An Imporant Small Business Lesson Learned the Hard Way

For those of you who follow me in the media, you know I've been a serial entrepreneur for a very long time.  In my late 20s, I owned and operated a boutique advertising agency.  

I enjoyed the close relationships I developed with my clients.  In fact, that was part of the problem -- I got a little too close.  One client in particular was a family-owned business in the process of expanding through franchising.  They referred to me as their adopted daughter. Ah -- Isn't that sweet.
 
My company handled marketing for the franchising  operations.  Because of the company's rapid expansion, the account soon became more than 80 percent of my business.  That was my first big mistake. Never put all your eggs in one basket.  Diversity your customer base.

My second mistake was not cutting them off when they started falling behind on invoices.  My relationship with them, and probably my age, kept me from making the right business decision.  Ultimately, the company went bankrupt, and I was left with thousands of dollars of unpaid bills which included fees I owed to outside vendors. By taking out a loan and going back to a corporate job, I was able to pay everything off, but it was a very expensive lesson. 
 
Imagine what would happen to your business if one of your largest customers filed Chapter 11 owing you thousands of dollars.  Many businesses, such as mine, are unable to recover from such a disaster. 

 “When one of your customers files bankruptcy, you have little or no protection under the bankruptcy laws.  A lot of business owners are surprised to learn that,” explains Chris Kelleher who owns The Law Firm for Business and who specializes in working with growing businesses.  “I have to remind my clients that regrettably the bankruptcy courts were built for the debtor, not for the creditors.” 

In order to protect yourself from a customer’s business failure, don’t be too quick to push product out the door.  Frequently, when trying to increase sales and capture market share, businesses extend too much credit to people who don’t deserve it. 
  
“It’s difficult for a business that is trying to grow and expand in a competitive industry to have a tough credit policy, particularly in hard times,” Kelleher says.  “But, when you extend credit you really need to screen your customers carefully.

Here are some red flags to watch for:

*  Tax problems, liens and lawsuits.  Companies often file bankruptcy to forestall attempts by its creditors or the Internal Revenue Service to seize its assets.  Pending tax liens, other liens or lawsuits could signal the customer is in trouble.

*  Changes in payment patterns.  Signals to watch for include partial or sporadic payments by a customer who formerly paid in full; delay in payment of 60 days or more by a customer who used to pay promptly; a dramatic increase in a customer’s volume of orders, with the same monthly payment; and frivolous complaints to reduce the bill or to delay payment.

*  Management turnover.  While management changes may be necessary turnover among top and middle management can signal trouble, particularly if the customer constantly replaces its chief financial officer or other top financial personnel.

*  Breakdown in communication.  Un-returned phone calls, unanswered correspondence or managers who are always unavailable are circumstances which should trigger a review of that customer’s credit status.

*  Bad news.  A firm should keep its ear to the ground for unfavorable information about its customers.  Local and business newspapers, trade associations, credit services and Securities and Exchange Commission reports can be good sources.  Although such information sometimes is unreliable, it nonetheless can serve as a starting point for making further inquires about a customer.

* Increasing reliance on the company.  While it may be flattering for a firm to obtain an ever-increasing share of a customer’s business it should be wary if this occurs.  Sometimes the reason for the increase is that the customer is being cut off by its other suppliers and has no one else to order from.

*  Layoffs and downsizing.  While layoffs and downsizing may be inevitable in a recession, a company should be wary of a customer who has to cut not only the fat but also the muscle and bone in order to survive.

The bottom line is that while you may be managing your own business well, your customers may not be doing the same.  Surviving a customer’s bankruptcy is a matter of good planning, vigilance and professional advice.