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5 Big Blunders CEO’s Make That Lead to Crises

My last white paper was about the faux pas of CEOs in crisis, but in writing that paper I started thinking about some of the biggest mistakes CEOs, presidents and business owners make that result in crises. Since you may not be facing a crisis right now – and I hope you never are – I wanted to share these blunders with you so that you could either avoid them or start rectifying them.

1. Growing a Business Without Proper Equity or the Right Financial Structure

It’s never wise to try to grow your business without enough money. I once carved an injected molding company in Toledo, OH like a Thanksgiving turkey because the president sunk $2.5 million into his pet project: making the perfect bottle-cap. He effectively leveraged the entire company by borrowing against it to pursue this dream. Not only did he bet the ranch, but he tried to grow and evolve his business without sufficient funding to keep it running. Let that be the first lesson: make sure you have enough capital before making any big moves.

2. Growing a Business Without a Sufficient or Competent Management Team

The corollary to having enough capital to grow your business is having the right management team to do so as well. I’ve run Ocean Pacific twice. The first time was because they were expanding overseas without the proper personnel who understood sourcing and distribution in international markets. Though they lost a ton of money before we arrived, we were able to scale back to domestic manufacturing and refocus the company on design and licensing.

Many years later we were brought back in for a similar reason. Not only had the company lost control of its brand, entered into poor licensing arrangements and become embroiled in trademark issues, but they had accumulated a ton of debt. Once again, the management team couldn’t handle its responsibilities. The company was restructured through bankruptcy, selling its licenses to a private equity firm. Learn from Ocean Pacific and don’t embark on new strategies for growth without acquiring the right management team first.

3. They Allow Idiot Family Members to Run Key Divisions of the Business

Putting family members in key positions of your business can be dangerous without written expectations and a timeline for control, advancement and responsibilities. It takes a unique father and CEO to balance the intersection of a family and a business. Problems arise in many places, but particularly as it comes to entitlements, compensation and selling the business.

I had a mechanical engineering company in New York that was in the middle of a restructure that included a large union shop. The father had died and put his wife in charge as CEO. The son, resentful of his diminutive role due to a lack of delineated expectations and a board-approved succession plan, and, in his eyes, inadequate compensation, was stealing a lot of money. When we confronted good ol’ Charlie, he took a kitchen knife to his mother. Fortunately, she lived, got a restraining order, and kicked him out of the company.

Mixing business and family is not easy. Be careful and have the sense to know when someone is incapable of doing the job he feels entitled to do, family or not. Always manage expectations by putting everything in writing.

4. They Skew the Facts to Boards, Creditors and Constituents to “Sell the Deal”

As I’ve discussed before, honesty really is the best policy. The CEO of a hard drive manufacturer in California desperately wanted a line of credit from his bank for $60 million, so he stuffed the channel in order to make his company appear worthy.

Stuffing the channel is when a manufacturer oversells product to put sales on the books, despite knowing that much of the merchandise will come back unsold; this inflates the books by overstating the top line, thereby improving the bottom line. This strategy led to the loan, but when the company repurchased the inventory on the channel within 60 days, it became out of compliance on the line of credit. Once the bank defaulted the company I was brought in to salvage what I could and to hopefully restructure the company. The company survived thanks to some hedge fund loans, but the CEO lost his job because he skewed the facts.

Not bending the facts is so important that it deserves a second story. Before the technology was so ubiquitous, lazer-tag equipment had a very high value, and a Texas-based company seeking a large loan claimed it had more inventory on its books than it did; the company added the inventory in its Ireland-based location to the US books. The US auditors never verified the inventory and granted the company a far larger loan than it could handle. When the company filed for Chapter 11, I was brought in as CEO; within weeks of my new position I discovered we were $75 million short in inventory. I immediately went to the judge to convert the case to a Chapter 7 rather than try to bring the company through the bankruptcy and be embarrassed by the fraud. The creditors ultimately sued the accounting firm and made millions of dollars from faulty accounting, once again highlighting the blunder of skewing facts.

5. The President/CEO/Owner Can’t Keep It in His Pants

I have more examples for this one than any other lesson I know, but I’ll highlight this case with two basic stories to indicate how easy it is to get caught and how ruinous it always is. The president of an apparel manufacturer had other interests: he wanted to design the perfect yacht. He certainly succeeded in making a great one, such that he ended up in a prestigious yachting magazine. However, when he and his innovative yacht were photographed for the cover shoot, he failed to ask his girlfriend to get off the yacht or at least cover up her delightfully revealing bikini. When his wife saw the cover of the magazine, she filed for divorce and he lost control of the company.

In another case I was brought in to resolve as president, the CEO and Chairman of the Board of a retail establishment was caught with his kids’ babysitter while his company was going through a Chapter 11 restructuring. Once the matter became public, he lost focus on the business and the employees and the creditors lost faith in him. Ultimately, the business was sold off in pieces.

Gentlemen: keep it in your pants. Not doing so can be very expensive. For the record, I have similar stories about the other gender, but I’ll save them for another time.

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The CEO’s 10 C’s of Borrowing

Bankers and business owners can have trouble communicating because their mind-sets are different.

As someone who began his career as a banker and who has spent the last 30 years doing interim-CEO turnaround management, I understand the banker’s mindset while having profound insight into what makes businesses run successfully from the top. Most of my day is spent playing “Let’s Make a Deal:” negotiating with lenders, creditors and bankers in order to get CEOs and their businesses new terms that allow continued operations.

In my experience, it’s particularly difficult for these two groups – business leaders and bankers – to understand each other because they’re coming from such different places and have seemingly different priorities.

Part of the process is helping both sides see that they’re in a partnership. Both bankers and business owners want to see the business continue to run because that’s the most likely way for the bank to recoup its loans and eventually see profits, and its the only way that the business will turn from debt to profit.

Thus, as a business owner, you should strive to understand how your banker thinks – and why he thinks that way. This can have a positive effect on your relationship and make it easier to get money when you need it. I present to you, then, “The CEO’s 10 C’s of Borrowing,” which will help you become a better borrower, enhance your relationship with your banker and make money more available when your business needs it most.

1. Character is of the utmost importance to bankers.

Bankers need to know you’ll do the right thing when your company is in distress. If they can’t trust you, they can’t put money in your hands. That doesn’t mean fake good character – it means have and demonstrate good character.

2. Carelessness comes down to poor record keeping.

Carelessness can also hurt your bank by causing it to write-off loans needlessly or even lose its federal loan insurance such as SBA Guarantees. Run your shop well, which includes good book-keeping practices, regular audits, competent comptrollers, and mixing up your monitoring practices. Not being careless also means verifying for yourself the details of your business’s financial situation.

3. Complacency is not an asset.

Banks are interested in how you react to tough situations. Don’t just tell them what you’re legally required to when they ask; keep them updated to avoid surprises. Bankers hate surprises. This is all a part of the larger principle of being proactive rather than reactive. Proactive business owners keep their banks apprised of the situation, which makes their banks more likely not to react to unfortunate circumstances by demanding payment on loans.

4. Contingency Plans are key for orderly succession if something happens to you.

Bankers value stability, and even though many business owners think they’re invincible, history has proven otherwise. If your bank knows what will happen in the event that something bad happens to you – like disability or death (God forbid) – that’s comforting to them. If they know what will happen to your business in the event of various catastrophes, they’ll continue to work with subsequent leadership. It’s also wise to introduce your banker to the future generation of leaders at your company. Have contingency plans. Nothing works out like your spreadsheets suggest.

5. Capital is your net worth (assets minus liabilities).

Bankers want an extra cushion of equity so they can be more flexible with your company in case it has a bad year. A CEO and a banker need to balance one another’s needs in order to maintain sufficient capital. I sometimes find that telling entrepreneurs, owners and CEOs to keep extra capital around is like telling a dog to save part of his dinner for later, but if you can show your banker that you’re capital-wise, he’ll be more likely not to call your loan after a bad year.

6. Collateral is a bank’s leverage and makes bankers feel more comfortable.

Collateral does not repay a loan, as many entrepreneurs think when they pledge their assets, but again, it does ease the banker’s mind.

7. Capacity is your ability to repay.

Bankers check to see if you have champagne tastes but a beer wallet. If you seem like you can repay what you’re asking for – which is to say, a reasonable sum and not your dream loan – you’re more likely to see the money. Shoot for the stars in life, but a bank loan is a different matter.

8. Competition works to your advantage.

Banks are concerned about their competitors’ interest rates, collateral packages and guarantees. You can use this to your advantage by doing your homework when seeking a loan and making that clear to your banker (though no one likes to feel threatened, so be courteous about this). Knowing about your bank’s competition can also let you prepare for a quick capital search should your banker pull out.

9. Controls are your built-in monitors.

Bankers want to know about your company’s controls. Do you have checks and balances for payroll clerks, controllers, CFOs, and inventory personnel? Do you watch the back door? Outline the steps you take in your plans and conversations with your banker; ask for his recommendations. If you find an issue, correct it and then update your banker that you’ve fixed the problem.

10. Communication is essential.

Almost every one of these tips hinges on communication. Don’t keep things from your banker. If he knows what’s happening he can work with you instead of against you. Work with your banker for the best relationship.

With “The CEO’s 10 C’s of Borrowing” in mind you’ll be better equipped to understand where your banker is coming from and not get frustrated when things don’t seem to go your way. Talk with your banker and try to understand him. It will only be to the benefit of your business.

Which of these have you found useful or true in your experience? Let us know in the comments.