You can get away with a great deal when times are good, but a major slump like the current crisis turns many minor issues into major problems. Good times may cover many sins, but bad times uncover many weaknesses. I highlighted that statement plucked from my article last week to emphasize one very important point, this financial and health crisis is proving to be a revealing test of leadership for founders and business owners. When the dust settles, we can either call their action (or inaction) an epic turnaround or a failed leadership.
Let’s go back to the case of A Co., the once-promising housing developer I mentioned last week. The company was led by a flamboyant and colorful leader that had a penchant for squandering money in different ventures without any real plan. He was a one-man army that gambled on many business ventures and his many successes in the past made him an overambitious salesman without any patience for consensus decision making. In short, he was an autocrat who doesn't want to listen to his team and, with all his accomplishments, ceased to believe in the existence of failure. To my mind, he was a staunch believer in this myth “If you stand still, you die."
When the crisis hit, A Co. suddenly went belly up. Overall, it was a combination of external and internal blind spots that compromised the business. But a company is as good or bad as its leaders so the real fault lies on those who run them. It was clear that the senior management team also overlooked business fundamentals. Either they were complacent or shortsighted or both. It didn't help that the board was in reality a paper board run by this one-man army-founder. Cowed executives and directors who are mostly family members were there to tell him what he needed to hear. In short, he created a climate of fear among his subordinates. Any business failure is an extension of failed leadership and A Co. was a reflection of what was entirely wrong with family-owned businesses with a poor governance infrastructure.
Listening to the founder’s narrative, it was clear that his business was highly leveraged as a result of overexpansion. His aggressive campaign went beyond the company’s financial resources leading to excessive leverage. It is fundamental that loans carry a fixed interest rate. The rate does not depend upon how well or badly the company is doing, equity dividends do. Therefore, high leverage is a warning signal that no one should ignore. Poorly managed, sales-driven companies tend to leverage their equity beyond the prudent level. When there is a negative turn in the cycle such as the COVID-19 pandemic or if one of the business units of the family business can no longer service its debt, a chain of events leading to the firm’s demise is started.
The crisis that brings a firm to its moment of truth can take different forms, depending on the size of the firm. For small and mid-sized enterprises, there is, in general, no crisis until severe losses threaten the business. This usually exhibits itself as a form of liquidity crisis. Management usually is unwilling to acknowledge the problem until they run out of money. When the crisis started, financing institutions willingly supported their client companies. After the first year, they are now starting to talk about restructuring, and if repayment continues to be in limbo by the end of this year, your friendly creditor will now say, “We are going after your assets.”