Chief Executive Boards Blog: A Near-Death Experience

I talked with a business owner this week who told me a fascinating and inspiring story, describing the "near-death experience" he had in his business this past year. Wow, that sounds like serious stuff. And it was. The cause? Lack of access to capital -- the business equivalent of an oxygen shortage. The rescue? A non-bank financing alternative.

This is an owner, like many, who is a good operator. He knows where his costs are. He understands his financials. He has a handle on his capital requirements and he understands the risks and dynamics of his business. And he's in a risky and dynamic business -- contracting -- that's been hammered over the past 2 years of recession.

One thing he realized early on was that he needed to secure his lines of credit, and he did that. He scaled back his work force as contracts became less plentiful. He also realized he had to shed some debt, primarily on equipment he didn't need, and he sold some of that. And, finally, he realized that taking work at or near cost to "keep the crews busy" was an unsustainable exercise in trading dollars. As you'd expect, competitors seduced by that idea drove prices to the mat, and some failed as a result.

Despite those challenges, this contractor managed to clear a small net profit in 2009 and is also profitable for the first quarter of 2010. That's the near-death experience part -- realizing all along that he was one phone call away from his bank calling or reducing the line of credit he needed to keep the company in business.

Fast forward to the spring of 2010. Pent-up demand and increased public sector funding has resulted in an uptick in available work, and competitors are coming up for air -- prices have recovered to pre-recession levels. Some, of course, have perished, leaving fewer survivors to compete for the increased demand. In fact, he says, "The next couple of quarters are shaping up as two of the best in the company's history."

The problem? You guessed it already. His bank that's holding his existing line of credit, doesn't want to loan him any more money. The problem with that is that contracting is one of the more working capital intensive businesses I know of. You have to mobilize jobs, make payrolls, buy material, etc. before you can issue progress billings to customers and before the accounts receivable aging clock runs far enough 'till you get paid. So, a contractor with an increase in contracts is dead in the water unless he can either self-fund the working capital needs of the new jobs or find a source of debt to fund them.

The solution? Right now, it's not banks. In this case, his bank has refused to help any further, citing concerns of "being criticized by examiners for too much risk." Strange, that's how banks used to make money -- by finding solid customers whose business risks they understood and believed in. Not lately.

So, he set about finding alternative sources of capital, in some unlikely places. One unlikely place was a large General Contractor customer. He had won a job that he knew he didn't have the working capital to start up. He went over to see the owner, explained that he'd never start a job for them that he didn't see a way to complete, showed him his financials, and the owner agreed to write a $100,000 loan for six months! He also went to a family member, who ponied up another loan. He confirmed more than once, "You realize this is risky, don't you?", and the relative said, "You've always known what you were doing before, and I don't think that's changed."

Is that strange, or what? A bank, presumably in the business of making money by lending money, won't support him. A customer and a relative, however, say "Sure, I believe in you." Welcome to 2010.

Well, this is an interesting and unlikely tale. The takeaway? Business owners persevere, despite adversity that would stop the average person in his tracks. In this case, we have a business owner who just wasn't willing to take the first ten "no's" for an answer. He knows how to make money in the contracting business. He knows it takes working capital to do that, and knows how much. And he knows that there's capital available out in the marketplace -- it just doesn't happen to be at banks right now. And he found the capital he needed, in a couple of places you'd usually expect only startup companies to be looking.

When this is all behind us, I believe the commercial lending landscape will be radically changed. Banks will be relegated to the lowest-risk segment, providing operating checking accounts and low-risk lines of credit to finance receivables and highly liquid inventories. Nature abhors a vacuum, and the vacuum that's being created by overly-conservative bank underwriting will be filled by an entirely new type of lender -- perhaps small syndicates of independent investors or peer lending by cash-rich companies to peers whose risk they can assess and underwrite.

Welcome to 2010. This isn't a unique case -- see: "Peer Lending - A Non-Bank Financing Alternative"

If you have experiences or stories of peer lending among business owners, please click "Comments" and share those with others.

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