Small business owners having a difficult conversation about their business

A Rough Patch

Eventually, every business, no matter how well run, hits a rough patch. While large businesses are used to hiring consultants, and have people and processes in place to get the most out of such consulting engagements, most small business owners do not. Consider the following – fictitious, but unfortunately all too common − story about a small business owner who hired the wrong consulting firm, and paid a steep price for his mistake.

Davis Johnson is 53 years old. He is happily married, with two teenage girls, and has a small architectural design firm with nine full-time employees and four part-time contractors. He launched the business almost 20 years ago and under his leadership the firm grew steadily for most of that time. But over the last two years growth has stalled, and more recently revenue has started to decline.

Davis is worried he will have to lay off staff to stay in business. He is pretty sure he is going to need additional financing to turn things around, so he asks two close friends (both are mid-level executives at Fortune 5000 firms) for advice. They tell him he will definitely need to raise a significant amount of capital to turn the business around. He decides he needs a business plan, and after another few rough weeks with the business, he decides he needs professional help. He consults his friends again, and they both recommend hiring a well-known international business consulting firm.

Things Are Looking Up

The firm has an office nearby, so he calls them up, makes an appointment, and meets with one of their senior consultants the next week. The meeting goes well, and he is impressed by their beautiful office, their great marketing materials, and the personal attention they give him. He asks for a proposal. It is considerably more than he expected to pay, but they say they’ll have everything finished in less than six weeks, so he decides to go ahead, and asks them to send him a contract. The contract is quite long and full of legalese which Davis doesn’t quite understand. But he likes these guys and trusts them, and he doesn’t want to pay his attorney for reviewing the contract, so he signs it and pays the initial fee.

At first everything seems to be going well. The consultants ask him lots of detailed questions and really seem to understand his business and his vision. After about four weeks, they send him a first draft of the business plan. It is beautiful, with attractive formatting, lots of professional looking images, charts, graphs and appendices highlighting detailed financial calculations. But when he reads through the plan more carefully, he discovers that he doesn’t really understand a lot of the numbers, and the plan as written doesn’t really reflect the realities of his business very well.

Reality Sets In

His firm’s revenue has never exceeded two million dollars, but the plan calls for him to raise five million dollars so he can open eleven new offices in other cities, and hire over 90 new employees over the next three years. He isn’t happy with the plan, so he asks to speak to one of the senior consultants he originally met with. It turns out that person just left the firm, and a new, less senior person has taken over Davis’s account. Davis meets with him, and the new consultant assures Davis everything will be straightened out, so Davis leaves, feeling much better.

Three weeks later, he receives a second draft of the plan. It is a little better, with slightly slower growth, fewer office openings, and a less aggressive marketing and sales plan. Now the plan calls for him to raise just three million dollars, add five new offices and 37 new employees over three years. But this still isn’t what he expected, and it certainly doesn’t match the realities of his small business.

So he asks for more changes, waits another three weeks, and then receives a third draft. It is only slightly different from the second draft, so he meets with the consultant and requests more changes. Unfortunately, the contract he signed specified a maximum of three drafts, and this would be the fourth draft. So Davis will have to pay the remaining balance specified in the contract now if he wants the fourth revision. The firm kindly agrees to waive additional fees for the extra work, so Davis gives his consent, pays the remaining balance and waits for the final draft.

Three weeks later he receives the final draft. It looks better, with a more reasonable growth rate (a capital raise of one million, three new offices, and addition of 18 new employees). The plan still seems a little bit unrealistic, but by now Davis is so exhausted by the whole process that he just decides to accept this version and move on.

He takes his business plan to the bank the consulting firm recommends, expecting them to quickly lend him the money requested in the plan. But the bankers seem a bit skeptical, and they ask Davis a lot of questions that he can’t answer. (He still doesn’t understand all of the assumptions or projections described in the plan.) The bankers smile and tell Davis they need to review the plan in more detail, but they will get back to him shortly. Another few months go by, and finally, Davis hears back from the bank. They have good news − he has been approved for a loan! Unfortunately, they also have a few conditions:

  • The bank is only willing to loan $600,000, just 60% of what he said he needed in the plan.
  • The bank requires Davis to put up his home and his business assets for collateral.
  • The bank insists on a higher interest rate on the loan than his plan projected.

Almost six months have now passed since Davis started this entire process, and since business conditions have continued deteriorating he was forced to lay off three employees last month to stay afloat. He doesn’t feel like he has many options at this point, so he signs the loan documents, gets the money, and starts rebuilding his business.

Two years later he is back up to about where he was when he first hired the consulting firm. He now has 11 employees and three part-time contractors, and revenues have stabilized at roughly the same level they were two years before. But he also has $300,000 of debt to pay off, and his profit margin has dropped from 12% down to 9%.

Lessons Learned

While Davis isn’t a real person, the basic story outlined here is. It is a composite of actual events from real companies we have worked with or spoken to over many years. Sure, Davis and his business survived, but things certainly didn’t go the way he had hoped. What went wrong, and what could he have done differently?

  • First of all, he waited too long before he started looking for help. He saw the deterioration in his business fully two years before he did anything about it.
  • He hired the wrong firm. He was mesmerized by the big name and image of an international consulting firm. He was one of their smallest clients, and they treated him as such. They honestly tried to help him, but they had almost no experience with companies his size. They were steeped in the worlds of private equity, investment banking, and IPOs. Slow growth and small bank loans just weren’t their thing. It was a bad fit. He would have been much better off if he had hired a small business consulting firm that had a better understanding of his business.
  • He didn’t spend enough time explaining what he wanted when he first met with the consultants, so once Davis answered their questions, they assumed they were done. They didn’t understand his situation, his business, or his industry. Davis should have been more persistent and asked them to explain their process in more detail. He also should have insisted on better and more frequent communications, especially during the first few weeks. And when the consultants insisted Davis needed much more money than he wanted, and insisted he could grow at a much faster rate than he felt comfortable with, he should have either walked away or insisted that they adjust to the realities of his business.
  • He signed a contract that was heavily weighted against him. That almost goes without saying when a tiny company hires a giant firm. The odds are stacked in favor of the large firm. There isn’t much one can do about it, but if Davis had asked his attorney to review the contract before he signed it, he almost surely would have walked away from the engagement. Even if he had decided to go ahead, he should have insisted on an option to get out of the contract if he was unhappy with the consulting firm’s work or their process.

Two and a half years after Davis first met with the consulting firm, he is basically back where he started.  But he has wasted a lot of time and lost a significant amount of money following an unrealistic and poorly conceived business plan. He could blame everything on the consultants, but Davis is mature enough to realize that he bore significant responsibility for his situation since he hired the firm almost solely based on his friends’ recommendation. Luckily everything worked out OK and he can chalk it up to experience, but if he could go back in time, he would definitely do things a little differently next time.