Disaster Planning

In the film Apollo 13, astronauts and engineers went through seemingly endless simulations of what might go wrong on a flight to the moon. The astronauts complained that some of the scenarios were unrealistic and almost impossible to occur. But when a near disaster occurred on Apollo 13, the engineers and astronauts were confronted with a problem that had never been considered; however, because of their prior experience with disaster training, they were able to develop a solution.

Rather than being negative, anticipating what can go wrong can be profoundly positive through either prevention or quickly responding to a crisis. The wise small business owner should appreciate Murphy’s Law (“Anything that can go wrong will go wrong”) and Murphy’s first corollary (“And it will go wrong at the worst possible moment”). The most pragmatic small business owner will also realize that Murphy was an optimist.

The Federal Emergency Management Agency declared 741 natural disasters in the United States for the period 2000 to 2011. Of that number, 66 percent were declared across the following six states: Texas (#1), California, Oklahoma, New York, Florida, and Louisiana (#6). However, every state and territory was represented.^[5] Planning for the aftermath of severe storms, flooding (e.g., perhaps snow melts too fast), fire, a hurricane or a tornado, a terrorist attack, or—in some areas—an earthquake is the key to getting back to business with a minimum of disruption. Not all businesses will face the same likelihood of these disasters occurring, but everyone faces the possibility of fire, severe storms, and flooding. Every situation will be unique, with the complexity of issues depending on the particular industry, size, location, and scope of a business.^[6] The widespread nature of a the typical disaster means that public services, such as police, fire fighters, and medical assistance, will be unable to reach everyone right away. A business might be going it alone for a while.^[7]

According to a recent poll conducted by the National Federation of Independent Business, man-made disasters affect 10 percent of small businesses, and natural disasters have impacted more than 30 percent of all small businesses in the United States.^[8] Man-made disasters are disastrous events caused directly and principally by one or more identifiable deliberate or negligent human actions.^[9] They include such things as arson, radiation contamination, terrorism, structural collapse due to engineering failures, civil disorder, and industrial hazards.^[10] The better prepared a business is, the faster it will be able to recover and resume operations…if that is the decision. Having a disaster plan can mean the difference between being shut down for a few days and going out of business entirely.^[11]

Four key facts about disaster planning must be kept in mind: (1) disasters will occur, (2) an owner must have a plan before the disaster occurs, (3) react with urgency but do not panic, and (4) ride it out.^[13] If an owner is committed to having a disaster plan for a business, the plan and process can be structured in a variety of ways. For this section, however, the recommendations on Ready.gov serve as the structure for our discussion. These recommendations reflect the Emergency Preparedness Business Continuity Standard (NFPA 1600) developed by the National Fire Protection Association and endorsed by the American National Standards Institute and the Department of Homeland Security.^[14] The recommendations are divided into three areas: plan to stay in business, talk to the people, and protect the investment. The topics discussed here are presented in Figure 6.1 “Disaster Planning”. They have the greatest immediacy for a small business.

A business owner has invested a tremendous amount of time, money, resources, and emotions into building a business, so he or she will want to be able to survive a natural or man-made disaster. This requires taking a proactive approach so that the chances of the business surviving are increased. Unfortunately, nothing can be done to guarantee the survival of a business because there is no way to know what kind of disaster may occur—or when. There is also no way to know what kind of business environment the owner will face after the disaster. There are, however, several things can be done to increase those chances of survival. Resist the temptation to put emergency planning on the back burner.

Talk to People

Without good communication, the internal and external structure of a business—and its daily operations—will face challenges that may ultimately lead to its downfall.^[21] Strong communication skills are, therefore, a vital part of business success. When first starting out, the owner will need good communication skills to attract and keep new customers. As the business grows and new employees are required, these skills will be needed to hire, motivate, and retain good staff.^[22] It is for this reason that the employees of a business should play a central role in creating a disaster plan.

Protect the Investment

Last but certainly not least, take steps to protect the business and secure its physical assets. Among the things that can be done, having appropriate insurance coverage; securing facilities, buildings, and plants; and improving cybersecurity are at the top of the list.

Physical and Economic Injury Disaster Loans

In the case of a physical disaster, a small business owner may apply for a low-interest SBA loan of up to $2 million to repair or replace damaged real estate, equipment, inventory, and fixtures: “The loan may be increased by as much as 20 percent of the total amount of disaster damage to real estate and/or leasehold improvements, as verified by SBA, to protect property against future disasters of the same type. These loans will cover uninsured and or under-insured losses.”^[41] It is also possible that small business disaster relief loans may be available at the local, county, regional, or state level.^[42]

The SBA can also help small businesses that were not damaged physically but have suffered economically.^[43] An Economic Injury Disaster Loan of up to $2 million can be granted to meet necessary financial obligations—expenses the business would have paid if the disaster had not occurred.

The interest rate on both Physical and Economic Injury Disaster Loans will not exceed 4 percent if you do not have credit available elsewhere. Repayment can be up to 30 years, but this will depend on the business’s ability to repay the loan. For businesses that may have credit available elsewhere, the interest rate will not exceed 8 percent. SBA determines whether the applicant has credit available elsewhere.^[44]

Disaster Assistance from the Internal Revenue Service

The Internal Revenue Service (IRS) provides some disaster assistance and emergency relief for businesses through special tax law provisions, especially when the federal government declares their location to be a major disaster area. The IRS may grant additional time to file returns and pay taxes. While doing disaster planning, check the latest special tax law provisions that may help a business recover financially from the impact of a major disaster.^[45] It would also be a good idea to check out what kind of record keeping the IRS requires so that a business will be fully prepared should it be necessary to take advantage of what the IRS offers.

SCORE Business Advice

Disaster recovery will push the limits of a small business…and then some. Locate the closest offices of SCORE (Service Corps of Retired Executives)—a nonprofit association dedicated to educating entrepreneurs and helping small businesses start, grow, and succeed nationwide—and enlist their support. SCORE provides confidential business counseling services at no charge.^[46]

Online Disaster Assistance

DisasterAssistance.gov is a one-stop web portal, self-described as access to disaster help and resources, that details over sixty different forms of assistance from seventeen US government agencies where a business owner can apply for SBA loans through online applications, receive referral information on forms of assistance that do not have online applications, or check the progress and status of online applications.^[47][48]

Benefits.gov wants to let survivors and disaster relief workers know about the many disaster relief programs that are available. There are questions for a small business owner who has suffered damage because of a natural disaster to answer to find out which government benefits the business may be eligible to receive. The site also provides a link to DisasterAssistance.gov ^[49]; ^[50]

When Walking Away Is Not the Owner’s Choice

There will also be those times when walking away from a business may not be the owner’s choice.

• The owner wants no one else to run the business and is unwilling to give up equity. Every small business founder faces the founder’s dilemma—that is, the dilemma between making money and controlling the business.^[54] It is tough to do both because they tend to be incompatible goals. Founders often make decisions that conflict with maximizing wealth.^[55] If an owner wants to make a lot of money from a business, the owner will need to give up more equity (the money put into the business) to attract investors, which requires relinquishing control as equity is given away; investors may alter the board membership of a business.^[56] To retain control of a business, the owner will have to keep more equity, relying on his or her own capital instead of taking money from investors. The result will be less capital to increase a company’s value, but he or she will be able to run the company.^[57]

  In a recent study of 212 new ventures, it was found that in three years, 50 percent of the founders were no longer the CEO, only 20 percent were still “in the corner office,” and fewer than 25 percent led their company’s initial public offering (IPO). Four out of five found themselves being forced to step down at some point.^[58][59] Although specific to new ventures, this information has a clear message for all small business founders/owners: wanting to make a lot of money while still controlling and running the business are not compatible goals. One must decide which goal is most important, understanding that the choice of letting someone else run the business will likely result in being forced to step down…and perhaps out of the business altogether.

• The owner is facing bankruptcy. One study, ^[60] found that firms with less sophisticated owners or managers with respect to experience and training increases the likelihood of bankruptcy as do a deteriorating market and having less access to capital. There can be other reasons as well—for example, employee theft, fraud, or a consumer liability lawsuit that drains a company’s assets.
• The owner may be the cause. The owner could be killing the company or, at the very least, shooting himself or herself in the foot. There are several ways in which this could happen: ^[61] (1) micromanaging, which may lead to, for example, employees presenting problems or issues but no solutions, unusually high turnover, and never receiving a project that the owner does not change; (2) spending money in the wrong places—for example, spending money on items not needed, such as a fancier location, hiring more staff than needed, and attending costly trade shows with limited or no return on investment; (3) chasing after every customer instead of focusing on the ideal and regular customers that should be reached; (4) the owner is not on top of the numbers, perhaps because he or she is not financially minded and has not taken the time to become financially minded or hire someone as the finance person; and (5) the owner is not a people person, perhaps being a “my way or the highway” kind of person who invests no emotion or warmth when dealing with employees and colleagues, or is an egomaniac.
• The owner is seriously ill. Being ill will raise doubts about a company’s future, and new businesses are the most vulnerable.^[62] If there is no one in the owner’s family who is interested in or willing to take over the business, this can add additional stress to the situation.
• The industry dies or implodes. Sometimes the demand for a service or a product just dies—for example, web-consulting companies during the dot-com bust in 2000 and 2001.^[63] Henrybuilt Corporation, a Seattle firm that specialized in designing kitchens from $30,000 to $100,000, saw its sales come to a standstill in 2008. Everyone was cancelling projects. The company modified its product and was able to survive.^[64]

Resources to Help Make a Decision

The decision to walk away from a business—whether that decision is voluntary or forced—is not an easy one to make. Consult with an appropriate mix of individuals; a partner or partners if applicable, your spouse, your family, an attorney, an accountant, and perhaps someone from SCORE. Each individual can offer a different perspective and different counsel. Ultimately, however, the decision is the owner’s.

One thing is for certain. Whether the escape is voluntary or forced, there should be an exit strategy.

Liquidation or Walkaway

There are times when a small business owner may decide that enough is enough, so he or she simply calls it quits, closes the business doors, and calls it a day.^[68] This happens all the time, to hundreds of businesses every day—for example, a small shop, a restaurant, a small construction company, a shoe store, a gift shop, a consignment shop, a nail salon, a bakery, or a video store.^[69] This closing of the business involves liquidation, the selling of all assets. If all debts are paid, it can also be referred to as a walkaway.

To make any money with the liquidation exit strategy, a business must have valuable assets to sell—for example, land or expensive equipment. The name of the business may have some value, so it could be purchased by someone for pennies on the dollar and restarted with different owners. There is also a possibility that there may be a substantial amount of goodwill or even badwill if a business has been around for a long time. Goodwill is an intangible asset that reflects the value of intangible assets, such as a strong brand name, good customer relationships, good employee relationships, patents, intellectual property, size and quality of the customer list, and market penetration.^[70] However, if a business is simply closed, the value of the goodwill will drop, and the selling price will be lower than it would have been prior to the business being closed.^[71]

Badwill is the negative effect felt by a company when it is found out that a company has done something not in accord with good business practices. Although badwill is typically not expressed in a dollar amount, it can result in such things as decreased revenue; the loss of clients, customers, and suppliers; the loss of market share; the loss of credit; federal or state indictments for crimes committed, and censure by the community.^[72] For the small business owner who wants to close under these circumstances, there will be nothing much to sell but tangible assets because the business will have very little, if any, market value.

In all instances of liquidation, the proceeds from the sale of assets must first be used to repay creditors. The remaining money is divided among the shareholders (if any), the partners (if any), and the owner.^[73] In an ideal walkaway situation, the following occurs:^[74]

• All bills are paid off (or scheduled).
• All taxes are paid, and the various levels of government are informed of the closure.
• Contracts, leases, and the like are fulfilled or formally terminated.
• Employees are let go to find other jobs.
• Assets or inventory is depleted.
• No lawsuits are consuming money and time.
• Customers are placed so that they get needed goods or services.
• If needed, insurance is continued to cover unexpected claims after the firm closes.

The walkaway is the cleanest and best way to exit, but it is not always possible for all businesses that decide to close their doors. There will, of course, always be those instances in which the owner closes the business and takes off, leaving a mess behind.

Any small business owner thinking about liquidation should consider the pros and cons, which are as follows:^[75][76]

• Pros

  • It is easy and natural. Everything comes to an end.
  • No negotiations are involved.
  • There are no worries about the transfer of control.

• Cons

  • Get real! It is a waste. At most, the owner will get the market value of the company’s assets.
  • Things such as client lists, the owner’s reputation, and business relationships may be very valuable. Liquidation destroys them without an opportunity to recover their value.
  • Other shareholders, if any, may be less than thrilled about how much is left on the table.
  • If a company’s brand has any value, there is a loyal or sizeable customer base, or there is a stable core of employees, an owner would be significantly better off selling the company.

Family Succession

Many small business owners dream of passing the business to a family member. Keeping the business in the family allows the owner’s legacy to live on, which is clearly an attractive option. Family succession as an exit strategy also allows the owner an opportunity to groom the successor; the owner might even retain some influence and involvement in the business if desired.^[77] However, given that very few family firms survive beyond the first generation and even fewer survive into the third generation. ^[78][79][80] Succession is the most critical issue facing family firms.^[81] Succession is the transference of leadership from one generation to the next to ensure continuity of family ownership of the business.^[82]

A sudden decision to hand over the business to a family member is unwise. The owner will be burdened with problems that will likely lead to business failure. Succession in family firms is a multistage, complex process that should begin even before the heirs enter the business, and effects extend beyond the point in time when they are named as successors. Many factors are involved, and the succession should evolve over a long period of time.^[83][84] Further, because succession is usually followed by changes in the organization, particularly the change in the top position, it is thought to be an indicator of the future of the business. The better prepared and committed the successor is, the greater the likelihood of a successful succession process and business.^[85] The quality of interpersonal relationships, successors’ expectations, and the role of the predecessor are also relevant to success.^[86]

The ideal is for the family business to have engaged in formal succession planning: planning for the family business to be transferred to a family member or members. The failure to plan for succession is seen as a fundamental human resource problem as well as the primary cause for the poor survival rate of family businesses.^[87] Unfortunately, a very small percentage of family businesses plan appropriately for succession, and those that do frequently have mental, not written, plans.^[88]

Bankruptcy

Feeling the need to file for bankruptcy is a tough pill for any small business owner to swallow. Bankruptcy is an extreme form of business termination that uses a legal method for closing a business and paying off creditors when the business is failing and the debts are substantially greater than the assets.^[89] Because bankruptcy is a complicated legal process, it is important to get an attorney involved as soon as possible. There may be options other than bankruptcy, and consulting with an attorney will help. The owner must understand how bankruptcy works and the options that are available. It is also good to know that not all bankruptcies are voluntary; creditors can petition the court for a business to declare bankruptcy.^[90]

Chapter 7 small business bankruptcy, more commonly referred to as liquidation, is appropriate when a business is failing, has no future, and has no substantial assets. This form of bankruptcy makes sense only if the owner wants to walk away. It is particularly suited to sole proprietorships and other small businesses in which the business is essentially an extension of its owner’s skills.^[91][92] Under Chapter 7 bankruptcy law, a trustee will take a business apart, selling assets to satisfy outstanding debts and discharging debts that cannot be satisfied with the assets that are available.^[93][94]

Small business bankruptcy allows an owner to run a business with court oversight. The owner loses control of the firm, but it continues to operate. The owner is protected from creditors in the short term because the court orders an automatic stay that prevents the creditors from seizing your assets. Unfortunately, the outcome is not pleasant. The owner is out as manager, and the creditors end up owning the business. If the owner cannot pay the $75,000+ in legal fees, the judge will probably order liquidation.^[95] This form of bankruptcy applies to sole proprietorships, corporations, and partnerships.^[96]

The amount that creditors can collect will depend on how a business is structured. If a business is a sole proprietorship, the owner’s personal assets may be used to pay off business debts, depending on the chosen bankruptcy option. If a business is a corporation, a limited liability company, or some form of a partnership, the owner’s personal assets are protected and cannot be used to pay off business debts.^[97]

Alternatives to Bankruptcy

Instead of going the bankruptcy route, a small business owner could do the following things: ^[98] This is also known as a Consumer Proposal within Canada. 

• Negotiate debt. This involves trying to reorganize a business’s finances outside a legal proceeding. The owner can work with the creditors to renegotiate the terms of payment and the amount owed to each creditor. If a business is basically profitable but the debt situation is due to an unusual circumstance, such as a lawsuit or a temporary industry slowdown, this could be a successful solution.
• Improve operations. If the owner is in a position to fix the cash problem by fixing the underlying problems in the business, it may not be necessary to declare bankruptcy. An owner should look at cash-flow controls; eliminate unprofitable products, services, and divisions; and restructure into a leaner and meaner organization.
• Turn around and restructure the business. This alternative combines debt negotiation and operational improvement—perhaps the best choice. By doing both things at the same time, an owner will be in an even stronger position to improve the balance sheet, cash flow, and profitability—and avoid insolvency.

Taking a Company Public

An initial public offering (IPO) is a stock offering in which the owner or owners of equity in a formerly private company have their private holdings transferred into issues tradable in public markets, such as the New York Stock Exchange (NYSE).^[99] From the initial owners’ perspective, an IPO is often seen as liquidation, but it is also a money event for a company. For this reason, an IPO makes sense only if a small business can benefit from a substantial infusion of cash. ^[100]

IPOs receive lots of press, even though they are really very rare. In a typical year, there may be 200 IPOs, perhaps even less. Consider the following data:^{[101][102][103][104]}

• 2008: 32 IPOs
• 2009: 63 IPOs
• 2010: 157 IPOs
• 2011: 159 IPOs

Why are the numbers so small? ^[105] The IPO process is costly, labor intensive, and usually requires an up-front investment of more than $100,000. Detailed reports are required on a business’s financials, staffing, marketing, operations, management, and so forth. Preparing these reports typically costs hundreds of thousands of dollars, sometimes millions, every year. The Sarbanes-Oxley Act alone, a product of the Enron scandal, costs even the smallest companies several hundred thousands of dollars in consulting fees. Lastly, many companies are not valued very highly on the stock market.

When thinking about an IPO, consider the following pros and cons: ^[106]

• Pros

  • The owner will be on the cover of Newsweek.
  • The stock will be worth in the tens—or even hundreds—of millions of dollars.
  • Venture capitalists will finally stop bugging the owner as they frantically try to ensure their shares will retain value.

• Cons

  • Only a very few number of small businesses actually have this option available to them because there are so few IPOs in the United States each year.
  • A business needs financial and accounting rigor from day one that is way beyond what many small business owners put in place.
  • The owner will spend most of his or her time selling the company, not running it.
  • Investment bankers take 6 percent off the top, and the transaction costs of an IPO can run into the millions.

Stever Robbins of Entrepreneur paints an amusing but very dismal picture of what is actually involved in an IPO.^[107]

You start by spending millions just preparing for the road show, where you grovel to convince investors your stock should be worth as much as possible…Unlike an acquisition, where you craft a good fit with a single suitor, here you are romancing hundreds of Wall Street analysts. If the romance fails, you’ve blown millions. And if you succeed, you end up married to the analysts. You call that a life? Once public, you bow and scrape to the analysts. These earnest 28-year-olds—who haven’t produced anything of value since winning their fifth grade limerick contest—will study your every move, soberly declaring your utter incompetence at running the business you’ve built over decades. It’s one thing to receive this treatment from your loving spouse. It’s quite another to receive it from Smith Barney. We won’t even talk about the need to conform to Sarbanes-Oxley, or the 6 percent underwriting fees you’ll pay to investment bankers, or lockout periods, or how markets can tank your wealth despite having a healthy business, or how IPO-raised funds distort your income statement, or… In short, IPOs are not only rare, they’re a pain in the backside. They make the headlines in the very, very rare cases that they produce 20-year-old billionaires. But when you’re founding [and running] your company, consider them just one of many exit strategies. Realize that there are a lot of ways to skin a cat, and just as many ways to get value out of your company. Think ahead, surely, but do it with sanity and gravitas. And if you find yourself tempted to start looking for more office space in preparation for your IPO in 18 months, call me first. I’ll talk you down until the paramedic arrives.

For some small businesses, although not many, an IPO might make sense—and may even be necessary. For most, however, an IPO is clearly not a viable exit strategy.

Selling the Business

Another possible exit strategy is selling the business. Although the sale of a business is sometimes described as the end of entrepreneurship or as failure or defeat,^[108] selling the business can also be a relief and the beginning of the next phase of the owner’s personal and professional life. As in the case of SoBe (highlighted at the beginning of this chapter), the owners sold the business because, among other things, it was becoming something they did not want it to be—and it was no longer fun. Whatever the reason, an owner can sell a business only once, so be sure that it is the right exit strategy. The owner should address the following questions:^[109][110]

1. Can the business be sold? There are many things that make a business attractive to buyers: a solid history of profitability, a large and loyal base of customers, a good reputation, a competitive advantage (e.g., intellectual property rights, patents, long-term contracts with clients, and exclusive distributorships), opportunities for growth, a desirable location, a skilled workforce, and a loyal workforce. If a business does not have at least some of these things or others of equal value, it will not likely generate much interest in the market.
2. Is the owner ready to sell or does the owner need to sell? Selling a business, when it is a choice, requires emotional and financial readiness. The owner must think about what life will be like after the business is sold. What will be a source of income? How will time be spent? Has the owner “sold out” or could more have been done with the business? Does the owner love what he or she is doing? Many small business owners suffer real remorse after handing their businesses over to a new owner. Selling the business because the owner is forced to will engender very different emotional and financial challenges.
3. What is the business worth? The owner may have no idea. For example, the owner of a small professional services firm felt the firm was worth more than $1 million. After a lengthy search, however, the owner received less than one-half that amount from the buyer. On the other side of the coin, the owner of an information technology (IT) company planned to sell the company to an employee for $200,000. However, after advertising the business for sale nationwide, the owner sold it for one dollar shy of $1 million.

It is recommended that an owner start planning for a sale at least three to four years in advance. Sometimes, even five years is not long enough. It is very easy to become overly attached to a business, so it will be difficult to see how the business really looks to an outsider.^[111] Selling a business is an art and a science. If the asking price is too high, this may signal to potential buyers that the owner is not really interested in selling. Because there are several methods used to value a business, it is a good idea to hire a professional.^[112]

There are different ways to sell a business (see Figure 6.5 “Four Ways to Sell a Small Business”). Acquisition, friendly buyout, selling to the employees, and selling on the open market are discussed here. Be aware, however, that if a business is floundering and it is well known that the business is having major problems paying bills, vulture capitalists, might start circling. A vulture capitalist is a venture capitalist who invests in floundering firms in the hope that they will turn around.^[113][114] A venture capitalist is an investor who either provides capital to start-up ventures or supports small companies to expand but does not have access to public funding. Venture capitalists typically expect higher returns because they are taking additional risks.^[115]

Figure 6.5 Four Ways to Sell a Small Business