Stories from the Field: Issue 03

“E-Z Loans” Are the Hardest to Pay Off

By Chris Todd

You can’t blame a CEO for feeling confident when the business he starts finds its niche and takes off like a rocket. But woe unto the executive whose confidence blinds him to the importance of heeding the advice of his management team when he needs help navigating the spaceship through an unexpected meteor shower.

For 15 years, this family-owned business ran smoothly, providing prescription medications in easy-to-use packaging for nursing homes and retirement centers to dispense to their patients. While the operation wasn’t unique, it was still the only one of its kind in the area, so the market seemed stable and secure until…

big national operations started gobbling up local nursing homes.

Things started to change. The national companies had their way of doing things, and their own network of vendors. It didn’t make much of a difference at first, but the wave of consolidations eventually took its toll. Client after client was peeled away, and losses began to mount, but the owner remained hopeful. After all, he had made this company what is was, and all he needed to guide it through this storm was one big contract and securing equity funding from a group of local investors.

As revenues slipped, the company’s comptroller recognized the bind the business was facing. Cutting costs was essential, he said, and the most impactful cuts would be in payroll. But the owner, loyal to the employees who had helped the business grow, decided not to heed his navigator’s advice.

To bridge the payroll gap as he banked on future sales, the owner began taking out Merchant Cash Advances (MCA), the business equivalent of a “payday loan.” The comptroller warned that this was dangerous but the owner went ahead. The company met payroll, but the loans piled on top of each other, with an APR of nearly 50 percent on a six-month loan.

Sooner or later, it was bound to happen.

Just as the navigator had feared, by staying the course the owner was about to blow up his own spaceship. The company’s bank took a look at its latest financial statements and the numbers were, to say the least, quite disappointing. The bank requested an immediate partial pay down on the company’s line of credit. So the owner took out yet another MCA, this one for $400,000, to meet the bank’s request. As the MCA repayments mounted, working capital disappeared. The company could no longer buy the 30-day supplies of medication it needed to stick to its packaging and delivery schedule.

Still dreaming of the big contract that he would never land, the owner kept rolling the dice with one new MCA after another.

With his options running out, the owner called Beane Associates.

We quickly uncovered the common traits of distressed companies…

bounced checks, stretched vendors, declining sales, high overhead…

and hundreds of thousands of dollars of Merchant Cash Advances. As we talked to management and employees and sifted through the financials, we even discovered a few things the company’s bank hadn’t figured out. No matter how you sliced it, the situation was bleak. The spaceship was about to crash.

As in virtually every one of our engagements, this one had a “light bulb moment” that confirmed that the company’s situation was unsustainable. Every time the company took out a new MCA the lender automatically debited the company’s account each day for a portion of the amount borrowed. The same amount came out every day, and multiple daily debits were being made as the number of unpaid MCAs grew. If the company’s bank had been monitoring the account, the downward spiral might have been stopped sooner. And, if the owner had heeded his comptroller’s warnings, or if he had sought outside advice, as Beane Associates often recommends, before going the “easy credit” route, the collapse might not have occurred at all.

We told the owner that he had three choices…

none of them good. He could file for bankruptcy immediately, sell the company immediately, or find a way to fund the working capital shortfall.

He took the third option, and we immediately put together a 13-week cash-flow projection to validate that this choice was viable.

Fortunately, the owner was a partner in another business, so he quickly cashed out his share in the partnership and paid off the outstanding balances on the line of credit and the MCAs.

Still, we had more work to do. We advised the company on restructuring payroll tax payments, extending repayment plans with unsecured creditors, and cutting salaries for all personnel (with a deeper cut for the top executives). With the books in balance again, and the owner realizing he was in no position to attract outside investors, he redirected his attention to develop the hospital-focused niche market he had previously identified. The pieces came together and cash flow quickly turned positive.

The owner paid dearly as he learned his lesson, but he was able to save the business and point it in a new direction.

We were in and out of the engagement in less than three months.

We were able to make a huge difference in a very short amount of time – and that makes us feel good about our work.