Inflation or Deflation?

Well it's been about 7 years since I last blogged. Is it because the Blog is Dead? Whatever. No matter. Today I share my thoughts on an interesting discussion I heard between Frederic Mishkin, Patrician Mosser and emceed by Kate Davidson (WSJ). The first two are NY Federal Reservists. Google them and be impressed. They've got serious cred.

The topic at hand was discussing how the Federal Reserve and Congress have reacted to economic issues related to COVID-19. Here are a few takeaways, at least the ones I understood and hopefully copied down well enough:
(Note: I am NOT an economist, PhD or super-smarty so grains of salt required.)

The Fed acted Fast. The CARES Act came out to the tune of $2T (yes Trillion) in 1 week after the official "It's a Pandemic" announcement of 3/11/20.

But, how could this happen so quickly? I can barely get this little blog out in an four hours.

Well, it turns out that the Financial Crisis in 2007 was a test run and most of the tools, credit facilities, smarty-pants ideas, etc., were just re-dos from the 2007 Plans. (Remember TARP, Troubled Asset Relief Program?) More specifically, this time the Large Asset purchases were made in conjunction with the Federal Reserve and joint efforts with the Treasury (and we should talk a little about that partnership).

The Large Asset purchases were so vastly expanded that in mere days (not months like in 2007/8) it was a larger commitment than all of QE1 + QE2 combined. BTW, QE = Quantitative Easing. Ben Bernanke wants to rename it "CE" = Credit Easing since the entire point of buying up questionable assets is to shore up balance sheets and increase the ability of financial institutions to offer credit to customers; they are restricted by the value of the assets they have via daily and tested ratios. If the assets they hold are junk-y (low value) then they have less to leverage. Make the junk go-away to someone else's balance sheet or give it a better credit report card because they (US Government) now backs it (even if it still is junk-y) and that helps the ratios. As well, the US government does a little fancy bookwork in their ledgers and just magically gives the transacted financial institution some money (resulting in increased credit for loans). Boy, any economist or Fed Reservist is eye-rolling big time right now with my explanation but I told you at the top, I'm not expert. Somehow though, we regular-ish folks have to understand what the heck they're doing, while they spend so much money that we have to pay back. This is my shot at it.

So, back to the explanation. Congress passed the $2T CARES ACT. The Fed Balance Sheet ballooned from $4T to $7T. Turns out $2.5T of that was Asset purchases... But guess what? Of all of the "Indirectly Lending to non-financial sector" programs (for regular people, small and medium-sized businesses) that the CARES Act declared on March 15, 2020, only 2, yes TWO programs are up and running (as of this writing July 1, 2020 or 3.5 months after announced). The Fed Reservists said that the mere announcements of the programs' existence is what matters greatly. That's why the bond and stock markets are up amid such uncertainty. Boy oh boy. Something rings funky in my ears about that with each passing day. Businesses that truly have little to no reserves to tap into while Sales and Revenues are small fractions of pre-COVID days. I sure hope the banks can figure out the Loan processes f-a-s-t and get the funds downstream where they need to go.

Here's another goodie: The Fed announced in March they'd buy Municipal Bonds, ostensibly shoring up any lack of confidence in that area. Note: no or lower local revenues means less tax money for municipalities, means iffy payments for outstanding bonds, means nervousness for anyone who can think ahead, means lower prices for bonds. Funny enough though, the Fed started buying munis just 2 weeks ago, another 3.5 month delay but this time for a different reason. The Fed was ready to buy but the private market (regular people) filled the gap and snapped up munis as prices fell for bonds (rates go up--clasic see-saw of value:rates). Private people like higher rates. Once the appetite for private buying slowed, the Fed stepped in and continued purchasing bonds but months went by between announcement and action on the Fed's part.

Oh what about this? I've been recently whining and finger-wagging about "Moral Hazard" and "Here we go again!" snorts. Well, the smarties on the call pointed out that the markets falling was not the MBAs fault this time. It was an "Act of God" as they say. COVID-19 stopped the economy and made everyone go home. So, this is a proper time to intervene and buffer the economy or any ill effect it would have on its citizens because like a war, it is short-term. There will be an end to COVID (hopefully). So, run up the debt and we'll pay it off later when the economy rebounds. This is meant to provide classic bridge financing for a little while. The shock to the economic system from the health crisis is only as good as the healthy policy results. If there is no health compliance, COVID continues to ravage destruction on the economy (and us) then there is no economic policy that will fix us. (Hints: masks, testing,+++)

So, this blog piece is titled "Inflation or Deflation?" I may be the last person left on earth to learn this difference but in case I'm not, here goes. I researched (for nerdy fun) years ago after the 2007 Financial Crisis, what was to happen next? And in all of my non-academic research (read: late night Google searches) I found "Inflation!" as the historical answer. I walked around for the next 13 years expecting it. To this day that answer was wrong and I've never understood why. I kept waiting for the interest rates to shoot up and bonds to go down and the prices of food to shoot up and cars and, and, and. Nada. Zip. Zilch. In fact, negative interest rates and nominal inflation. Alright, housing prices in California went up but they always do that, at least for most of my life. So watch this one:

*When there is a Supply Shock (not enough supply of whatever) it pushes prices up (inflation).
*When there is a Demand Shock (not enough demand for whatever) it pushes prices down (deflation).
 *During the Pandemic, we have both.

--We've been hearing of the supply chains being disrupted during the pandemic so there is less on the shelves or, or, or. (supply shock)
--We've had less demand for things and services either because we're afraid of the germs or because we just don't have the discretionary income to buy or, or, or. (demand shock)

It remains to be seen what the Fed can do about either of the above if COVID continues unabated.

What is clear though is that if inflation is the outcome, that is all bad. So many other countries use the dollar (and our interest rate) for Loans or to back their currency. If our interest rate climbs, theirs does too.  Their Loans increase when pegged to us and the whole shebang has big trouble. If the countries that have those Loans have nowhere else to get further Loans or get the Loans restructured or find other sources of Income (which may have been why they got the loans in the first place) it all tumbles.

Final thought, and boy these seem random but they were really great and somewhat orderly in the discussion I heard. I'm just writing tidbits here. Hope it's readable for you.

The Fed and the Treasury are in bed together and this is not a first but perhaps not ideal. In 1951 they were separated after World War II when the Fed was subservient to the Treasury. (Think Bonds issued at rates pegged so that more bonds could be sold to make tanks and beat Hitler.) It took the "Accord of 1951 between the Federal Reserve and the Treasury Department" to clean up that compromised situation. Having a Treasury that is telling the Fed how much risk to take is not really their job. Risk should be calculated by the Federal Reserve.

Hmmm. Now what? Well, wear a mask. (Did I already mention that? Oh, and wash your hands.) Read and learn. Write your congress representatives when things feel wrong to you. Vote. Help your neighbors and friends. TTYL!

Shall we call it a Budget or Spending Plan?

I like the latter.

For those who like to spend, "Budget time" might sound like a ball and chain, a rein to be pulled by someone else, a collar that restricts. Do I have more analogies? Probably, but I think you get my point.  It's October and that is the time I bring up the word "Budget" with all of my clients. "Time to create next year's Budget!", I say gleefully. You see, I like budgeting.

The way I look at it, all of the dreams of a business owner finally may be quantified and documented in that financial kind of way, so they can be actualized. No more frustration that "all we do is talk about things but we don't ever DO them". So here's how I frame it:

• Let's pick a Revenue Goal for the year. 
• Are we shooting for Growth? Stability? Gimme a number.
• How will we go after that Revenue? 
• Anything different than the status quo? If so, it costs money. How much?
• Exactly what will we do differently? New Sales or Marketing approaches? How much do those cost?
• Do we need more people at our business to handle the Revenues? If so, when do we bring them on? (It's easy to calculate if we know the capacity of our current employees.)
• Any new laws that might cost us? (i.e., Obamacare, Healthy San Francisco, increased Workers Comp.)
• Any new benefits we want employees to have?  (i.e., 401(k) match, commuter checks, life insurance)
• Are we expecting to give our employees' raises this year? (If it's been awhile, consider it.)
• What about our Fixed expenses? Are they expected to increase? If so, build it in. (i.e., Rent increases, may be contracted already.)
• Review all Indirect costs to see if they are tight. In good times, expenses such as phones, office supplies, travel, lodging, trade conferences and "Misc." may run away. Pull them back in lean times.
• What new business do we want? What is the "dream" that we've always wanted to go after? Pick it apart, create a roll-out strategy and then quantify all of the costs on a monthly basis. Put these numbers in the Budget.

The idea is to create a Spending Plan on a monthly basis. This is a bit easier for those who have been in business for years because there is history to look at and build from. For new businesses, you have to put on your imagineering hat and input numbers. "Just make it up", I tell people all the time. Nobody gets hurt when it's just on paper.  Create it in Excel and use your Chart of Accounts. Be sure every category has a number for every month. Create a list of Assumptions so you can do a sanity check later. Trust me, you'll need it to remember how you built the thing.

Involve others in this process. Don't crawl up to your Ivory Tower and build it alone. Get input from those who will have to create the Revenue and spend the Expenses. That way, you have the mighty "buy-in" that everyone talks about. It's easier this way: they build the numbers. Much more fun to follow what they built then be handed some seemingly random number with the command: Do this. Ugh. Bad idea. Involve the management team and their staff whenever possible.

Now, if the sum total of the expected Expenses far exceeds the expected Revenues, you may all have to get out the eraser and re-think the Expenses. That's right. It's an iterative process. That is, unless you fully expect to lose money for a period of time and have your bankroll/funding idea already in place (i.e., bank loan, family and friends' or your own money ready to fund any losses/red ink). Just know that whatever tale you tell on paper-- however rosy it is there -- it usually doesn't get better in reality. You could get lucky and hit the idea of the century, but don't plan for that kind of success. Over-estimate Expenses a little and under-estimate Revenues, too.  Good chance, you'll be fine by year-end if you plan well.

Mid-way through the year (June), I suggest you take a look at your Budget and review your assumptions and the numbers for the balance of the year (July-December). If you have made any poor assumptions at Budget creation time, fix them now and call it the "Revised Budget". You may have new information now that you didn't have the prior October. Work with and communicate the changes to your management team. They, in turn, can tell their staff so everyone is working toward the same goal.

If you find by the end of the year that you weren't even close (huge budget variance), don't worry, you'll get another chance next year. If you need help finding and fixing the errors, look around for a business consultant or speak with your accountant (especially if they have operations experience). Point is: get help.

Live and learn and spend wisely.  Happy Fall and Happy Budgeting.

Up In the Air--Is there a balance between Entrepreneurship and Life activities?

I have always been an Entrepreneur. Can't help building the better mousetrap. Can't help seeing when there is a problem that could be solved if only seemingly minor tweaks could be made.  But at my age, I do not want to live in an apartment and work out of it too with my two college friends so that I can make rent payments while looking for VC money (ala airbnb.com).

I applaud the chutzpah of the three founders of airbnb who, in 3-4 short years, started their venture and have recently raised $112M from VCs (famed Marc Andreesen is one of them). In fact, the recent Series C round of investment had a valuation of $1B. This means that the $112M they received gave those investors just 12% ownership in the company. Wow. And that is after seed funding of $600k a few years ago and $7.2M last year. Things are getting spendy. Granted, airbnb has a customer base now and a great story. They also have a great PR machine that tells of treehouses and castles for rent and Obama-O's they sold to survive. But with about 50,000 customers/places for rent (as of Feb. 22, 2011 interview), and them taking 10% of rental deals off the top to broker the transaction, we can estimate their cash flow to be as follows:

• Average rental: $100/night
• Average rental period: 4 nights
• Total rental: $400
• % of listings that rent: 50%
• # of rentals each listing gets per year: 6

$400 x 6 = $2,400 --> Total income received by renter per listing

50,000 x 50% = 25,000 --> Total # of listings that receive rentals

25,000 x $2,400 = $60,000,000 --> Total Income of all rentals

$60M x 10% = $6Million --> (my) estimated Revenue for airbnb for this year

That means that aibnb received a 167x Revenue multiple for their valuation. Nice! Not sure who else has gotten those kinds of multiples from investors but whoever their I-Banker is, my hat is off to them!

To do some sensitivity analysis, since after all I am using educated guesses here, let's say they have twice as many customers, or 100,000. That still gives them an 83x Revenue multiple. Whoa. Still a fantastic deal for them.

But the point of my story is/was, where is the work/life balance? In many stories that I read about airbnb, the work-around-the-clock tirelessness of the founders is repeated over and over. I know that investors invest in teams and not ideas, but I would hope that there is some balance between what airbnb guys do and the rest of their lives. I know they're young but they won't be forever. It's really a good idea to establish balance earlier than later. Being rewarded with $112M is not very good incentive to change one's behavior, but eventually burn-out will prevail if they don't get the balance right.

In the meanwhile, I wish them the best.  It's said they are moving into a big, new Potrero Hill (San Francisco) office. Hope they spend the $150M slowly and wisely. Those bucks were hard-earned (read: blood, sweat and tears). The next round may come or may not be needed at all. Just hope the balance occurs along the way.

Flip Out!?

OK, am I the last to know? Two weeks ago, we just gave our employee a Flip Video for his birthday because he wanted one, and he's a videographer, and a young guy who likes cool and convenient gadgets. It was even branded with Tina Malia's image. He was psyched!

So then I am out yesterday and I hear that Cisco killed the Flip Video. WHAT?! So, I did a bit of on-line research and found out that it was announced almost two weeks ago. Where have I been? So that got me to wondering...

Why did Cisco kill the Flip Video? I mean, I read their Press Release and the company's spin but...

Let's review. Cisco paid $590M for Flip Video TWO years ago. Last year, Flip Video was the top-selling video camera in the US with 26 percent of the market. (Aside-- when I worked at Sony, they used to say that if they had 20 percent of any market they were super accomplished.) All of those sales for Flip only amounted to 2.5 million units sold. I repeat "only" and it's only because the other thing that Cisco is much more known for is their routers and switches. There are none of those in a Flip Video camera. Oh, and let's note that sales were up 15% from the prior year- Wow- and in a recession. But I'm still confused. Why did they kill the company after paying millions a minute ago? And do they do this often? Take a success and buy it to bury it? Oh, and not only did Cisco kill the business, they didn't sell it to someone else and try to get some of their money back. Now I'm really confused. There's got to be more than meets the eye to this, don't you think?

One theory, unspoken by Cisco, of course, is that this inexpensive option for insta-video competed with their very expensive teleconferencing business. The one comparable hurdle is that Flip has no networking capabilities but that doesn't seem like it would have been a big problem for Cisco to solve if they had wanted to. Cisco has several billions of dollars invested in the teleconferencing business on both the higher and the lower end but all B-to-B not B-to-C. On the lower end, they paid $3.2 billion for Webex at a time that Webex had sales of only $380 million, or a multiple of 10x gross revenues! So why would they keep a product for sale (Flip) that sells for $100 that even has the potential for undercutting their larger priced sale? Now THAT sounds like a strategy. Buy, try, re-think and flush. Buh-bye Flip. RIP.

Feels good to help the small guy (& gal) price their business

Great news: Just heard from a client that they sold their pool maintenance and repair business and the Valuation work I did for them made a big difference!

They owned the business for eight years and made a good living from it along the way. But the really good news to me was that after I did a Valuation for them, they used the price we came up with and found a willing Buyer to pay them that price. They earned over 63% from the price they paid for the business. We can do a simple calculation to see that they earned almost 8% simple interest on their investment per year on the Asset called "the pool service business". And let's not forget that the general economy had gone through a major recession in the same period of time.

In fact, real US GDP (in constant 2000 dollars) as reported by the US Dept. of Commerce was:

Q1 2002: $11.47B

Q4 2010: $13.38B

An increase of $1.91B or 17% growth in real GDP from 2002-2010 (or 2.13% simple interest/yr.)

It would have been so easy as the Seller to just fall into the general sentiment of the times saying, "These are tough economic times", and "We'd just better get what we can and get out!". That would have been a great disservice because in fact it was a very healthy business and they deserved to be compensated by the prospective Buyer for the opportunity they set up for that next person to make money. I think of it as selling a money printing press; all the next person has to do is show up and press "Start" and it makes money for them.

So while the economy flailed a bit, the pool repair business increased in value over 63% in the same period. And, the owners got paid to work in the business along the way. So, what can we draw from this info?

1. The owners bought an undervalued business. (Maybe)

2. The owners increased the value of the business by adding customers and services. (True)

3. The owners were very smart to get a proper Valuation for their business so that they were informed Sellers when they went to market it through a Business Broker. (Absolutely true! And the owners agree.)

As an aside, Business Brokers, while they do provide a good platform for buyers and sellers of small to medium-sized businesses, not all of them offer complete Valuation services. Rather, they often use quickie multiples of Gross or Net Income (3x) across the board when pricing businesses for sale. This might under- or over-value many businesses, often leaving money on the table at selling and negotiation time.

True valuations take time, energy and must include good financial records. If the historical financial and accounting records (Profit & Loss Statements and Balance Sheets) are not in good order (and this is often the case for small and medium-sized businesses) the first job is to clean them up. Only with clean financial statements can the Valuation work be done well. So, a business owner who wants a Valuation done must be ready to potentially pay for two jobs:

1. Financial clean-up; and

2. Valuation.

In the end though it is well worth the expense. The total cost of the clean up and Valuation for this business? $3,000. Money they easily made up in the proper pricing of the business at sale time.

Short on Cash? Get a Bank Loan?

Cash (& bank credit) are kings in times like these. If credit is tight, your business needs money, customers are slow to pay and bills are piling up, then get and preserve cash.

It's a tough time to be in business.  We read that fewer people are spending, there is less disposable income and getting a loan is tough. Perhaps revenues are down, cash is dwindling and the economy is still lackluster.

It's time for a reality check.  They come in many forms: check register balances, stern talks with CPAs, bankers, and significant others. But is everything revealed in the numbers? It is hard to deny what financial statements tell business owners. If there is a loss in any period, we probably already know it from cash flow issues such as vendors waiting longer than usual for payment from us, or our Invoices getting paid slowly by our customers. So, what to do if cash is really tight?

We have many options ranging from the least expensive and restrictive to the most: self-funding, friends and family loans, bank loans, Angel investors, VCs and the mother of them all, the IPO. For now, we'll assume you already have your own and some friends and family money in your business, so today let's look at a bank loan.

First off, we're all in this together. What affects those at the top eventually trickles down to those of us closer to sea level.  When the Fed Rate is close to 0% as it is now, that is the best possible rate for large institutions to lend money between themselves.  At such a time, it follows that our lending rates should be low too.  We are "riskier" borrowers (a debatable topic considering recent events) so we have to pay a premium to the Fed rate bringing our bank borrowing rate to Prime (which is 3.25%) plus a point or so.

Banks have become much stricter in their qualification process of borrowers as a result of the mortgage mess.  As a small or medium-sized business, you will almost certainly be asked for a 'personal guaranty'. That means that even though you are funding a business that might be incorporated, something you've done to specifically separate business from personal, the bank will still ask you to sign personally to let them use your personal assets to settle any debt if you have a business inability to pay.  I always encourage business owners to ask not to sign this and the banks rarely comply.  Especially today, banks want even more collateral (separate personal real estate attachments) in addition to personal guarantees for businesses that look like they are losing revenues.

Before you commit yourself to borrowing money, assess whether your Sales slump is due to reduced, temporary consumer spending or if this is an ongoing trend in your business that signals an irresolvable business issue.  The Fed chairman tells us that, "Financial markets remain quite strained and credit conditions tight".  That means that even if you can borrow money today, you may not be able the next time you soon need it.  And your cash shortfalls may not be over.  It's important to know the root cause of this instability.  You may be too close to it to even see it.  Ask others who have that insight.  There are marketers, coaches, business consultants and other informed counselors who can help you see the forest through the trees.  You certainly don't want to put good money in after bad in this environment.  It hurts to cut your losses and move on but if you get that message repeatedly, do it.  You may be saving more than just your business.

If you have given your business model the critical eye and you can honestly say you're just hit with the economic woes of today, then get that temporary financing loan. If the bank gives it with a fair rate, take it.  Knowing you may not get another shot to go back to the well, spend the proceeds thoughtfully.  This means follow your budget - a topic for another time.

Valuation Obsession

As a Business Consultant to small companies (2-200 employees), I often come across the owner dilemma of fading interest in their venture and a desire to leave the business. But then what? Who takes the reigns? Who is willing to buy the venture? And my God, at what price?

I feel like I have hit paydirt with a combo software that has come to market: webKPI with Fintel financial analysis. It is a web application that is so easy, anyone could use it. Now, anyone might not understand what it's telling you. For that, I'd suggest a professional business advisor to interpret the results. But here's how it goes:

Load up a QuickBooks file (P&L and Bal Sheet) to the webKPI on-line application. This of course, assumes you've already purchased the product. You can then see sooooo many things like WHAT YOUR COMPANY IS WORTH, for starters. Ok, that should have been the grand finale but since it is my lead-off topic and my great obsession in life to give small business owners a shot at getting true value for their businesses at sale time, I can't help myself. So there it is: a dashboard of financial metrics not the least of which is a moment-by-moment valuation of a business. How do you like them apples? It is often said to calculate a valuation is part art, part science. Fine, but there's a LOT of math and this program cranks that out in seconds. I have done valuations by hand many times. They take a long time even with great Excel models. Each company is different and adjustments have to be made. Overall, the great effort is in the calculations and this program does it quickly and accurately. I am so happy this product exists. I do not currently use it in my business consulting practice but I have in the past. Good guys who invented it and who still own it to this day. Good product, fair price, time-saver. Win-win-win.