Credit folks tend to focus on the financials, ratios, and number analysis in reviewing a business. What there is a tendency to overlook is the people who run the company. This plays an essential role into how well a business can grow, build efficiencies, or handle difficult problems. Understanding what makes the business owner tick, is key in understanding the leadership ability behind the company.
We work to understand what makes our borrowers tick. One construction company I worked with funded their crew with spec buildings that they built and then sold. A problem hit when the housing and retail space market slowed down during the crash, yet their attitude was to continue building and hope that the market would take off again. They did not have the financial staying power to weather the storm. This client is contrasted with another developer who learned the business through one of the early developers of strip centers that were close to Wal Mart stores. Understanding his thought process, shows us his depth of execution and experience in the property development arena. You are more comfortable with the second member between these two.
One client I had had ownership into several different types of businesses that were not related at all. The main sponsors had the attention span of a gnat. Instead of seeking to run each company efficiently and profitability, they often left one company dangling on the verge of break even before running to the next shiny new thing. This group is a polar opposite of another one that is very disciplined, focused, works on maximizing revenues and becoming more efficient, and is a leader in their area. They don’t chase after the squirrels and have a strategic growth pattern that is well planned and executed. So between the two groups, guess which one is a better credit risk?
Understanding psychology of the sponsors is important in any credit relationship. Perhaps when a company or industry is experiencing stress, it is even more so. Today, we are seeing challenges with agriculture producers, especially those in the grains who leveraged themselves up in the good times to acquire more land and equipment that have debt which cannot be serviced at today’s price levels. We are also seeing this with some of the primary oil related and secondary oil impacted companies.
In each case, the sponsor has experienced or will experience a loss. It may or may not end up as a loss on the income statement, but it definitely is a loss of the potential revenues and with those, hopes, plans, and dreams. The sponsor will go through the stages of grief, just as one would with a loss of a job, family member, or friend. The successful sponsors are those who can work their way through the grieving process quickly and successfully.
In 2011, Wright outlined the seven stages of grief as: (1) shock and denial, (2) pain and guilt, (3) anger and bargaining, (4) depression, reflection, and loneliness, (5) the upward turn, (6) reconstruction and working through, and finally (7) acceptance and hope. Studying and understanding each of these stages is important to identifying where the business owner is after a loss. Also, how well they can work through these stages is key in how well the company can be turned around.
As an example, we have seen wheat farmers who are still today, in the denial that the prices they saw in 2013 are not in place today. They still may rent ground out at rates that were acceptable in the market 3 years ago. They think the present price levels are an aberration from the norm and we will see wheat double in its present price yet this year. If they don’t verbalize this, this is how their actions are. They may sit on large amounts of harvested grain, refusing to pay down operating lines, in hopes of getting a better price in the future. These guys have a long way to go in the grieving process.
I had a client that killed their business by staying in the anger and bargaining stage too long. This group worked well together in the good times, but when the times were tough, they broke apart and caused the business to fail. If they would have continued to pool their talents and resources together, they would have made it through. Instead, they turned on each other, turned on their banker, and turned on their suppliers. They tried to bargain their way out of the present situation. Failing to move past this stage led to their demise.
On the positive side, I worked with a company that experienced major losses on three projects. This was a problem credit, but on the bright side, we had teachable owners. They wanted to meet with us to understand how a creditor sees their business. At the meeting we identified issues of low margin, too much leverage, and lack of operating capital. Soon after this meeting, the family of owners moved quickly into stages 5, 6, and 7. They sold a division of the company and recapitalized their core business, retired debt and injected much needed working capital into the company. They also instituted a new computer pricing program and stuck with a minimum threshold of profitability on each job. Now they were not as tempted to chase after the low margin projects. They soon had a new problem, now they had too much money!
As a lender, you are a trusted financial advisor for your members. When a loss occurs, you need to understand where they are in the grieving process and be aware if they are stuck in one of the stages and how that can negatively impact financial decisions they make. You may need to help lead your borrower, through the stages of grief. How well they navigate through these waters will often be the difference between a loss to the lender and a financially winning business.