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Fun with localism!

I recently had a fun experience doing some shopping in my local economy, which resulted in a blog that Ventures published on their site. Ventures is a training-led Community Development Finance Institution (CDFI), which means they do some small business lending but the preponderance of their work is in doing training and technical assistance. I was on the board back when they were known as Washington CASH (Community Alliance for Self Help). Read more about my adventure here!

The business of survival

I recently did a quick consultation with a friend of a friend who is an independent personal service provider. She has a reasonable hourly rate, though it’s not clear every client pays that. She’s independent because she likes the schedule flexibility, but it does mean her schedule is often not full. Looking at past taxes, her annual gross income has been 50-55K annually. It’s below the the median wage of 64K, but well above the living wage of $26,600. Or is it?

The two common challenges for small providers are 1) bookkeeping and 2) marketing. She knew her business worked on a cashflow basis but was talking to me because some months cash was feeling a little tight. After pulling some numbers together, it became apparent that her monthly expenses are almost $2000/month with rent, internet, phone, website, licensing, continuing ed, insurance, credit card processing and taxes. Lots of those are expenses that don’t come out every month, but add up. They’re also largely fixed expenses. So really, that gets her down to just above living wage as a take home.

We talked about a few marketing strategies – how she might get more referrals or remind existing customers about her service and maybe sprucing up her waiting lobby (though that’s a capital investment). It turns out it’s tricky to relocate or sublet her specific space so it’s difficult to chip away at those fixed costs. One solution she employs is some of her clients pay in cash. That contributes to difficulty in understanding her real profitability. I notice in my own efforts to hire a housekeeper that the first two have asked that I pay them in cash. Is this one of the signs the economy is not working for everyone? That those who can, go informal? Looking at risks – did I mention health insurance? She has to pay her own health insurance and that is a big chunk of those monthly expenses. It’s a significant risk to a small payer and there’s little help for her at a living wage.

Thinking about the risks of healthcare got me thinking about the risk of a major health disruption. Medical issues are the number one cause of bankruptcy in the US. It’s also another way the relatively rich stay richer – property protections in bankruptcy. If you are a property owner, you can protect some of your property in bankruptcy, and thus some of your assets. If you are a renter, and you don’t own tangible property, you’ve got nothing that you can protect, so it strikes me it’s much more likely you’ll be forced into homelessness. In fact, when I google for data to support this, what I learn is that a bankruptcy on your record is one of the things that can come up in a tenant screening and affect your ability to get a lease!

Net – there is no net, not of the safety kind. My provider just has to have faith in the continuity of her business (her track record to date is reassuring). A little effort in presentation or marketing might literally pay off. We also need to hope Obamacare and eventually medicare stay there for her, and that she doesn’t have a major health crisis that impacts her ability to work.

My takeaway for individual service providers is that it’s important to break the habit of letting personal & business expenses blur together – a habit that the tax reporting on Sole Proprietorships supports. You need to separate your business from your personal expenses, and track true monthly costs. You need to add up all those periodic one-time costs and figure out a monthly amount so you know your bottom line and not get lulled into complacency by your top line.

Modeling for Success

In my years of angel investing, many is the time I’ve been in due diligence groups looking at a projection and someone asks “so where is the marketing spend to support that growth?” Usually the answer is along the lines that folks will discover the product online, or refer their friends, that it will “go viral”, and that’s what we’re all investing for, because we believe that it’s that kind of product, right?  Another common answer is that one of the roles will really be spending 50% of their time on sales, or that sales will be part of everyone’s job.

Many years and a few hands-on lessons later, I have a more experiential awareness of what needs to underlie that answer.  Once you’re in a company, trying to manage to those numbers, it becomes clear that there’s no substance to it.  We modeled 10% month-over-month growth! Well, it didn’t happen this month so now what?  Without a plan of the measurable activities that were expected to generate that growth, there’s no way to look back and ask: did those activities happen? If yes, perhaps they’re not the right activities so let’s try some different ones. Perhaps we think they are the right activities but the sales cycle is turning out to be longer than we expected, let’s keep an eye on that and prepare to make some adjustments lest we run out of capital before we’ve figured out the true cost of a sale.  If those activities didn’t happen, why not?

Startups are fundamentally short-handed and the sales/marketing person is often not a specialist, and maybe they haven’t done sales/marketing before.  Likely they’re getting some uptake because it’s a new product or service and they get a little bit of earned media attention and they don’t know that the product won’t continue to sell itself. A few things do grow purely on word of mouth, or are fundamentally viral in that use of the product inevitable exposes new potential users to it. Even those things can be broken down into assumptions: each user uses the product x times per month and exposes Y other users to it, Z% of those decide to try it for themselves.

But sadly, the truth is things have to be sold, and over time I notice  how successful businesses build the cost of selling into the product – things like mutual funds having “12b-1 trails” that throw a small percentage to the platforms that carry them, or retail products having to build into their price assumptions about doing periodic discounting, offering coupons, paying cuts to distributors and brokers.

I felt validated to see in a recent business competition, Business Impact NW went beyond asking for a financial projection and also asked for a specific sales projection.  They work with small, local businesses, and apparently they’ve also decided it’s an important next step to making sure the business is actually successful.

So going forward, my experience is that a general question about “where’s your marketing spend?” isn’t really enlightening or helpful to the business.  A better question would be: where’s your sales plan – who will do what activities to promote the product/service and what’s your expected effort-to-reward ratio?  I have heard investors ask “how long is your sales cycle?” when looking at products that will be making dozens of large sales. Time is one measure of effort, and thinking about person-hours and intermediary fees and google ads needs to apply to the hundreds of small sales too. Helping an entrepreneur break that down ahead of time will help them figure out how to adapt as they gather more data, and set them up to start measuring/monitoring those assumptions from the start.

Who taxes you?

A good friend of mine has always refused to participate in loyalty programs. He figured, not unreasonably, that the company’s interest and his are not guaranteed to be aligned and the trouble of monitoring that was not worth whatever benefit might be gained.  So it’s only recently that I’ve considered getting a mileage credit card.  As part of a change in household, I signed up and began my new relationship with Bank of America.

Wait a second, Bank of America? A big corporate bank? I’m supposed to be an Impact Investor, a triple-bottom-line consumer. Why would I divert a significant percentage of my annual expenditure stream through their card, allowing them to pull a tithe from the business community via invisible-to-me credit card fees?  Because one thing I’m well aware of as a business consultant is that all those points and miles we earn are paid for by the businesses where we use our cards- through slightly higher credit card fees.  Businesses have no ability to sort cards, if they take one Visa they must take them all.

Of course the reason I would do this is simple: payola, in the form of airline miles.  I started asking around among friends and in Seattle, an Alaska Airlines hub, the Alaska Airlines card is everywhere. My friends fly with their miles. Some friends have an Amazon card, held by “Synchrony Bank”, which I know nothing about. Milage cards are not just about miles: Alaska charges bag-check fees, which they waive if I book my ticket using an Alaska credit card. Using the card saves me $50 per round trip when I need to take luggage. Add in a free annual companion ticket and it only takes one trip per year to more than pay pack the annual $75 fee.

Economy is based on the latin word for household.  If we want to change the priorities of our household, we need to think about who is in it, making decisions.  The small decisions we can make about which institutions we support through our incidental activity can add up to big decisions. This was the premise behind the “move your money” campaign that lead many people to move their money from banks to credit unions.  Who provides your access to credit is, if you have a decent credit rating and can make choices, the same decision.  I’m currently banking at a credit union, and their card would be the obvious choice. Certainly on an interest-rate and fee basis, it’s a much better choice than the loyalty card. It just doesn’t come with such powerful payola.

Making that moral choice costs me real airline dollars! With an opposite-coast family, I will fly annually. I was feeling ready to make that stand anyway when my voice of envy took a new turn and made a case not about gain but about loss: successful businesses who take credit cards recognize the fees as the cost of doing business and price accordingly. For example, Square charges small businesses a flat processing fee of 2.75%, which greatly exceeds the fees paid to Visa, so Square is collecting credit card premiums from businesses regardless of whether or not they pass them on to the full consortium of Visa, BOA and Alaska Air. A pessimistic view might be that those of us not using loyalty cards are left subsidizing those who do, or just padding the pockets of the card processors.  Ooo, that argument was more difficult for me.  Fine, I thought.  Surely there was some compromise between selling my economic allegiance and leaving money on the table.

The answer I came to is a loyalty card with a values-based bank that I am proud to direct a revenue stream through, to a cause I believed in.  I remembered a friend who had a “Salmon Nation” card that supported an environmental organization in Portland.  It was issued by Beneficial State Bank.  I went to their website to survey their options and was immediately drawn to the B-Corporation visa (I get no referral if you click that link :).  A chance to support a cause I passionately believe in – an organization doing third-party certification of good internal corporate management in the 5 areas of Governance, Community, Environment, Employees and Customers. I applied and awaited my card.

In the intervening duration I thought again about the free trip I could probably earn every year if I instead selected a mileage card, or about how much stuff I still end up buying on Amazon despite my commitment to purchase locally as much as I can. Or the marginally higher fees I would have with this card than a vanilla credit union card (but still lower than a BOA card).  Was I being silly?  The card answered the question. I’m so pleased to pull out this card, and the opportunities it provides to talk about B Corporation and why I think it’s something more people should know about, I don’t for a second regret it.

I was also feeling less impressed with Alaska’s milage program; having just come off a binge of using up old United miles to travel to DC, Alaska required 30% more miles for the same trip.  Looking harder though, with the companion ticket, plus the free checked bags each way, using the Alaska card to book my annual opposite coast family trip produced a 400% return on my $75 annual fee.   So in the end I got the Alaska card, too, which I only use for booking Alaska travel.

The deep issue here that merits attention is how incredibly embedded in our everyday financial transactions there are invisible corporations that effectively tax us, and how little we know about those taxes or what they pay for.  It’s an interesting systems issue. Change does happen, Square is new on the scene and has bred a host of competitors, but it seems likely they’re yet another layer of technical middleman, taking another cut out of the value exchange between consumer and business.

Merchant Maverick was my go-to resource when I set up billing for a new business a couple years ago, they have a great writup on the credit card processing fee stack here.

Cash for Growth

I recently got to work with a small manufacturer who had a multi-week work-in-progress period.  This small business was using quickbooks but growing quickly and so often managing more by the level of cash in the bank account than by budget.  While I was working with them, the business got the hang of looking at their COGS and their variable costs vs fixed costs and more of an accrual style of reporting.  They also shifted to more of a product distribution model which meant longer receivable delays and more planning. I realized that with that supposed “improvement” of business maturity there was a possible loss: that of deliberately funding the increase of inventory to support sales growth.

When operating on more of a cash basis, this business had to use current sales to cover the cost of future growth, because they had to buy inventory this month, and do labor this month, for product that would not be ready until next month (or later). They had started out with a direct-to-consumer model and so sales were entirely cash in the beginning.  Since anticipated future sales were higher, they had to figure out how to create that product with the cash they had on hand, because inventory providers were unwilling to provide credit for such a small startup.  As they grew as a business and we focused on looking at accrual accounting, it becomes apparent why separately tracking cashflow is so important – because in an accrual presentation, the cash needed to fund the higher investment for higher future sales becomes invisible, each month looks like it can cover itself.

I once had an angel fund investment go south and what we heard back was that somehow in the transition from cash to accrual accounting they had come up a significant amount of money short (maybe 1/3 of the round they had just raised).  A funder stepped in a provided it, but at sufficiently punitive terms that our investment became pretty insignificant. The CEO and CFO were replaced, of course, but I had always wondered how that could possibly happen.  Now it makes sense to me, that if they had done their financial modeling on an accrual basis and not attended to cashflow, they could have raised a bunch of money for growth and missed how much inventory they’d have to build to support that growth and how far ahead of sales they’d need the cash.  It’s also possible that they underestimated how long their cash-conversion-cycle would be:  that route from dollar invested in inputs, created into goods, shipped to distributors, sold to customer, and then easily 90 days from shipped-to-distributor until finally returned-to-company.

Another angel I know invested in a homey wood-toy company who got caught by that: the homey wood toys were manufactured in China and required a 6 week boat ride to get to US distribution.  Growing sales required also growing an even bigger cycle of toys in the manufacturing/distribution pipeline.

Net: although accrual style accounting is standard for a mature company, you lose important information if you don’t still also do a cash accounting.

Once a week I drive to a gig in Olympia, WA. It takes a little over an hour to get there, and with traffic just under 1.5 hours to get back. A total of 2.5 hours round-trip, 150 miles.  It’s a lot of time and naturally I’m interested in improving it.  I started with improving the drive:  initially I was driving my 20 mpg SUV.  I considered purchasing a new car, but around that time I also got into a new relationship.  My partner needed a new car and so we picked out a Prius at 40 mpg that I could drive on my commute days.   Next, I got into audio books.  That was such a satisfying use of the time (it’s how I got all the way through Piketty’s Capital!) that I’m sure it influenced at least one extension of the gig!

Now, for work reasons primarily, I am doubling-down for a period. I stay with a friend in Olympia so I can work two days and commute once.  This bigger commitment also spurred a re-evaluation of my commute.

As noted, by car it’s generally 2.5 hours total round trip. 150 miles at my new gas milage of 40 mpg, assuming $3/gallon (it varies greatly over a year!) is $11.25.

Seattle to Olympia is not quite a transit route. It cuts across two transit systems so my one effort at bussing felt like a huge hassle- two transfers and a total of 2.5 hours each way for a total of 5 hours. Total cost RT is about $12.  There was an uncomfortable 20 min outdoor wait at one transfer. My fare card does not work in one system so I would have to get bus fare or carry change.

Then there is Amtrak. The most expensive out-of-pocket solution, it’s $18 each way, plus $5 for a bike, for a total of $46. The train ride is 1.5 hours, followed by a 50 minute bike ride. Add getting to the station in the morning and it’s 3 hours door-to-door.  So 6 hours RT and $46.

So what am I doing?  Well, simple time and $ math would suggest I’ve continued driving. The truth is that decision-making in business and in life is more involved than that.

One question is existing capacity and training.  Notice I don’t already have a farecard that works across both bus systems.  It’s useful to know that I used to be a weekly cyclist and have fallen off due to life changes and miss it.  It’s useful to know that I sold my SUV and my partner and I are now a one-car family. When I commute, the car mostly sits all day unused, and he is without car for two days. He has much more flexible workdays and could use the car.
Once I look more closely at the choices – how can I adapt to them?  I was able to make use of the audiobook time in the car, an hour-at-a-time worked really well for me.  The bus trip could also be audiobook time, though with the two transfers it breaks it up into less than one hour chunks.  That’s meaningful because I also meditate for an hour every day.  The train/bike commute is a 1.5 hour train ride – just right for getting in that meditation.  I also try to work out multiple days a week, so the bike commute can substitute for a workout.

It turns out that on Tuesdays I was getting up at 5:15 am to meditate, then go to 7am yoga, then eat a little something, usually end up fiddling around a bit and so not hitting the road till 9. I’d pick up my lunch on my way in and get into the office after 10.  With the train commute –the fixed 7:25 am departure time keeps me on better schedule in the morning. I get to sleep till 6:15, hustle to the train (and so I’ve packed my lunch the night before rather than picking it up on the way with the car), do my meditation, have some fiddly time, get in a :50 minute bike ride and be at the office by 9:58.   On Wednesdays again I get in a workout and a meditation. In truth, that’s not a clean tradeoff because I was just not working out on Wednesdays, so it gets back to values: am I attracted to a decision that adds more workout time? Yes!

The higher cost is still a factor, but once I commit to a path then there are optimizations that can be made. With Amtrak, if I purchase 2 weeks ahead I can save 30% right now.   With the bus, there seems to be a transportation office in Thurston County that might be able to help me plan a more efficient trip, but I didn’t hear about that until I’d been doing the commute and mentioning it to people.

Net:  Good decision making certainly involves looking at the numbers, but it also involves looking at the context, making a decision, and continuing to refine from there. There will always be things you’re not likely to know until you’ve gotten deeper down a path.

This weekend I attended a panel discussion at Pinchot University alumni day, where a series of grads talked about how they’ve actually funded their businesses to-date.  There were some common themes but it was a wide range of sources, that I’ll organize in circles of personal connection.

First and foremost is your own pocket. A common theme is being able to run the business without paying yourself, so most entrepreneurs had supportive spouses with secure jobs. For those who need to get paid and so need to start with funding, the funding starts at home, for example, one entrepreneur was able to launch after receiving a small inheritance.  Two other sources that did not come up are home equity and retirement equity.   Home equity loans were a common business funding source before the meltdown, I’m not sure how common those are now.  More recently I’ve heard from one or two entrepreneurs who have tapped their retirement funds. If you take the money directly out, you’ll have to pay big penalties for early withdrawal. An alternative is to find a self-directed IRA fund and then invest in your own business.

At the next ring out is getting money from other people who want to support you. One entrepreneur got their startup funds in unsecured loans from friends and family, at 10% interest to reflect the risk of such loans as family saw it. Community Development Finance Institutions or CDFIs were cited by several entrepreneurs. These are very much like bank loans in cost and terms:  all the loans discussed in group required collateral and for large loans borrowers had to make personal guarantees. The advantage of a CDFI loan is they’ll lend to businesses that banks wont – for example banks will usually require a stronger track record of profitability.

Financial support can come in ways that aren’t cash infusions: favorable terms on rent or long repayment periods on supply purchases were ways these early entrepreneurs found support.  Specific loans for equipment or supplies can be less risky for lenders and so easier to obtain because repayment can be tied to a specific revenue stream, or collateralized by a specific item.  For example, a couple businesses were able to get loans to purchase supplies in larger lot sizes to get a price break, and then repay that loan as the supplies were consumed, and then repeat again for the next order. Several cited equipment loans.  The folks making these loans were community members met through networking or just through business operations who wanted to be supportive.  One business’s supplier let them have 5 months to pay the invoice.  These opportunities are built through personal relationships, and to some extent have an informal personal guarantee.  A loan against a purchasing contract from a potential customer can be another way to fund supplies and give security to a would-be lender with a less personal relationship.

At least two of the businesses had been through local business accelerator programs, and one of the entrepreneurs pointed out the importance of making sure those programs also provide access to capital!  Both program graduates did get some grant funding as a result of participation in different programs, and one got access to ongoing borrowing opportunities.

The best source of funding for a business is of course, revenue. However one entrepreneur cast this in an interesting light – they’re still focused on their original business idea and think it can become self-sustaining but that it’s a long road.  So they started a different, but related, line of business that will be profitable more quickly and that can cover fixed costs that support both businesses.  I thought that particularly for social entrepreneurs, bootstrapping with a more mainstream business while you work on your cutting-edge idea is a path worth pointing out.