Entrepreneur’s Wealth Digest
A question we are frequently asked is, “When will the next recession be?” We all know that the business cycle is real and that the next recession will eventually be here. However, we have no idea when it will occur and with what severity. We don’t know because the global financial system is incredibly complex and difficult to predict. This doesn’t mean that we don’t go through mountains of financial data (we do), and try to get some leading indicators to help us better understand what is likely to happen. Even so, we never know for sure. If this group of highly educated financial professionals who have made an entire career out of doing this work at a high level doesn’t know for sure, it means that nobody else really does either.
So what should our response to the unknown be as entrepreneurs? We face unique challenges because not only are we in the business of having our businesses do their day-to-day work, but we are also in the business of deciding when to expand, hire, invest, or sell those businesses, and timing on each of them is key. So we have the uncomfortable task of making decisions where timing has a large impact on the result but without any ability to accurately predict if our timing will wind up being good or not. Is anyone still wondering why 91% of the US population prefers to work for someone else instead of owning a business?
What we can’t do is let worrying about the start date of the next recession or high growth period dictate how we move our business forward. We can create scenarios to help stress test our decisions based on what the world throws at us. Those scenarios should always focus on liquidity and how you can manage the risks of the environment turning against you.
This represents the amount of access you have to capital to either make a direct investment or provide backup if your cash flow is disrupted. The easy-to-access portion of your capital stack is represented by business cash, personal cash, business lines of credit, personal lines of credit, and liquid assets like your publicly traded investment portfolio. We can dive deeper into things like secured lines of credit based on real estate or business equity, and even 401k or cash-value insurance loans, but for the purposes of planning for business decisions during a recession we should stick to only assets where you don’t have to request additional credit.
You can do this with a simple Excel sheet. Simply label each category from above, create a row for each account, and add amounts by account to get your total liquidity stack.
I also recommend looking at this in the context of time instead of dollars. When a recession inevitably hits, the question becomes, how bad will it get, and for how long? So let’s look at what our burn rate is to decide how long we can ride out the storm. Take all your recurring personal expenses and split them into two categories, optional and non-optional. So things like groceries, utilities, medical expenses, and debt payments should go in the non-optional. Things like vacations, clothes, entertainment, and big-ticket expenses like second-home purchases should be labeled optional. Then do the same with your business. What are the core elements that you need to make your business run and where do you have some control? Things like rent or mortgage, equipment leases, core technology, and key staff expenses should be non-optional. Staff retreats, vendors, and positions that are overstaffed are optional.
We started this exercise with the premise that you shouldn’t get stuck on your business plans just because a recession might be in the future. This generally means not postponing decisions that will help you grow, like hiring, asset purchases, buying competitors, or investing in new offerings. Think about what those items are and which categories they should go into. Is buying a competitor the next big thing that will drive your business strategy forward? Is it hiring another service team to meet expanding customer demand? What about building out another production line in your manufacturing facility? Whatever these are, think about the immediate and ongoing cash demands and where you think that capital will come from, usually either owner capital or debt.
To put this all together let’s think about the following example:
The decision point is whether to add another production line for their HVAC widget. The new line will cost $1,200,000 to install and requires another 3 employees to operate at $210,000 of annual cost. Without the line, they have to start passing on orders which continue to increase and potentially lose some customers who need higher volume but don’t want to split orders over two manufacturers. The new line should increase capacity by $1 million in revenue in year 1 and $2 million in year 2 and beyond. With the new line they can meet their increased demand for the next 2-3 years and the 20% profit margin will stay in place.
If you are this owner what questions are you asking yourself? Likely, how should I best finance this new line? They are running a bit lean on the personal asset side but have plenty of liquidity coverage, with about 63 months available based on their personal burn rate. The best fit is likely some combination of personal assets and outside lending for the new line. This owner should be thinking about how solid their recurring revenue is, how much disruption they could experience in a bad economic environment, and how much of a shortfall they might need to cover.
The specific outcome in this example isn’t important, but assembling your numbers and reviewing them allows you to ask yourself the questions you need to be asking. So model out revenue disruption, ask how lean your business could get if it had to, and think about what financial levers you would have to pull.
If you have a question or simply want to talk through your financial planning, we are here to help.
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DISCLOSURE: Jarrod Musick is an officer of Destiny Capital and Entrepreneur Aligned, a DBA of Destiny Capital. This article is for informational purposes only and should not be relied upon as a basis for your investment, business, or personal financial decisions. We recommend consulting with your wealth advisor, CPA/tax advisor and/or attorney, as applicable to your situation, prior to implementing any new tax, legal, or investment strategy.
Jarrod was born into financial planning and solving financial problems. With his financial advisor father Steve telling stories about finance around the dinner table from an early age, the idea that everyone has a different financial situation was always there. After an early professional career spent in nonprofit and government, Jarrod came back to his roots helping people plan and invest in 2011. Since then, he has worked with individual clients, led internal teams and ultimately became partner and the CEO of Destiny Capital in 2017. With a passion for helping entrepreneurs change the world, Jarrod ultimately oversaw the creation of Entrepreneur Aligned in 2020. With both Destiny Capital and Entrepreneur Aligned, Jarrod leads teams that help people live lives of abundance where money is simply a tool to let everyone be a positive force for the world around them. When he isn’t working with the talented teams for EA and DC you can find him chasing his twins, wily trout or a podium spot at an OCR race.