Question: A national casualty insurer wants our home-remodeling business to become one of its "affiliated" contractors. Is this a good deal?
Answer: I've seen this before. Be wary! Read on for the sad tale of my friend Frank.
He lost control of pricing to the insurance company. The saga begins when Frank was required to use the insurer's damage-estimating software. The estimating program was designed to satisfy the insured--at the lowest cost to the insurance carrier. With this, one can expect revenues to drop 10 percent or more, while costs stay the same.
Frank was flooded with damage insurance claim referrals. Afraid to offend the all-powerful insurance company, he added new employees, supervisors, office equipment and office space. He built in lots of new overhead expenses.
Cash flow went up in smoke. Previously, Frank got paid 50 percent of a job when the homeowner signed the con-tract and the remainder at completion. However, with insurance claim repairs, he got no money upfront and was paid 45 days after completion. To cover cash shortages, his line of credit quadrupled, as did interest expense.
Frank's banker didn't take the time to understand the business. He lent money based on a credit bureau loan-scoring model. When the banker finally received Frank's financial statement, he was unpleasantly surprised and tried to call the loan--which Frank couldn't repay.
With cash flow and profits crashing down, Frank dropped his marketing programs and laid off his estimator. He was a captive of the insurance company.
Today, the IRS is at the door. Frank does not have enough cash to make his payroll-tax deposits. At best, he will have the IRS hammering him for a long time. At worst, he may lose his business. The moral of the story: Don't saw off more than you can chew. Talk to other remodelers working with this insurance company in other parts of the country. Is it working for them? Get your accountant to run cash-flow projections based on the problems that plastered Frank. Most importantly, don't be afraid to say no.
George M. Dawson (email@example.com) is a small-business consultant and author of Borrowing to Build Your Business: Getting Your Banker to Say "Yes" (Upstart Publishing, $16.95, 800-235-8866). Send him your financing questions at firstname.lastname@example.org.