Beware low volume, high volatility stocks such as Groupon and LinkedIn

If you trade stocks on your own, beware low volume, high volatility stocks such as Groupon and LinkedIn. Large institutions can buy these stocks up in large volume, drastically increasing the share price due to the low volume of available shares. Then individual investors see the price increase and they want in on the action, so they buy, and oftentimes they are buying from the market-maker that created the price increase. When the price tops out, the market-maker has sold out at a huge profit and nobody is left to buy up the shares at the inflated price; and then you have freefall.

Three Things Every Entrepreneur Should Know before Starting a Business

Sometimes, entrepreneurs come up with a ‘game-changing’ business idea that will revolutionize the current industry.  Other times, they are trying to improve on a current idea, by adding their own expertise.  One characteristic that seems to overlap many start-ups is that the focus is on the idea or the product, with less emphasis on the financial minutia of creating and running a business.   The following are three things that every entrepreneur should know before they even register their business with the local agencies:

1.       What are they REALLY good at?

This is a vague question because it covers various points that are all important. 

-          From the business level: What differentiates them from current providers?  Why will people buy from them instead of their competitors?  Anyone with the idea that they will not have any competitors should

-          On the personal level: What will be THEIR role in their company?  Not every great salesperson makes for a great sales manager.  The ability to balance a checkbook does not necessarily make for perfect bookkeeping or create CFO skills.  Besides, if they are great at sales, they shouldn’t be doing bookkeeping, because they should be focusing on increasing revenue.  Someone who thinks they can do it all risks becoming a jack of all trades and master of none.

2.       What is their financial strength?

Again, this opaque question encompasses multiple aspects that need to be considered:

-          Does the entrepreneur have the personal liquidity to sustain him/herself in the beginning when the business isn’t earning money?  For how long? Company failures often arise from overly optimistic projections that end up in financial ruin.  A common bit of advice given is, “estimate the worst-case scenario and double it.”  If a person starting a business also has to worry about paying their rent or mortgage and buying groceries, they will be distracted from growing sales and product development.

-          What is the company’s funding potential?  Is the entrepreneur going to raise money from selling assets? from friends and family? from a bank or other lender?  What are the assets of the company that a lender would consider?  One of the best rules of business is so good that Danny DeVito starred in a movie with the ‘rule’ as the title: Other People’s money.  It is best to use invested and borrowed money than to lose your own personal assets.  Many people do not want to give up equity or pay interest because they feel they will lose out on future profit, but since most businesses fail, and all businesses require more money than ever expected, borrowing or taking on investors increase a company’s liquidity, while decreasing the owner’s potential personal loss.  Another saying in business: “It’s better to have a small piece of a large pie, rather than have an entire tiny pie.”

3.       What is the Timing for the business?

As you guessed, this question also has multiple facets.  The entrepreneur must accurately plan the timing for both the entrance and exit of the business even before the first day of operations.

With regards to starting the business, the entrepreneur must objectively decide: Is this the best time to enter the market?  A person starting a business just because they were laid off from their job might not be the best reason.  Also, is the economy right for a start-up of this type?  For example, consumer products companies generally do not do well in a recession.

An entrepreneur needs to gauge perceived demand for their product or service, and ideally have customers, pricing and sales volume projected out, using real demand metrics, rather than the ‘Chinese Rule’ (“if just 10% of the people in China bought this product we would become millionaires”). 

Lastly, what is the timing for the inevitable exit from the business?  When will the entrepreneur know they have succeeded or failed?  What measurement will they use to track this level of success or failure?  Will it be at a certain threshold of revenue or income? or debt?  Nobody likes to fail, but it is essential to recognize failure early and adapt, rather than lose all personal assets and declare bankruptcy due to stubbornness. 

As you see from this article, I have not provided any answers regarding what is right or wrong or factual knowledge you need to learn before starting a business.  I have merely provided you with questions you should be able to answer while you are planning your business.  If you know these three things, then you will know the essentials for starting your business.  Best of luck to you!

Dot-Bomb 2011, The Sequel

Recent IPOs and IPO filings are a scary indication that the financial markets did not really learn anything from last decade’s dot-com bust. 

First, let’s start with some facts: Groupon’s recent IPO filing shows that their 2010 Revenue was $713MM with a net loss of $217MM, not including the $203MM expenses due to acquisitions.  This was certainly a huge increase from 2009 when their revenue was only $30MM, and 2011 will probably blow 2010 out of the water; revenue through March 31, 2011 is already $645MM. 

Except for the losses, this definitely sound like a company poised for success. However, filing an IPO with a valuation of $20B is not only absurd, but is virtually criminal.  To borrow a quote from the article ‘Groupon's $20b valuation “irrational”,’ Sucharita Mulpuru, an analyst at Forrester Research, said, "It's just not a rational valuation.  It's not based on logic; it's based on whatever the highest bidder will pay for the company."

To compare this to a ‘real’ company: in February 2011, Sanofi  offered $20B for Genzyme, which is a company with revenue over $4B and a net income of over $400MM.  Real revenue; real profits.

I have no problem with the owners seeking $20B (they are geniuses if they get it), but I caution any investors who fall for the hype in these valuations and fuel the next crash ‘Dot-Bomb 2011, The Sequel’.

Volunteering: Giving to others is rewarding to yourself

Recently, I finally got back to volunteering, which I have not done on a regular basis for years.  I kept telling myself things like, “I don’t have time, so I will give money instead”, and “I will make up for it later in life when I have more free time.”   I am grateful that I stopped making excuses and started making volunteering reservations at the San Francisco Food Bank.  I only work a few hours a week, and I am one of many, so it can be tempting to think, “Does this really matter?”  To maintain focused, I try to imagine the families that are eating the food that we are preparing for delivery, and I encourage myself by thinking, if even one more family gets food because of my direct actions, then that is rewarding enough.

I love my job and I am grateful for work and for being able to afford my groceries, and it is extremely rewarding to put in my time and energy, not only to help others, but to also remind me how lucky I am.

Ownership Succession within the Family

On March 28, 2011 there was an article in Yahoo! Finance titled, ‘Why I Fired My Father From the Family Business’ by Mitchell Kaneff.  In this article, the author describes starting at the family company when he was fifteen, and after working there for seven years after college, his father made him president. However, as is often the case when there is a ‘hand-off’ rather than a true purchase or acquisition, the promotion was in name only; his father had a hard time giving up control.  His father remained CEO and continued to make a lot of the decisions, and there was uneasiness among management about the split chain of command.  As the title implies, he ultimately fired his father, and fortunately it went well for their relationship.

This article describes a scenario that I have seen repeatedly.  It is understandably hard for someone to create and run a successful business and then hand it off to their son or daughter.  Businesses are like children to many business owners; they consider their business their legacy.  My sister doesn’t like to leave her baby with a babysitter because she is so worried about the baby and misses it; and that is for just being gone a few hours.  Even with the best of intentions when a business owner is handing off the business to their heir, it is like handing off their baby to another person, with the same separation anxiety.

My advice to any business owner giving their business to their kid is, “Don’t look back” – not even to offer ‘friendly advice’.  It rarely goes well, and there is too much potential for things to go very poorly and ruin the most important relationships of all: family.

The ‘breaking point’ for a business owner; advice for a business owner contemplating bankruptcy

Final excerpts from interviewing Reno Fernandez, a bankruptcy attorney from Macdonald & Associates, in San Francisco, CA.

What is the ‘breaking point’ for a company that files bankruptcy? Is there a ‘last straw’ that convinces them to file?

An early warning sign is when cash flow is insufficient to pay invoices on a current basis and you have to start “slow paying” trade creditors.  Next, trade creditors will frequently refuse to provide goods or services except on a cash on delivery or ‘COD’ basis.  A more serious red flag is when a crucial line of credit is frozen, which can effectively force a bankruptcy if the company has immediate cash needs.  Much more serious is the commencement of foreclosure proceedings or the recordation of a notice of default – it is important to pay attention to the timeline following the notice of default and be prepared to file a case before the sale date.  In the real estate context, the appointment of a rents and profits receiver is a common move by creditors.  A Chapter 11 case should be filed quickly to regain control of the property, and an emergency cash collateral motion should be filed to obtain authority to use the rents.  Managers and owners should pay close attention to their financial statements during the prevailing economic crisis and seek advice before any of these events occur, if possible.  The earlier problems are identified, the more options there are, including workouts, pre-negotiated plans, assignments for the benefit of creditors (“ABC’s”) and others.  As time goes by, these options begin to disappear.

What advice do you have for a business owner contemplating bankruptcy?

The best advice is to be proactive in selecting attorneys and advisors.  Your attorney should be familiar with the business world and have experience taking a variety of businesses through successful Chapter 11’s, such as restaurants, developers, lenders, retailers and manufacturers.  At a minimum, your attorney should be a bankruptcy expert, and you should politely avoid letting your family attorney or corporate counsel dabble in bankruptcy and “experiment” on your business – a common observation by outsiders is that “the laws of gravity are suspended in bankruptcy,” and you need someone who is comfortable operating in that environment.  Most attorneys will, or should, talk with you for free, and a call can be instrumental in educating yourself about your options and formulating a strategy. 

Readers, I recommend that you call Reno if you or someone you know is contemplating bankruptcy:

Reno Fernandez

Macdonald & Associates

221 Sansome Street, Third Floor

San Francisco, CA  94104
Tel: (415) 362-0449 Ext. 204

www.mac-associates.com | California Bankruptcy Blog

Common mistakes that business owners make prior to filing (and after filing) bankruptcy that end up hurting them during the bankruptcy

More excerpts from interviewing Reno Fernandez, a bankruptcy attorney from Macdonald & Associates, in San Francisco, CA.

What are common mistakes that business owners make prior to filing bankruptcy that end up hurting them during the bankruptcy?

The most dangerous mistake is waiting too long before getting professional help.  I have heard some heartbreaking stories from clients who took out a second mortgage on their home or used their retirement (which is generally exempt in a personal bankruptcy) to buy time for their business and weather the storm only to find out that they have no hope of recovering their contribution to the business.  In this case, it would be far better to address the causes of the financial distress up front and either conserve or use the owners’ resources to give the business a fresh start from a stronger position.  In addition, lending to a business during the bankruptcy (called Debtor-in-Possession or “DIP” financing) can be done on a priority or secured basis and is far more secure than making capital contributions or loans to the business prior to filing.

What are common mistakes that business owners make after filing bankruptcy that end up hurting them during the bankruptcy?

It is critical to retain professionals, such as attorneys, accountants and consultants, that are both experienced in handling complex Chapter 11 cases and sensitive to costs.  Professionals who do not take this practical approach put the case at risk of administrative insolvency, which means that professional fees climb so high that they outstrip any potential recovery to other creditors.  This can result in the ouster of management and appointment of a Chapter 11 trustee or conversion to a Chapter 7 liquidation.  Larger businesses especially should keep in mind that a committee of unsecured creditors may be appointed to represent the interests of trade creditors, and the committee’s professionals are also paid from the assets of the business.  It is important for debtor’s counsel to be able to account for and inform you about these costs and put in place appropriate controls.

Readers, I recommend that you call Reno if you or someone you know is contemplating bankruptcy:

Reno Fernandez

Macdonald & Associates

221 Sansome Street, Third Floor

San Francisco, CA  94104
Tel: (415) 362-0449 Ext. 204

www.mac-associates.com | California Bankruptcy Blog