was the time, when, why and how do you do it?
It was August 1996 when I wrote a column for Snowboarding Business on selling your company. Given how long it takes to sell a company, and the timing of the snowboard industry consolidation, I was probably about a year late writing it. As I write this article, I have a high level of confidence that nobody (but me) has an issue of SnowBiz from August 1996 lying around, so I figure I can plagiarize the hell out of that article.
A Cautionary Tale of Success
Doug Griffith left K2 in the early 90s to start American Snowboard Manufacturing (ASC). Len Hall joined him a little later. ASC grew and prospered. Scott came and offered to buy the company. For a bunch of money. They were going to make snowboards and be cool and would need their own factory.
But Doug and Len hesitated. “If it’s worth this much money now,” they thought, “How much more will it be worth after another year of growth?”
Doug and Len had been around a while and knew something about business cycles. They knew enough to realize that their crystal ball was just the slightest bit cloudy. One of them, and I don’t know which one, had the acumen and perspective to step away from the euphoria of running a profitable, exciting, fast growing business and say, “Well, the truth is I’m not exactly certain how long this ride is going to last.”
They sold.   They took the money and ran. Skedaddled. Laughed all the way to the bank. Now, I’m sure they had a little seller’s remorse initially as they worried about how much money they might have left on the negotiating table. But their remorse no doubt went away as the snowboard industry went into the depths of consolidation hell. Scott stopped producing boards for the US. They sold the factory to A Sport. I have no idea if it’s still operating.
Their timing of the sale was prescient. If they could buy and sell stocks like that, they’d own the world. If they hadn’t sold when they did, they would probably have had some hard times before they sold the place for not much, or just had to close it down. There are a lot of people who are (or were) in the snowboard business who weren’t as insightful/lucky as Doug and Len. They either got a lot less money (or just got debt assumed) or they went out of business with nothing to show for a lot of hard work, except maybe some creditors chasing them around.
I’m not claiming that skateboarding is like snowboarding and is going to go through the same cycle. Nor am I saying that everybody who owns a skateboard, or skateboard related business, should try and sell now. What am I saying?
  • Business cycles happen.   Someday, skateboarding won’t be as hot as it is now and your company, even if it’s exactly the same, will be harder to sell and worth less.
  • Getting a business ready to sell, and selling it, takes time. Want to have a deal done in a year and get the best deal you can? Start now. Anybody can sell a good company fast if they are willing to sell it cheap.
  • Figure out what you want to do and what you are trying to accomplish. Then decide if and when you should explore selling. It’s true that you can just wait for a buyer to show up. But you won’t be in control of the process and probably won’t get the best deal.
  • Business is a risk. Money in your pocket today is worth more than money in your pocket tomorrow. That’s why we have interest rates, a measure of time and risk. Given that time and risk, and the difference between what you can sell for today compared to tomorrow, it might not make sense to wait. Especially if you expect valuations to decline. That is, a company might be worth more today than tomorrow even if tomorrow’s company was bigger and more profitable.
  • Supply and demand matters. If times should get hard, there will be lots of sellers and fewer buyers. If you sell, you want to do it when you’re the only one for sale.
If you’re going to sell your business, let’s make sure you do it right and for the right reasons. You can maximize your chances of success, and minimize wasted time, by focusing on what I call the five “Gets.” Get real, get a goal, get ready, get agreement, get help. 
Get Real
It’s as predictable as the sun coming up in the morning. The owner believes in his business so much that his perception of what it is worth to a buyer is, in my experience, almost always out of line. A sophisticated buyer won’t ignore your projections, but he will discount them. He will recognize the growth potential of your business, but balance that with a realistic assessment of the competition. He will want to know very specifically why you have been or will be successful. He will base his offer to you on the potential return he objectively thinks he can earn compared with other investment opportunities he has. He will value your business in ways that are standard for valuing companies in this or similar industries.
He will recognize that your growth depends on increasing working capital investment in the business and that he, not you, is the one who is going to have to take that risk. He will admit that there are some synergies in combining the two companies, but will believe (probably correctly) that his organization will be more responsible for achieving them than yours. Accordingly, he will be reluctant to pay you for them. He will understand that the business is dependent on you and perhaps a few key managers, and will be concerned with your motivation once the deal is closed. So if you expect to receive the value you perceive in your business you should expect to do it in an earn out.
He will look closely at your historical financial statements. They will frequently be the single most important (though not the only) factor in determining the price he is willing to offer and no amount of explaining, rationalizing, projecting or shucking and jiving will change that.
So, to begin, make a realistic estimate of the value of your company. There are many ways to value a company. None of them give a right or wrong answer. But when you are done you will have a reasonable range of value for your company. You may also want to value it under different scenarios. For example, your company may be worth more as part of a larger organization because your sales will no longer have to support, on a stand-alone basis, all the overhead expense you currently have.   Value it, in other words, as the potential buyer would to get insight into his thought process.
This knowledge is a powerful negotiating tool. Make sure you have it.
Get A Goal
What do you want to accomplish by selling (besides get money)? What do you want to sell; assets or equity? How do you want to get paid? Will you take stock? Cash at closing only? Is an earn out acceptable? What will be your role be in the business after the deal closes? For how long? How hard do you want to work following the sale? What is the minimum price you will accept? 
There is no way to know if an offer is a good one or a bad one unless you know what you are trying to accomplish by selling the business. You always want the other side to put the first offer on the table, but you never want them to be able to control the negotiating process because you haven’t thought long and hard about what a good offer looks like.
The converse is that you must also know when to walk away. If you are desperate for a deal, you’ll get a bad one.
Get Ready
From the time the first contact with a serious purchaser begin, it you can generally expect it to take six months or longer to close a deal. But preparations may begin literally years earlier, when the owner concludes that her best long-term strategy is a sale of the business.
Try and increase awareness of your company among potential buyers. You can do this, for example, by being active in the appropriate professional associations. Get articles about your company published in trade journals.
Have systems that prepare consistent, accurate financial statements and information that can be easily verified or audited. It’s a critical element in determining a purchase price and an important indication that you are a competent business person the buyer can rely on to operate the acquired business.
Clean up your balance sheet. Get rid of old inventory and write off uncollectable receivables. It’s never a good idea to fool yourself about the value of assets, and you won’t fool a potential buyer. But by not making these adjustments you may find your own competence and credibility questioned during the acquisition process. “What other surprises are hidden here?” wonders the potential buyer.
Have a current business plan that validates your strategy. Make sure the warehouse is brightly lit and painted. If there’s any tax issues, litigation or disputes with employees out there, settle them.
You can’t put your best foot forward if it’s stuck in the mud.
Get Agreement
This may seem a little obvious, but it’s a good idea if all the shareholders agree with the decision to sell the business and have a common understanding of what constitutes an acceptable deal. Legally, it’s possible to sell a business with the approval of less than 100% of the ownership. But in a private company, with only a few shareholders, it can be difficult. A buyer may be concerned about litigation by a minority shareholder. If a dissenting shareholder is expected to continue to work for the acquired company, an uncomfortable operating situation can result.
While you can’t please all of the people all of the time, it’s usually a good idea to try and get acceptance (enthusiasm would be nice) from other key stakeholders. These may include customers, suppliers and key employees. They will all be asking “How is this going to affect my relationship with this company?” and you need to have an honest and accurate answer.
Get Help
Sale of a company demands an accelerating time commitment from the owner. My experience is that as the deal gains momentum, you can either manage your business or work on the deal. There’s often not enough hours in the day to do both well.
Let’s look at a typical scenario. You’re selling the business you built. It’s your baby. You’re proud of it, and are far from objective. To make it more interesting, you’re entering into a process with which you have little or no experience. And this deal is potentially the most important and lucrative transaction you have ever entered into.
Let’s say that on the other side of the table is the representative of a larger company. He’s been through this before and knows what to expect. At the end of the day, whether or not there’s a deal, he gets paid the same and goes on to work on the next deal. He’s completely dispassionate and may not have any stake in the outcome.
Somewhere in the course of the negotiations he looks at you and says, “I assume you’re willing to warrant that there are no outstanding disputes with any federal, state or local tax authorities except as disclosed in appendix A of the agreement?”
Now, a good response, assuming it’s true, is something like “I’m willing to warrant it to the best of my knowledge,” but if you’ve never done this before, you might not know that. Happily, you’ve got an attorney sitting by your side to handle those kinds of issues.
But if he’s the attorney who drafted your will, helps you collect from delinquent creditors, or kept you out of jail after the IRS audit, he may be waiting for you to speak up. Your attorney must be experienced in representing sellers of business.
Right now, there are some skateboard industry companies that are a lot more valuable today than they will be in a year or two. I don’t know who they are, or whether their decline in value will be due to industry changes, competitive pressures, or operational mistakes. But right now, I’m not aware of a single successful skateboard, or skateboard related, company that is for sale. One that was might command a lot of attention and an attractive price. I’m not saying, “sell” but I do suggest you think about it. If you decide this is the right time, make sure you do it right. You may only get one chance.



Everybody Needs a Balance Sheet; Notes from the Conference Retailer Panel

It’s not that this group of retailers, speaking at the Transworld Industry Conference in Banff, was wrong in the comments they made about how suppliers work with them. God knows I wouldn’t want to be a snowboard retailer and, in the words of one participant, it may indeed be a good year if you manage to pay your bills and spend 100 days on the hill.

 Among the things retailers said they needed were better margins, more thoughtful distribution from suppliers, support for stores that hold prices longer, discretion in managing warranties, better communications, and complete orders shipped on time. Judging from the comments after the session ended, had it been a supplier panel, the suppliers would have spent the whole session complaining about not getting paid on time.
“Nobody’s right, when everybody’s wrong,” somebody sang a long time ago. In this case, everybody’s right, but it doesn’t seem to matter. I asked the first question when the session ended: “Is there anything the suppliers are doing right?” I didn’t get any specific, positive answers.
Why can’t we all just get along? Suppliers should get paid on time, and retailers should get complete orders on the dates requested. It would be good for everybody and for the industry. It would even be good for the consumer. Here’s why I think it’s so hard to make it happen and a few things you might be able to do to improve the situation.
It’s the Balance Sheet
It isn’t any secret that this hasn’t been an easy industry to make money in whether you’re a manufacturer, brand, or retailer. The result is a lot of weak balance sheets. Without getting into the gory details, that makes it hard to cash flow your way through a season. From the manufacturer, to the brand, to the retailer, almost everybody needs somebody to finance them. And the cheapest source of working capital is almost always your supplier, no matter where you are on the food chain.
If your balance sheet is weak, finding that financing can be tough, or at least expensive. Often, it’s both. I have one client who, because of his weak balance sheet, had financing costs that were nearly ten percent of sales. That’s a huge number in most businesses. It’s especially big when margins aren’t that good to start with, all your business has to be done in four months, and marketing costs are high. The way you finance your business can and does make the difference between a profit and a loss. No wonder everybody tries to get the other guy to pay for it.
The bad news is that it’s sort of a zero sum game- what one side gets, the other side loses. No wonder the retailer panel had an “us against them” feel to it and was so focused on complaints by both retailers and, after the presentations, suppliers.
What can we do? I’ve got no magic wand for weak balance sheets or seasonality. But I do think there are a few things we might do to at least improve understanding between suppliers and retailers and maybe make things work a little smoother.
Are a pain in the ass for everybody, but I doubt they are going to go away. We tend to spend a lot of time negotiating what is and what is not a warranty, and how it should be managed. Retailers want total discretion, authority, and support from the supplier in managing them. Suppliers aren’t quite sure they can trust the retailers to deny an unjustifiable claim from a good customer if they know the supplier will back them up and replace the product.
How about if suppliers and retailers negotiate a warranty allowance equal to some small percentage of sales? It’s the retailer’s to use as they see fit, with the caveat that they have to return the warrantied product, or maybe just review it with the rep in the store, so the supplier can see it’s being put to good use. The bad news is that it would be a direct cost known at the beginning of the season. The good news is that if it worked right the warranty process would be reduced to an accounting entry, hopefully eliminating a good part of the hassle that goes with handling warranties. That may not be direct, visible cost like a warranty credit, but it shows up in employee time, phone calls and inventory management.
What percentage should it be? What if you, as a supplier, proposed just a bit less than what you already know it costs you to handle warranties every year anyway? Try it with just a few key accounts to start with.
Invoice Due Dates
Everybody wants to be paid early and to pay late. Me too. I have no suggestions for changing human nature, but I do think there’s a need for clarification. When I sat in the supplier’s chair, I always thought (hoped?) that if an invoice was “due” for payment January 15th, that was when I should have the money. Silly me. I have the feeling many retailers act as though that’s the date when they need to begin to consider paying the invoice.
What if you offered accounts an extra one percent discount the following season if all their payments were received by the due date? What if, with your largest accounts at least, you actually discussed what the “due date” meant and agreed on the day you’d have the money, not arbitrarily setting the due date as 120 days from invoice date, but on a date, perhaps a bit more or less than 120 days, when payment seemed to be possible and make sense.
Okay, okay, I know no agreement means anything if the retailer doesn’t have the money to pay and the supplier can’t afford another one percent discount. It’s that balance sheet thing again. Still, it couldn’t hurt to have similar expectations as to what a due date is.
With email and the internet, there’s probably no excuse for retailers and suppliers not to know what the other knows about inventory availability, shipping, and order status. Even if the message is, “We don’t know,” which is the case more often than you would think. With as much high quality, similar product as is out there, communication should be a source of competitive advantage for companies who do it well.
Retailers and suppliers can improve communication by walking a mile in each other’s shoes. A retailer might invite managers from key suppliers for a discussion about managing open to buy. Lay out a scenario where shipments come in incomplete and either later or early than what was specified. How would they merchandise with an incomplete shipment? When would they cancel and order another brand, if it’s available? What do you do when the supplier can’t tell you when it will be there?
Suppliers might request retailer’s insight into working with factories. Want the best prices? Let’s reduce the breadth of product lines and let the factory make the longest possible production runs. Oh, but you also want complete mixes in four different shipments in lots of new colors? Well, then the factory has to stop and start production so that we have some of all sizes and shapes of boots, boards, bindings, or outerwear to send you. There go the lower prices from efficient production. Unless we have them make it all really early and ship it to us. But there’s that balance sheet thing again. Who’s going to finance that inventory while it’s sitting around?
Our bank only loans us forty percent of the value of inventory, but they’ll finance seventy-five percent of current receivables, so we’d really like to ship it all to you retailers right now.
The retailer, of course, wants an exclusive territory extending 300 miles in all directions and doesn’t want anybody who discounts before Easter opened. The supplier wants to open everybody his major competitors are in and see his existing dealers increase their orders significantly every year. Retailers looking for any kind of geographic exclusivity probably need to work with smaller brands. Option, for example, has built dealer relationships that involve a certain level of exclusivity. They have decided that full price sell through and higher margins for themselves and their dealers is more important than the highest possible growth rate. At the other extreme, Burton has the market position, and advertising and promotion programs to be aggressive with distribution.
There will always be a distribution conflict between suppliers and retailers. My suggestion is that both focus not just on sales, but on gross margin dollars earned, as a way of measuring the success of their relationship with the other.
I hope that at the retailer panel at next year’s Industry Conference, the discussion can focus on what we can do better to work together, not just on what’s wrong. I also hope there’s some good snow.



Quality Financial Planning for Every Action Sports Retailer; No Accounting Degree Required

Rarely, but once in a while, I come across something I want to plug. Not too long ago, it was the new Board Retailers’ Association (

. If you haven’t joined yet, get moving.  Opps, there I go plugging them again.).

This time, it’s some inexpensive, easy to use, financial planning software that the Retail Owners’ Institute has developed. So today, instead of ranting and raving about some possible industry trend, or saying something depressing about how the skate industry might be evolving, I thought I’d say glowing things about this software in the hope that some of you might check it out.  
I doubt there’s an action sport retailer (or at least not a successful one) who hasn’t figured out that some form of good financial planning is a requirement for success. I’ve written from time to time about cash flow, budgeting, margin analysis, and financial statements. I’ve tried to present some simple ways to approach those issues, but at the end of the day the need to create and manage separate templates for all the planning tools, or trying to integrate them, can be a bit of a daunting task. This software solves that.
I became aware of the software, called Strata-G Financial Planner, when I went to a seminar on retailer financial planning at the Snow Industry Conference in early April. Yeah, I know it was the Snow Industry Conference, but let’s get real- most core retailers are not just skate, or snow, or surf and, fundamentally, they have a lot of the same business issues. So I decided to write this for Skate Biz because that was my next deadline and no other pressing topic was popping into my head. What? TransWorld has reorganized again? Only one biz mag now? Never mind.
Retailer Owners’ Institute Co-Founders Richard Outcalt and Patricia Johnson started going through their presentation on financial statements and how the balance sheet related to the income statement and stuff like that. This was not exactly the dynamic and inspiring part of the presentation, especially for a finance trained guy like me who, for better or worse, has had the accounting classes they were trying (with some success) to compress into 20 minutes instead of two years.
So my eyes glazed over a little. But when they got to the part of the presentation that focused on the financial planning software, I perked right up.
It Can’t Be This Easy
That has my immediate and overwhelming thought. Three lousy input screens covering historical data and some rough plan numbers for the next year that you can modify with a click of a button is all that’s required?   Then it spits out projected income statement, cash flow, and balance sheet by month with ratios included? And you can add the departments you could possibly want and it gives you open to buy for each one? 
Where the hell was this thing when I needed it? Every financial model I ever built took at best days to create, and there was always some fudge factor to get the balance sheet to balance. Uhh, actually, you see, it’s not that I really  fudged my balance sheets. I mean, it’s not like it really mattered. Give me a break- it was only a little, tiny, teeny weenie fudge. And I was the only one who would ever find it anyway- I made sure all my models were complicated enough to guarantee that.
Anyway, how ‘bout this Strata- G Financial Planner Software? Ain’t it great! Go to and check it out. You can even download a fully operational copy for evaluation purposes that works for five days, which means I have three days to finish this article.
There are a couple of reasons why the software is so easy to use. First, the structure of the financial statements is such that it really only works for retailers and, from my point of view, it’s particularly well suited to smaller retailers. What that means is there isn’t a bunch of extra stuff that adds complexity in the name of giving the software “flexibility,” which I have found is often a code word for making software too complicated to use.
Second, it’s financial planning, not accounting software. That means there aren’t endless line items for you to complete. It’s concerned with showing trends, not detailed nuts and bolts. Operating expenses, for example, are entered in only five line items; payroll, selling, occupancy, administrative, and depreciation expense. Want more detail? Want a different line item for each size of post it note you buy? Great! There are lots of people who will charge you a fortune to create that model. I personally will charge you as much as you want to pay, so call me.
In the end, when you have that gloriously complex model, you won’t be able to see the forest for the trees, which kind of prevents you from achieving the whole goal of financial planning. And, by the way, it will also leave you right down in the mud with me, fudging your balance sheet to get it to balance for no good reason other than that you love to screw with Excel.      
What could keep this software from working for you? To get the most use out of it the fastest, you need good historical numbers to enter as a starting point. I have to believe that most successful skate retailers (or snow or surf or candle retailers, for that matter) already know that and have those numbers. If you’re one of the shrinking number of retailers sitting there thinking either 1) “I’ve got those all in my head,” or 2) “My accountant gives me that stuff two months after the end of my fiscal year,” or the dreaded and ultimately fatal 3) ”I don’t need that- I run this business on my gut,” do not visit the Retailer Owners Institute’s web site and do not download this software and do not waste even the ridiculously cheap $139.00 this software costs, because you’ve got bigger problems to solve first.
Did I say $139.00? My mistake. At this presentation, I was sitting next to Board Retailer Association founder Roy Turner. His eyes lit up at approximately the same time as mine and, being as impressed as I was with the software, he’s made a deal with the Retail Owners Institute. Members of the Board Retailer’s Association can now purchase the software for $100.00.  For those hundred bucks, you not only get the planning software, but training software that teaches you all about open to buy and financial planning. It usually sells by itself for $119.00
Using the Financial Planning Software
If I were a retailer, there are two things I would use this software for. As a management tool, I’d use it probably weekly to make sure my plan reflected any real or projected changes in business conditions and to make sure I had a plan that made me a profit for the year. Margins looking better (or worse) than originally projected? Take thirty seconds to change it in the impacted department and see what the change for the year looks like. Higher or lower inventory levels looking likely? Put in the new inventory numbers and see how your open to buy changes.
The magic here (assuming you have those historical numbers) is that Strata-G takes almost no time to use and will get more and more valuable as you use it. Even entering the initial data will take very little time, though of course you can spend as much time as you like envisioning the future.
When you think that the future you’ve envisioned might change, you can project how those changes will impact your business and decide whether and how to react sooner rather than later. Changes made sooner rather than later have more of an impact over the year and are usually less painful to make in the first place.
The second thing I’d use Strata-G for is to make my banker, or other financing source, happy. Bankers are not interested in taking risks. They are not impressed by three inch thick financial plans because extracting the essential facts from them is time consuming. They have to present and defend their loan to you to others in the bank and the easier you make that, the more they like you. I make those observations as a former banker.
This software allows you to give your banker the information they need to understand your plan and financing requirements in a simple but complete format. You can do some simple “what-if-ing” with your banker so you are both on the same page in terms of possible risks. The only thing I might add to the information you can print out is a list of assumptions. It’s always nice to explain why you did things the way you did them. It gives bankers a warm feeling to know that you’ve considered the possible impact of things that could go wrong.
Go take a look at this software. It will save you time and help you make better business decisions faster.



Numbers, Numbers Everywhere And Who Knows What They Mean

I do confess it. I was trained as a finance guy. I have an MBA, started out in international banking (Ask me about Carnival in Brazil sometime!), and did some corporate treasury and investment banking kind of work. Given the way things have changed, I decided it was okay to come out of the closet. Please don’t throw me out of the industry.

Using this experience to get a handle on the snowboard industry isn’t an easy thing to do. With the acquisition of Ride and Morrow by K2, there is no snowboard only company left that provides public financial information. What is available is not all prepared in the same way. Canadian accounting standards are different from French accounting standards, are different from United States accounting standards are different from German accounting standards. Details on the snowboarding parts of business are typically unavailable.
Nevertheless, phone calls, internet searches, and rummaging through some file folders produced public information on K2, Far West, Adidas (Salomon), Quicksilver, Vans, and Rossignol. What trends, or confirmation of trends are visible from reviewing this data? How much small print can I read before going crazy or blind?
As required, I’ve converted numbers to U. S. dollars based on exchange rates on November 3, 1999.
Size Matters
The first thing to note is that, with the exception of Far West, the owner of Concept Outerwear (revenues of $7.4 million in 1998), there are no small companies in this group. Vans, at $205 million in its last full year, is next in size. Quik and Rossi were $316 and $338 million respectively. K2 comes in at $575 million and Adidas wins the heavyweight division at $5.3 billion.
It’s easier to compete in a highly seasonal, very competitive market where margins aren’t that great and products are, for the most part, only differentiable by marketing if you’re big enough to spread your overhead and have year around cash flow. Even Far West, by orders of magnitude the smallest company in this group has some of those things going for it. Without diversification, having a viable financial model in the snowboard business is a struggle unless you’ve got Burton’s market share.
These numbers represent each company’s total revenues. The snowboard portion is much smaller.
In some ways, then, it’s good to be big if you’re going to be in the snowboard business. It can also be seen as bad, if you believe that the sport derived its energy and success from the commitment of people who were 100% focused on snowboarding, risking everything they had, and were as much concerned with snowboarding as with the business of snowboarding. If snowboarding is just one of your lines of business, and sometimes a small one at that, it may not always have your full attention.
How Big Is It?
The people at Rossi were great. They sent the English language version of their annual report Fed Ex. It tells us that 8.4% of their revenue, or $28.4 million is from snowboarding.  Their snowboard business grew by 13 percent over the prior year. They sold 143,000 boards.
They also estimated worldwide board sales at 1.45 million units in 1998/99. They thought it had grown 5% over the prior year.
I don’t know if that estimate is at the wholesale or retail level. It really doesn’t matter. What’s interesting to note, based on my own estimates of board sales four or five years ago, is that the rate of growth in board sales hasn’t exactly been spectacular. Probably not much more than the five percent Rossi estimated over last year. Makes you wonder about some of the estimates of growth in the number of snowboarders we see. Could be that a lot more people are renting. It could also mean that a lot of people try it and get counted as “snowboarders” but don’t go very often if at all.
For all I know, the culture has been so furiously marketed and the style so widely accepted that people who have never snowboarded consider themselves snowboarder and get reported as such in the surveys.
Just kidding, I hope.
Boards, boots, bindings and accessories made up $10.7 million of Quiksilver’s sales in 1998- approximately 3.4% of total sales.   That includes Mervin and the late, lamented Arcane step-in binding system. Quik also sells some snowboard apparel, but the amount isn’t identified separately.
Vans snowboard sales come from a number of sources. They sell the Switch binding and boots that work with it. They also sell traditional strap bindings. Vans has a line of snowboard apparel. They also earn some amount of revenue from licensing Switch technology to other brands, including Nike, North Wave, and Heelside. Finally, the company now owns the High Cascade Snowboard Camp. There’s not a number anywhere that indicates how many dollars this all comes to,
K2 is no help either. All their annual report says is that the “Sporting Goods” segment of their business had sales of $405 million in 1998. That includes inline skates, skis, bikes and fishing tackle, not to mention snowboards.
Well, it’s time for some creative estimating. Somewhere around here, I’ve got some carefully prepared, hand scrawled estimates of relative market shares for snowboard brands.   Go with me on this, and we’ll assume that those estimates are valid worldwide and not just in the US. I know what Mervin’s and Rossignol sales were. If these market share percentages are at all reasonable, a seat-of-the-pants guesstimate for K2 snowboard hardgoods sales would be (drum roll please) $65 million, or eleven percent of their total sales. That’s before the acquisition of Morrow and Ride, of course. Those two deals should more or less double K2’s snowboard hard goods sales.
Adidas reports that Salomon doubled its snowboard sales to $42 million. It doesn’t indicate if that number includes Bonfire. $42 million is about three-quarters of one percent of Adidas’ total sales for the year.
It just doesn’t look like anybody is going to live or die by snowboard related sales, though with the addition of Morrow and Ride, K2 is going to have an even greater focus on it. It’s more like companies are having a hard time figuring out how to grow and be profitable in sporting goods, and winter sports especially, and think snowboarding can help them figure it out, beyond what it contributes to sales.
The Bottom Line
Soft goods are good. Hard goods are bad. Winter sports are tough. Summer activities bring diversification and hope. And there you have it.
Quiksilver and Vans are both growing and making money. They have limited exposure to snowboard/ski hard goods and sell product all year around. Other soft goods players we haven’t talked about are doing well too.   They are riding the demographic crest and the culture snowboarding and other so-called extreme sports have created.
Rossignol has seen its sales shrink over the last two years. It’s also lost money in the last two years. 72.5% of its sales came from ski related hardgoods (skis, boots, bindings, poles, cross country skis) and 85.8% came from winter sports. They hope to double their snowboard revenue over the next three years.
Adidas lost a little money in 1998, the first year in which Salomon was consolidated into their financial statements. They had earned a profit in each of the previous four years. Salomon’s overall winter sports business grew only one percent. Eighty percent ($364 million) of Salomon’s total sales were from winter sports. The Adidas annual report described Salomon’s overall financial performance this way: “The operating result improved due to a number of measures to enhance earnings and almost reached break even.” YeeHah!!
The good news was that twenty percent of Salomon’s business was summer related, up from eleven percent the previous year.
K2’s sales have grown in each of the last four years. They have been profitable in each of the last five. But in 1998, their net income fell to $4.8 million from $21.9 million the previous year. This was largely due to increases in their product costs and selling expense out of line with the sales increase.
K2 divides its business into three segments; sporting goods, other recreational and industrial. Sporting goods include snowboard hard goods, as well as skis, bikes, fishing tackle, and some other stuff. Sporting goods did $405 million in sales, down from $411 million the previous year. This represents 70% of the company’s total revenue. It earned an operating profit of $5.3 million and, after a reasonable allocation of interest expense and corporate overhead, probably lost a little money.
Mountain bike and ski sales fell. K2 snowboard product sales increased, though we don’t know by how much. They do say the following:
“Although also feeling the effects of poor weather conditions in late 1998, snowboard products benefited from strong demand for its Clicker step-in binding, related boots and snowboards.”
Other recreational includes apparel, skateboards and shoes. Industrial is mostly monofilament line. It earned them $18.4 million in operating profit on sales of $125 million. There’s a lesson there somewhere. Screw snowboarding. Sell line for weed trimmers.
The Bottom, Bottom Line
The hard good guys slug it out with each other to get a bigger share of slower growing markets with lower margins and high marketing expense- an impossible financial model. Mean while the shoe and apparel guys, who can appeal to a broader demographic because they aren’t tied to a particular sport, clean up.
It’s not a pretty picture, there’s not a happy ending, but that’s what the numbers show.



Fat Lady Sings. K2 Buys Ride

K2’s purchase of Ride, announced on July 22 and expected to close within 100 days, is as close as we’ll ever get to a capstone on consolidation.

We all were intellectually aware of consolidation, but this makes you aware in your gut. Burton and K2 now control what I’d estimate to be 65 percent of the U. S. snowboard hard goods market. Add Salomon and Rossignol and the number jumps to north of 75 percent. The number two, independent, snowboard only brand in North America is now Sims
Three questions:
·         What the deal?
·         What does it mean for the industry?
·         How is K2 going to manage it?
The Deal
The only info we’ve got on the deal comes from the press release and Ride’s 8K filing with the Securities and Exchange Commission. K2 is buying the common stock of Ride. That is, it’s buying the whole company- not the assets like in the Morrow deal and so many other snowboard deals.
So K2 gets all the assets and all the liabilities, known and unknown. If a two-year-old Ride binding blows up, somebody is hurt, and Ride is sued, K2 will be responsible. In an asset deal, they typically would not be- which is one reason asset deals are often popular.
Ride’s stock will be acquired in exchange for K2 common stock. Ride shareholders will receive K2 shares “with an approximate value of $1.00 for each share of Ride stock owned.” Given the number of Ride shares outstanding, that means a purchase price of around $14.3 million. Both boards of directors have approved the deal. One of the reasons it will take so long to close is that Ride shareholders have to approve the deal as well.
The deal is being structured so it’s tax free to Ride’s shareholders. Ride’s directors have already agreed to vote their shares in favor of the deal.
To get Ride from the July 22 agreement date to closing, K2 has agreed to extend $2 million in interim financing to Ride in exchange of a promissory note that can be converted into Ride stock. The note’s initial interest rate is eight percent. That rate increases one percent every 180 days up to a maximum of eighteen percent on the unpaid portion of the note and any accrued interest, however the notes is payable in full on November 19, 1999.
The note is convertible by K2 at any time into Ride’s cumulative convertible preferred stock and is automatically converted under certain circumstances if the merger agreement between K2 and Ride is terminated. K2 would get one share of the convertible preferred stock for each dollar that is still owed from the principal and unpaid interest of the note.
If somebody else buys Ride, or agrees to buy ride, before the note is repaid or converted, K2 can demand to be paid in cash for up to a year based on the price of Ride’s stock (which could go up if a better deal comes along).
Ride, as a public company, has an obligation to consider any better offers that come along. This note is structured not only to give Ride working capital to get it through the period until closing, but to make it less likely that any such deal will come along. If the deal with K2 closes, there’s nothing but intercompany debt that gets eliminated in consolidation and doesn’t much matter.
As another step in keeping Ride operational until the deal closes, the two companies have agreed that K2 will acquire Ride bindings with an approximate cost of $700,000 and assume Ride’s obligations to ship Ride customer orders of approximately $8.4 million in bindings and apparel. K2 will purchase approximately $4 million in inventory from Ride’s vendors to fill these orders.
What’s it all mean? The two companies are getting so far into bed with each other before the deal closes that it’s unlikely it won’t close or that another buyer will come along.  
The transaction will be accounted for as a purchase rather than a pooling, and now I’ve put my foot in it because I have to explain the difference.
First, if you buy assets, you assign values to the assets based on what they are really worth. So is you’re buying accounts receivable for $100,000, but know that only 85 percent are collectible you’d “allocate” $85,000 of the purchase price to those receivables. After you’ve allocated as much of the purchase price as you can to the assets, the rest is allocated to goodwill. Goodwill sits on your balance sheet and has to be amortized (taken as an expense some at a time) over a period of many years, but isn’t deductible for tax purposes.   In addition, no bank ever thinks good will is worth anything when considering whether or not to lend you money.
Allocation of purchase price in an asset deal also has a major impact on who pays what tax when the deal closes, but since this isn’t an asset deal and I hate it when readers fall asleep, we’ll skip that. You’re welcome.
A pooling is a straight exchange of stock where the values on the two company’s balance sheets are added up. No goodwill is created. No assets are written up or down and there’s no allocation of purchase price. The only adjustments are the netting out of any inter-company debts (amounts the two companies owe each other).
K2 is buying Ride’s stock with its stock, but it’s not a pooling because Ride shareholders are getting a certain value per share- not just K2 shares with a value completely dependent on the market. It’s a purchase. That’s what the Financial Accounting Standards Board says, so that’s the way it is.
Once K2 knows exactly how many shares it’s exchanging for Ride, and the market price of those shares at closing, it will know how many dollars it paid for Ride by multiplying the market price of each share by the number of shares they are giving Ride shareholders. The accounting interpretation of the deal is that K2 is buying Ride’s equity, a balance sheet number. At March 31, that number was 16.1 million dollars. I’m sure it’s lower now. I wouldn’t be surprised if it’s around 14.3 million dollars.
To the extent that the purchase price is higher or lower than Ride’s actual equity at closing, other balance sheet items will be adjusted to reflect fair market values. For example, if the purchase price is $100,000 higher than the value of Ride’s equity at closing, the value of other Ride assets will have to be increased, to a maximum of $100,00 if what they are really worth justified such an increase. To the extent that those adjustments don’t account for the difference between Ride’s equity and K2’s purchase price, goodwill is adjusted. It looks in this case like the purchase price will end up being somewhere close to Ride’s equity, so adjustments should be minor.
That’s enough of that. This article is in serious danger of turning into a lecture on acquisition accounting.
So what’s the deal worth anyway? The easy answer is that it’s worth the approximately $14.3 million in K2 stock Ride shareholders are receiving. That’s not a bad answer, but let’s go a little further, keeping in mind that there’s rarely a right answer when you value companies.
Ride’s March 31 balance sheet showed thirty two million dollars in assets and sixteen million dollars in liabilities. K2 gets all those as part of the purchase. The assets include $8.5 million in goodwill and $5.4 million in net plant and equipment. If I were K2 trying to figure out the value of Ride, I’d call the goodwill zero. I’d write down the plant and equipment. How much would depend on what use I was going to make of the factory. Let’s say they cut it in half, making the realizable value of the Ride assets around $20 million. The liabilities, as usual, are all real.
Let’s say that K2 could liquidate the assets for $20 and pay off the liabilities for $16 million. It doesn’t work that way of course, but if it did K2 would have $4 million in the bank. So they would have paid stock worth $14.3 million less $4 million in net assets, or $10.3 million basically for Ride’s trade name and order book.
But you can’t realize the value of that trade name and order book unless you operate the business. To do that, you have to invest a certain amount of permanent working capital. Ride didn’t have the working capital it needed. In a nutshell, that’s why it had to sell. My guesstimate, depending on the expense reductions K2 can find to reduce overall operating costs, is that K2 is going to have to invest maybe more than$10 million in Ride in additional to the $4 million in net assets that’s already in there. My guess is that Ride’s bank (owed $8.5 million at March 31) is going to want to be paid off and certain unsecured creditors who have been waiting a long time for their money will also have to be paid. 
K2, therefore, may look at it’s cost to buy Ride as not only the value of the equity it gave up, but as the additional capital they have to invest to normalize the balance sheet- $24 million in total or maybe higher. If Ride had been capitalized normally, that whole amount, and probably more, would have accrued to Ride’s shareholders. But K2’s offer was based on what it would cost them not only to buy but to operate Ride regardless of whether it went to the shareholders or not.
Good deal or bad deal? K2 got a good deal. Did Ride shareholders get screwed? Not given the alternative. My sense is that Ride’s management found the buyer to whom Ride has the most value. Furthermore, Ride’s balance sheet and recent public information suggest that cash flow issues were severe enough that scenarios where shareholders got less than one dollar per share were possible. Like a whole lot less. Like the big goose egg.
All of the web whiners who are bitching and moaning about this deal ought to give Ride employees credit for performing some operational miracles under impossibly difficult circumstances not of their making.
If you want to blame somebody, check out the nearest mirror. The person you’re looking at bought an over priced stock in an industry facing an inevitable and predictable consolidation. 
Industry Impact
Ride and Morrow are gone as independent snowboard companies. Atlantis, Division 23 and Type A are, in my judgment, unlikely to resurface as strong specialty brands. To Forum, Sims, Palmer, Never Summer, Option and maybe a couple of other brands this could be an opportunity depending on retailers’ perception of the deal. One brand I’ve talked with is already getting calls from retailers who were prepared to buy Ride but are reluctant to buy “another K2 brand.”
The strategic line between the niche players and the big companies are as clearly drawn as you could ever expect to see. If any single action can be said to mark the end of snowboarding’s consolidation phase, this deal is it.
Specialty brands can exist in their niches and maybe grow a little. But it’s financially unlikely that anybody will start another one. Those niche brands that exist don’t have the economies of scale, distribution leverage, and marketing dollars they need to chase the big players. And as independent companies, they probably never will.
Then there’s Burton with something like forty five percent of the U.S. market. They are left standing alone with the cache of a niche brand, but on an international scale, and the leverage of a large company. Ain’t nothing to analyze there. My guess is that they are thrilled with this deal.
As I indicated, some retailers may have some resistance to putting more eggs in the K2 basket. But if the consumer wants Ride boards, and K2 offers good terms, prices, service, quality and promotion, the retailers will pretty much get over it. They have before.
I would expect the complete programs from Morrow and Ride to improve as a result of being part of a larger, financially stable organization. And the production of boards in China is going to produce some price points that retailers aren’t going to be able to live without.
Sean- I don’t really want to add here what you added. I think I ask and answer the question you raise in the next section.
K2’s Decisions
What I think was the opportunistic purchase of Morrow (it was too good a deal to turn down) seems to have transformed itself into a strategy with the purchase of Ride. Of course, we don’t know exactly what that strategy is yet. K2 now has five snowboard brands, with K2, Morrow, Ride, Liquid and 5150. How do they get positioned against each other? How many of those brands can you imagine one retailer buying? If I were doing it, I’d make K2 the ski shop brand. I’d retain Brad Steward (between movies, of course) to consult on repositioning Morrow as the quirky brand it use to be. Liquid would be for the mass-market channel, and Ride for specialty shops, but with a more mainstream profile and higher volume than Morrow. I’m fresh out of market positions and have no idea what I’d do with 5150. Whatever the positioning decisions are, I’ll be interested to see if all five are retained. I wonder what Cass would pay for Liquid? I’d really like to leave this in. Let’s talk.
Even excluding the distribution issues, managing five brands against each other in the same organization is tough. I’m reminded that one of Bob Hall’s first pronouncements on becoming CEO of Ride was that the company had too many brands.
Of course, some of the brands he eliminated didn’t have enough volume to justify the required advertising and promotional expenditures, and I don’t think K2 faces that. Still, there are some obvious conflicts as K2 works to restructure its organization to manage the five brands.
For instance, you just know that the financial guys at K2 are sharpening their knives to slice expenses and walking around muttering stuff about synergies. And certainly K2doesn’t need two warehouses, credit departments, computer systems, purchasing departments, etc.
Maybe they don’t need two factories. Yet maintaining brand integrity means keeping sales and marketing separate. Will they have separate customer service departments with people dedicated to brands or will the temptation to have one group that answers the phone “snowboard customer service!” win out? Will all the invoices the retailers receive look the same except for the brand name?   How many brands will be made in the same factory? Will the T-shirts and beanies all be the same but with different logos? In a thousand ways, none of which, by itself, probably matters, the identity of the brands can be subverted in the perfectly reasonable pursuit of operational efficiencies.
I’m not saying it will happen, but making sure it doesn’t is a hell of a challenge. It’s not easy to be passionate about five brands at once.
Things to Watch
1)             Who’s going to run what brands?
2)             What will happen to Ride’s factory?
3)             What will be the fate of the Device step-in system and the lawsuit with Vans (Switch)?
4)             How will be product development be managed among the different brands?
5)             I’m sure we’ll figure out some more to add.