It’s very true to say that the events that cause a business to fail usually occur in the market- or macro-environments of the business simply because factors in those areas are largely outside its control. However, while we do have to have an understanding of what these factors are and how they might have a positive or negative impact on the business, a central issue for lenders is the quality of management in the business for two reasons;
- management should have sufficient experience and knowledge of the industry in which the business operates to be able to anticipate these events and to adapt operations to minimise any negative impact or to optimise any opportunities that might arise.
- management has to develop an effective strategy for the business and so has to take into account any possible changes or developments in the future operating environment, often well in advance of their appearance.
For those reasons, we need to be sure that management has a number of competencies, not just in running the business from day to day, but in being able to step back and see the bigger picture. But, competencies aside, a much bigger concern for the analyst is whether the management team have the right personal characteristics in terms of their temperament and attitudes or, to put it another way, whether they have normal egos. In his 2009 book, How the Mighty Fall (which should be required reading for anyone lending to businesses), Jim Collins set out a 5-stage process through which many businesses travel to their eventual demise. Perhaps, the most interesting point made in the book is that the seeds of business failure are sown when the business is, and has been, doing well. He defines this first phase as “hubris born of success” and reflects his view that when management has been successful, they become over-confident and arrogant and so don’t see the threatening external events coming down the road. They believe that they are so good that nothing can hurt the business – but of course they’re completely wrong. So, in our analysis of management, what indicators are there that help us assess whether temperament, attitudes and egos are appropriate?
- A degree of openness and transparency is a good indicator that the management team feels they have nothing to hide. This presents a better risk profile than the managers who refuse access to information. Management teams that present the following traits generally present a better credit risk profile:
- Accessible to answer questions
- Answer questions honestly
- Disclose transparent information
- Discuss strategy and other activities openly
- Actually execute stated strategy
- Are upfront about challenges and problems.
- Good corporate governance principles adopted in line with international norms. South Africa’s King Report on Corporate Governance, for example, says that the CEO of the company should not simultaneously fulfil the role of chairman. If the CEO retires from that position he or she should not become chairman until three complete years have passed since the end of the CEO’s tenure as an executive director. As if to underline that point, South Africa’s only corporate bond default to date was by a company in which the CEO was indeed also the Chairman.
- An able succession plan in place. Often, the lack of an identified successor to the CEO is an indicator of an outsized ego who feels irreplaceable and indestructible. This results in a management-dominated company in which the CEO and/or chairman are autocratic which, obviously, can be problematic. The issue of temperament and attitude is one that is crucial for an assessment of the sustainability of the business. Other negatives in the business can be addressed and mitigated – but an arrogant, egotistical CEO is difficult to get around.
In our free e-book, Business Lending Essentials Part 1; Assessing Business Risks, we take a broad look at the analysis of the business environments and provide some tools and techniques to enable analysts to apply a logical approach to the assessment of a business. The ebook is free and can be downloaded from www.businessbankingcoach.com by clicking here.