Paul Meeks, Independent Solutions Wealth Management Portfolio Manager
Paul Meeks is a long-time portfolio manager and professor of finance and accounting at military college, The Citadel.
The following is a transcript from an interview between Square and Paul Meeks. It has been edited for length and clarity.
What is a piece of advice you can give to a family owned business wanting to grow its business?
Paul: Many family-owned, multi-generational businesses don't have an end game. So the first thing is to have an end game and even if that end game is one generation after another, after another, will come in. At least that's your expectation. You know what happens when we try to forecast too far in the future? Inevitably it's going to be an error, right? Nobody can predict if their grandson or great grandson will want to carry on your business. So I would tell you to have a game plan. There are options like venture capital, private equity, if the firm's large enough maybe there is a possibility for initial public offering at some point. What you need to do now and update regularly (at least once a year) is to value the business. A lot of folks haven't put pen to paper to value the business. What you want to do is take a look at your peers. No matter what you do, you probably have a couple of peers that are publicly traded and it's publicly available, real time, free data, and valuations. So have a rough mean valuation for your business, kind of a worst case minimum, a best case maximum because once you're out there, you will never get dissuaded. Know your worth, right? That applies to you, me, anyone else, and, of course, our businesses too.
Are there some steps family-owned businesses can take to help plan for the longterm?
Paul: Have a succession plan. Best case scenario, if your son or daughter is that person - hey, that's awesome! But your son and daughter may not be interested or your son and daughter may not be as competent at managing a company, as you, the founder have been. I would say whether you're profitable or not, have a succession plan. I don't care if you are 60 or 90 years old, you need a succession plan and it needs to be articulated upfront.
This will also make your creditors and your investors have more confidence [in your business] because even if you're an absolute rockstar (and you probably were a rockstar because you got that business to that level), what happens when you leave? So a succession plan, whether it's a family member or somebody who can work with the family members after you've retired super important. I see so many companies not do it because it's uncomfortable. People don't want to have conflict within their family. It's uncomfortable particularly if you have to find a successor from the outside, but it must be done. You cannot go forward without it and so that's key.
I've seen scenarios where all these secrets were held by the founder. He or she retired or deceased and there are unanswered questions - what's our inventory position? what's our accounts receivable? what's our cash flow? Start building because this will also help your successor. Have high quality financials on a quarterly basis that are actually audited by reputable accountant. You can publish them or not, but man, it shows you that you're tightly managing your business.
Do you have any advice for navigating unexpected events that could impact the business?
Paul:
First of all, tight management of working capital. Working capital is current assets minus current liabilities which comes right off a balance sheet. The definition of a current asset is that we expect to receive cash from that asset within 12 months. With a current liability, we expect to pay cash for that liability within 12 months. So the major ingredients in your current assets are your inventories and accounts receivable, the major ingredients in your current liabilities are your accounts payable. Tight management of your working capital is your short term stuff.
Now longer term it's smart to have some leverage or some debt because when you borrow, at least with the U.S. tax code, any interest expense is tax deductible. So it is actually smart to have some debt on the balance sheet but on the long term side, you have to manage it carefully. Once you become a debtor, that means that whether you borrow money from a bank or issues bonds, you have to pay them interest before you pay back the principle at the end of the loan.
So make sure that your leverage or debt is manageable enough that in the worst, worst, worst case scenario, you're still going to generate enough earnings to cover your interest expense. You can easily do some planning. What are our earnings if our sales drop 20%? What are our earnings if our sales drop 30%? Do some game planning to make sure that you have in your worst case scenario enough operating income to make that interest expense.