I have always been an optimistic dreamer. The advantage of being an optimistic dreamer is that I never have to learn about following my passion and thinking weird. To a dreamer, it just happens naturally. However, the will to go against conventional thinking and make awkward key decisions not only don’t guarantee anyone’s success but also guarantee to put the person into more trouble. Not repeat a lesson in life and making new mistakes are therefore critical. Turning 26 is something remarkable, not only in term of a nice number that I have passed a quarter of a century and a third of my statistic-based expected life expectancy but also in term of being mature enough to see bigger milestones ahead approaching. There will soon be 30. And soon I will ask myself what the-dreamer-I have learned though out my 20s, what I want to share to those fellows on their early 20s, and where I want to go in my 30s. So, I will take a preemptive strike here and capitalize now what I have learned in my half 20s, so I will be in better shape to go the rest of my road named 20s. My fellows early-20s, I hope you enjoy my most precious lessons that I’ve learned through my last recent 5 years.
The lesson of survival: Eagle/Wolf/Shark – whatever the animal you are, know your ground.
Categories: Self Awareness, Life
Time of realization: Mid-late 2013
On Ventures: Board Member of Vietnam Organics, Investment Analyst of Vietnam Investments Group
This is the most critical survival and most expensive lesson for me. Some people are born and develop to be a free bird in the sky, some are born and develop to be a brave wolf in the forest, and some are born and develop to be a mysterious fish under the deep ocean. The lesson is simple: it is critical for the fish not to fly in the sky and the bird not to run in the forest. This lesson alone has cost many businesses to go bankruptcy and many deals to go distressed in front of my eyes.
There are many forms that this principle governs: business to expand into a related and unrelated industry, business backward integration and forward integration, newly-rich businessman to engage into real estate investment and trading, financier takes control of the business, etc. are examples of an expansions that contain high risks that should take with extreme cautions. In business, either you do different things within an industry or you do the same thing under different industries, thus, I will divide this principle into two dimensions: (1) Risk of engaging into different nature business activities, and (2) Risk of engaging into different industries.
For (1) Risk of engaging into different nature business activities, my favorite way to explain this point is through the cash-flow model: No business survive without cash, so tracing where the cash goes is a survival matter. There are generally three categories that cash flow into: Operation, Investment, and Financing – this is known as the ordinary Cash Flow Statement. And here is the heart of the lesson: there is a vast difference in mindset, required skills, knowledge, connections, and capital for each of the player who play in those fields. The person who is good in doing operation and running business day-to-day is not necessarily good (and generally bad) when doing investment, the same applies: those who do good in financing activities is not necessarily good (and generally bad) in doing operation.
And it is so critical to stop for a moment to rethink where we are good at and what we are doing. Misstep here often leads to the single most damage mistake in business.
The Typical Story 1: Operational business owners to invest into real estate/stock market
The most typical fallacy in doing business in Vietnam for the newly-rich generations is to be over-confident and step into a strange territory without well-backed capabilities (knowledge, capital, skill, and connections). The stories happen again and again is successful business-owners generated so much cash from operation to a certain point that it cannot be reinvested into day-to-day operation (domain of expertise: operating activities in a specific industry), then the owners start to invest into deal market, real estate, gold market, stock market (new territory: investment activities) and use leverage (new territory: financing activities). The investment fails and due to leverage, the results hurt badly into equity of the businessman and leads to lack of cash for normal, day-to-day, and healthy operation. Downward spiral happens, lack of cash for payment of employees, suppliers, and interest expenses. Assets are sold under fire, operation goes down lead to downfall in revenue. Bank downgrades credit and either stops financing or starts to heighten lending standards. This triggers the gun: when the bank stops financing, it is one of the most reliable milestone for the business to go bankruptcy. Because in order for the business to continue, the owners need to proceed cash to pay in advance many things: from human resources expenses to utilities expenses. When the products are made, it takes inventory time, and when the products are sold, it takes receivable time. The business generally needs to have some finance in the middle to fuel working capital for on going business activities. Some come to the loan-shark in black market, and it is generally not the right solutions. I have personally observed many family-owned businesses to go down in this fashion, across the country. Some used to own large asset base, up to multi-millions USD. Now it is all gone.
The Typical Story 2: Operational business owners overly aggressive to expand horizontally
I have known a couple of doctors – who own high level medical degree and get all of the respects from the hospitals, doctors, and patients. They are kind and have gut to do business at a large-scale. Started very humble, they gained some of their initial assets through saving and successful real estate investment. Since 1999-something, they owned their own hospital and served for thousands of patients from the middle of Vietnam: Binh-Tri-Thien province. You know the middle of the story: they got really rich with strong operating cash flows. They have connections to top of the country officials and even joined some of country-level summits with other countries. To the peak of their time, there even a bank who bought all of their debts which belongs to other commercial banks to centralize their debts and be their own and only one primary lender. The bank was so sure about their business to do such an action. In 2008, the market was so good that they decided to expand their hospital facilities, doubled the size of their current facilities, bought the next-door land to do so, invested into a third location over USD 2.5 million in capex. To that point, they had leverage so high that most assets were fueled from bank-debts in the hope that cash flow from operation will return soon enough to cover the interest expense. In 2009, interest rate shook up to 24% per annum and pushed the company into liquidity threat. There was a fierce fight between the company and the bank. The hospital ran out of cash. The bank knew that if they gave this hospital USD 250,000 in debt, then it was the hospital’s problem to not return the money. But the bank also knew that if they lent to the hospital USD 5 millions in debt, then it was the bank’s problem if the hospital cannot return the money. Even the relationship between the hospital and the bank was basically broken, the bank continued to several times fuel new finances into the hospital with the hope it would turn around some time. The turn has never come. The market was over supplied because fierce competition from other privately owned independent hospital in the same city. The government expanded its public hospital facilities and built new ones in the city as well as in the neighbor cities which cut significant demand to the couple of doctors’ hospitals. The bank finally gave up financing in the end of 2013 and tried to initiate a sale the debt to another bank. The lending officer was put in scrutiny. For the family, I assume all major assets are now under the bank as collateral. And medical is a quite illiquid and specialized industry. Assets were sold with a steep discount and there were not many buyers in the town. The business is now still on going but it truly is a very distressed business.
Analyze the case above, I take 2 key lessons for myself: First lesson: (1) Good operation today does not guarantee good operation tomorrow, and more importantly, the expansion decision is an investment decision, not an operational decision. Expand and increase supplies (build new hospital) is a completely different domain to doing hospital day-to-day activities: it is not about medical expertise, it is not about organizing the hospital, it is not about managing the doctors team. It is about: total supply of the industry within this geographical region match with total demand – is there a risk of over-supply? (Yes). Where to build the hospital? why? (supply demand study, geographical optimization study, demographic study, regulatory & tax study, etc) who to construct the hospital? how to negotiate with them? what kind of technology to deploy into the hospital? (that this question besides be answered with medical expertise, it also a question of financing: break-even analysis, ROI of the machine, leasing terms) how long will the new hospital break-even? how much stress this capital expenditure put into cash flow of the company? what source of finance the company is going to put into the expenditure? by what rate and what structure? – there are a series of complex financial and investment questions to follow and it is not in domain of knowledge, skill, and connection of the couple doctors. Second lesson: (2) financing is highly dangerous, and overly leverage is the shortest way to put the company into the risk of bankruptcy – one of the key down-turn for the business is its high leverage when expanding into building new hospitals – and then the interest rate shook up. That shock immediately put the fragile business into an under-prepared stress test. Reminds to The Typical Story 1 above, the business owner use cash from healthy operation, leverage it with bank loan before making investment decision into a strange industry (stock, gold, real estate). From my experience, all of the case of bankruptcies have some relations to bank debt. Let’s return to Modigliani-Miller model: finding a balance point between equity and debt requires expertise, not relations with the bank or management’s assumption.
The above two examples tell stories of operation businessmen to engage into investment and financing activities. There are many notable examples more that open a vast range of lessons such as investors overly control investees and involve into day-to-day operation activities. Or business to expand into different position in the value chain (backward integration and forward integration) without proper analysis of the different of business nature. Processing the fish and farming the fish is two completely different businesses. A unite between the two can (1) push gross profit margin and (2) save operational expenses for shared services (accounting, HR, IT, etc) and thus push higher operating profit margin. However, the execution is a critical challenge as the acquirer need to know exactly what it is going to do with the acquiree(s) – else cash can be burned very quickly.
Back to my personal thinking, it is not that the investment person should not ever engage into operation and vice versa. The idea is: it is critical to know what it takes to succeed in each of the position. The operational guy is an action oriented person. He doesn’t need perfect information. He needs to make things done and improve it tomorrow. He needs to make the action now. Meanwhile, the investment person knows he is engaging into a deal/action that may have lasting value. A decision to buy a company will take 5 years to exit. A decision to build a factory will takes 10 years for depreciation. He wants to have the perfect information. He wants to negotiate to the max of it as he knows failure in this game will be extremely difficult to revert. He prefers to give minimum decisions (for example, in investment there is only two: buy and sell) and spend most of his time to think and analyze. I have seen outstanding persons who are excellent of financing, investment, and operation. The key is: know who you are, know what you’re good at, and if ever you have to go into a new environment, be conscious about it and adapt to it. Learn it from the beginning, rethink about the fundamentals, some fundamentals are shared across the board (integrity, professionalism, etc) but some are not (action oriented investors may lead to hasty investment decisions, thinking oriented operation person may delay to give decision for too long).
Just for fun, I think the finance people (commercial bankers) are the fishes in the ocean, as on top of it you have the term loan-shark. The investment people (investors and investment bankers) are forest animals, as on top of it you have the Wolf of Wall Street. Finally, for operational people, I think they are birds – as they are led by the eagle-like entrepreneurs who have the wings of freedom.
8:28 PM – Mar 24th 2014, Ho Chi Minh City, Vietnam