What leads to business failure?

Sep 30, 2019

“What causes AEC firms to fail? I have been a student of this business for 39 years now. Here’s what I have seen.”

Most businesses in this country don’t make it to their fifth birthday. Even fewer make it to 10, 20, or even 30 or more years.

What causes AEC firms to fail? I have been a student of this business for 39 years now. Here’s what I have seen (in no particular order of importance):

  • Owners who have lost interest in their business. Let’s be honest – it happens. Some people get tired and burnt out. Especially when they have completely poured their hearts and souls into something for a long time. And not everyone is addicted to the game or the money. They may feel they have enough or have accomplished what they set out to do. If these are the people in charge, the business is headed for eventual disaster.
  • Owners taking too much money out. I have seen this time and time again. One of the best examples I will never forget was a firm owner who was taking $380K annually out of his less than $3 million annual revenue company. When I ran some numbers and told him the most he could afford to pay himself was $180K a year, he told me he needed $380K because his cattle farm was losing $200K a year. They eventually went out of business.
  • Employees are taken for granted. We had some friends over this weekend and the husband and I discovered we both had worked with a particular architecture firm – he was their client and I was their consultant. I remembered back to a time when their managing partner came to see me in our Natick, Massachusetts, headquarters after we had helped them with a financial turnaround some years earlier. He told me that the prior year was a record year for them and that they made a $2.6 million profit. But the bad news was they lost 70 percent of their staff and virtually all their second tier quit. After asking some questions do you know what I learned? They paid the entire $2.6 million in profit out to their owners and gave ZERO to anyone else! This type of selfishness can kill a company.
  • No attention to, or budget for, marketing. Marketing is what I like to call an “off balance sheet” investment. You have to spend money on it consistently and you have to keep doing new (and old) things. So many companies view it as an overhead cost to be minimized. My own textbook for the small business management class I teach at the University of Arkansas recommends setting the marketing budget as a percentage of sales. So if sales go down you spend less. The unfortunate thing is this is exactly what some AEC firms actually do!
  • Not monitoring working capital and not collecting AR. This has been the death of more companies than you know. Working capital – cash plus AR, less accrued short-term liabilities, accounts payable, and line of credit balance – is a number management HAS to see on a consistent basis in order to stave off problems and stay alive. And, of course, collections for most firms in this business are the biggest factor in what this number is. When you see AEC firms with 90-day average collection periods when others have 45 days or less, you know they are heading for trouble that greatly increases the risk of the business. And yes, companies have been shut down when the credit lines don’t ever get paid down to zero, if that is a covenant.
  • Bad accounting. Having bad numbers – not knowing what is profitable and what is losing money – and not having an accurate balance sheet – can sink a firm in this business. This is why having a competent CFO is so crucial to your survival. And many firms in this business don’t have such a person.
  • Failed ownership and leadership transition. Many firms never make it through their second generation. Sometimes the cause is that the owners didn’t do a good job of picking and developing their successors. In other cases, the successors were so hell-bent on doing everything differently that they “threw the baby out with the bath water” and got away from the basic strategies that made the firm successful in the first place. On top of that, many firms never even model their ownership buyback programs to see if they can actually afford to pay for them. This problem is exacerbated when the majority of owners are the same age and retiring at the same time.
  • Ignoring banking relationships. Your bank is your partner. And keep in mind banks cannot afford to take a lot of risk. They have very thin operating margins and are heavily regulated. You have to not only know and abide by your LOC covenants, but also keep these people informed about what is happening in your business, both good and bad, so if things do start getting a little dicey they won’t drop you like a hot potato.
  • Unwillingness to confront unproductive principals. Deadweight partners are a cancer. They sit around the office and set a horrible example for everyone else, and consume more than they produce. Get too many of these people and let the problem go on too long, and the business may never be able to recover. I have seen the downside of not dealing with this problem as well as the upside resulting from confronting it in MANY AEC firms.
  • Protection of other “pet” employees. Some companies develop a “family” culture that makes it very difficult for them to let anyone go, even the worst of employees. Sometimes this person has been with the firm a long time and served one or more of the owners well in the past but is now not doing their job, or worse, has a bad attitude that they are willing to share with anyone who will listen. They have to go because they are a cancer that, allowed to spread, can kill the company. Sometimes the pet employee is a newer hire, too. Management can’t admit they made a hiring mistake, so they wait years to deal with the situation and destroy the morale and productivity of the rest of the people working in the business in the meantime.
  • Unwillingness to cut unnecessary overhead costs. Too much office space. Too many company vehicles. Vacation condos running through the firm. Expensive lunches for partners only. Season tickets. Private secretaries or administrative assistants (someone please tell me what the difference is?). All of these things, if allowed to get out of hand, are like an anvil around your neck while you are trying to swim away from sharks.
  • Not valuing long-term client relationships. You see companies that do this regularly. They put their best people on new clients and give their old reliable repeat clients all of their new and inexperienced people to do their projects. It isn’t right, and I have seen it kill companies.

I’m sure if I had more room we could come up with more contributors to a firm’s demise. But I don’t!

Mark Zweig is Zweig Group’s chairman and founder. Contact him at mzweig@zweiggroup.com.

About Zweig Group

Zweig Group, three times on the Inc. 500/5000 list, is the industry leader and premiere authority in AEC firm management and marketing, the go-to source for data and research, and the leading provider of customized learning and training. Zweig Group exists to help AEC firms succeed in a complicated and challenging marketplace through services that include: Mergers & Acquisitions, Strategic Planning, Valuation, Executive Search, Board of Director Services, Ownership Transition, Marketing & Branding, and Business Development Training. The firm has offices in Dallas and Fayetteville, Arkansas.