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Cross That Bridge

Juggling growth and financial risk is one balancing act you can't afford not to master.
February 1, 2004
URL: http://www.entrepreneur.com/article/66500

When Regenesis Biomedical Inc., kicked off an aggressive sales campaign to cultivate a new customer segment, it marked a major-and risky-shift in the equipment company's longtime marketing strategy.

In 2001, Regenesis launched and started promoting its Provant Wound Closure System, which stimulates cells to replicate and express genes faster, to the home-care industry. But strict Medicare and Medicaid reimbursement rules severely limited its marketing base to certain private insurance clients.

So after extensive study of the health-care reimbursement structure, Regenesis shifted its focus in 2002 to medical institutions, whose flexibility in Medicare and Medicaid billing granted greater access to patients insured by the government-sponsored programs. While the potential payoff was significant, the strategy wasn't without financial risk. The company thought medical facilities were more likely to rent rather than buy the equipment, so the nearly $10 million firm, based in Scottsdale, Arizona, manufactured hundreds of the wound-healing devices. "Once that was in place," says president and CEO Daniel Puchek, 51, "we needed a sales force. Although we use independents and dealers, that costs a lot of money. You need to advertise and do trade shows to support sales. If you don't, you will never move the rental fleet. Those are the risks." Indeed, deciding how aggressively to fund the growth campaign-for which the firm had raised $4.5 million from investors as of last November-is a constant challenge. Says Puchek, "We need to focus very stringently on managing costs. At the same time, we have to invest to grow the business. And the two, in many ways, are diametrically opposed."

Balancing growth with the related financial risks is one of the greatest challenges confronting a developing business. Ultimately, the extent to which a business is willing to assume debt to capitalize on growth is strongly correlated with the owner's attitudes about risk. While known for their nerve at start-up, most entrepreneurs settle into a more conservative strategy over time. Business owners who fail to seize growth opportunities may also have tunnel vision. As a result, they don't recognize that inadequate capital is hindering growth.

The core of a cautious mind-set is often the desire to avoid a cash-flow crisis by not over-investing in growth. "They're not always patient in terms of the point where their investment may start to pay off," says Gregg R. Wind of CPA firm Gregg R. Wind & Associates in Marina del Rey, California. "If they're investing in machinery, it may take six months or a year to reap the benefits." In truth, financially fit firms can often wait a few years for profits to kick in after major spending.

While impatience is one explanation for a firm's hesitation, fear of debt is another. For some, credit anxiety is so pervasive that measures taken to avoid debt are counterproductive. An example is the firm that funds major purchases with cash, depleting reserves later needed for economic or market upheaval. "I don't think anybody likes their business to be referred to as highly leveraged," Wind says, "but in a setting where a proper amount of analysis is undertaken, debt doesn't have to be a bad thing."

Entrepreneurs often consider debt a risky prospect given that they have less control over the business as it gets larger. The reality is that the best entrepreneurs aren't always the best managers, and those who fail to recognize their limitations can stall growth.

Other entrepreneurs are so absorbed in everyday tasks that they fail to consider strategy in a broader sense. Business customers of First Business Bank in Madison, Wisconsin, often get a wake-up call when the bank shares the results of its annual client reviews. Many are shocked at what the analysis reveals. "It may show them that things are trending down, and their growth and profitability are leveling off," observes Corey Chambas, the bank's president and CEO.

Business owners needn't rely on financial advisors for such information. For a start, they can analyze industry data collected by trade groups to identify trouble spots and pinpoint opportunities. Meanwhile, holding strategy sessions for key managers will ensure that opportunities aren't missed due to unfounded fears and a lack of communication. "Your salespeople might believe there's an opportunity to penetrate a marketplace," says Chambas. "And your head of operations [tells] you that you have the capacity to do the additional production if you bring in another press or whatever it is you do. Your CFO might think there's a good enough return."

Even owners who aren't particularly risk-averse grapple with everyday choices that can alter their cash-flow position. For Regenesis, deciding how many medical devices to produce is one of them. "They have to be built in lots of fifties or hundreds," Puchek says. Consequently, the firm often has to purchase more devices than it has rental orders. Despite the dual challenge of protecting cash flow while simultaneously preparing for growth, Puchek is confident about the company's long-term prospects: "We know the business model. Now it's a matter of managing our cash and pushing to get where we want to be."

When extra capital is the antidote to sluggish growth, debt-averse entrepreneurs should bear in mind that they often have more control over funding issues than initially thought, says Wayne H. Stewart Jr., associate professor in the Department of Management at Clemson University in Clemson, South Carolina. While large lenders typically require borrowers to maintain financial ratios related to debt coverage and working capital, smaller creditors may offer more flexible terms. "If you're taking on additional debt, does the bank have covenants that restrict your operating decisions?" Stewart cautions. "And how much autonomy are you willing to give away?"

As Puchek can attest, soliciting input from creditors and investors can help relieve the stress of growth decisions. Those advisors can not only help firms avoid such pitfalls as burning through capital too quickly, but also prevent them from adopting an ultraconservative strategy that stifles development.

Weighing the Risks

When investigating a business opportunity that requires a significant capital outlay, a comprehensive cost/benefit analysis can reveal its long-term profit potential-or the financial impact of a possible loss. "Simply add up the value of the benefits of a course of action, and subtract the costs associated with it," explains Gregg R. Wind of CPA firm Gregg R. Wind & Associates in Marina del Rey, California.

An example, Wind says, is a sales director deciding whether to implement a new computer-based contact management and sales processing system. The sales department currently has only a few computers, and its salespeople aren't computer savvy. Any system upgrade would require extensive employee training. The company is likely to experience a drop in sales during the transition period. While total expenses, including equipment, installation and training costs, plus lost productivity, are estimated to be $55,800, the company's analysis reveals the new computer system would increase sales capacity, boost efficiency and enhance customer service and retention-financial benefits the company pegs at $90,000 annually. Based on the cost/benefit estimates, the company would see a return on its investment in eight months. (Payback time: $55,800 � $90,000 = 0.62 of a year.)

Crystal Detamore-Rodman is a Charlottesville, Virginia, writer who covers the small-business finance market.