Economic optimism among small business owners in Canada has led to a widespread lack of contingency planning, according to a new Harris/Decima report commissioned by BMO Bank of Montreal.
The survey found that more than three-quarters (77%) of 777 Canadian small business owners with revenues of $5 million or less rated the Canadian economy as good, while another 9% rated it as excellent.
Additionally, an astonishing 92% feel they can cope with financial difficulties, even though two-thirds of them say they have no contingency plan in case of an economic downturn.
“While this optimism among small business owners is encouraging, a contingency plan should be of paramount importance, especially in times of economic instability,” says Gail Cocker, senior vice president of commercial banking at BMO Bank of Montreal. “In our experience, the best time to develop and review contingency plans is during good economic times, rather than seeking solutions in the face of a sudden downturn.”
The study found that retaining business savings is the most popular way to deal with financial challenges. More than half of small business owners decide to use their savings to secure the future, and over 40% say they are ready to use their own savings in the event of a financial downturn.
Small business owners also pointed to cost cutting as a way to combat lean times. Process improvement was popular among respondents, and half chose to identify inefficiencies as a contingency plan.
“It varies from business to business. Generally, when there is concern about the economic future, business owners will cut back on their spending. Much of this makes sense. You also want to make sure they have sufficient contingency resources on hand in case the downturn is much longer than you expected,” says CFP Tina Tehranchian.
According to Tehranchian, who is principal of Assante Capital Management in Richmond Hill, Ont., for relatively young companies, slimming down and relying on cash may not survive difficult times – even if it’s a great business model.
He says one of the first things small business owners should do is make sure they have access to a line of credit from a good commercial banker. This will ensure that the company can survive and thrive if a recession coincides with the early, critical years of growth.
“In the first few years, a few bad months of low income can kill a great business,” he says. “For many micro-enterprises, banks require personal guarantees for their loans. It really comes down to making sure they actually have a line of credit – even if it’s on their home.”
Tehranchian mentions a home equity line of credit only because it is the most common form of security customers have, giving them a lower interest rate, which is essential in difficult times. He emphasizes that a home equity line of credit is not for all investors. I only suggest this to clients who are disciplined and only intend to use it as a way to protect their business. It’s not about paying off consumer spending.
If the business owner is married and the spouse has a large income from another job, the advisor may try to use this to obtain preferential interest rates on an unsecured line of credit.
More mature or well-capitalized small companies will likely be able to cope with a short-term drop in revenue, says Mark McNulty, an investment adviser at Raymond James McNulty Group.
Ninety-five percent of McNulty’s customers are dentists, and he says the economic decline is actually affecting their lucrative dental cosmetics business. Generally speaking, they have sufficient personal wealth and run businesses that can generally stay afloat in a downturn because most of their practice comes from insurance.
McNulty says his job as an investment advisor is to make sure financial markets don’t have too much influence on his client’s wealth.
“When it comes to investment management, we have what we call a ‘don’t screw up’ investment management philosophy. The main financial factor will be the money from your business. It won’t be a return on investment,” McNulty says. “We want to keep pace with inflation and achieve a real return of 2-3%; we don’t want them to take any significant risks. They have a real impact on their business, not uncontrolled investment management. If there is a downturn in the stock market, our clients will not have to worry about it; they can just focus on their own business.”
One of the difficult planning issues for clients is when to sell the company. McNulty believes it has always made sense to wait out an economic downturn before selling a business – assuming business owners can do so.
McNulty also says that tighter lending conditions mean fewer buyers for his clients’ businesses, where the expected cash flow returns can be quite significant. The money a dental practice is expected to make over the next three to five years will generally exceed the proceeds from the company’s reduced sale price.
“When you sell a business, let’s take a dental practice as an example, you’re selling a huge cash flow. This means that the seller is giving up free cash flow. Typically, the ROI on the capital invested in the business is around 20%. Tell me where you get ROI, where you get 20% of your investment and you have control over the results of the business.
In terms of personal investment savings, if a client believes there is a real risk that the business may not survive, Tehranchian suggests that the client consider moving his or her registered long-term assets into segregated, creditor-protected funds.
“This strategy really works better the longer the assets are in the insurance company, because the longer you have the assets in the seg fund, the more likely you are to be successful in court by keeping those assets,” he says.
Posted by Mark Noble, Advisor.ca, mark.noble@advisor.rogers.com
(04/11/08)
