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Sex, drugs and rock and roll – all signs of an individual going off the rails. But what are the tell-tale signs for a business on the way down?

Companies that are failing have fountains in foyers, flagpoles outside their plush offices and expensive cars with personalised numberplates in their car parks – or so the old adage goes.

Now, most people think that so-called tell-tale signs like these are complete nonsense and are just for superstitious wimps who cannot make decisions based on well-researched facts and properly thought out logical conclusions.

I happen not to agree with this so I thought I would go through my very, very thin black book of business failures(!) and see if I could come up with some danger signals that were consistent amongst these companies.

So here goes.

Greed is not always OK
I can remember at least three companies that I have financed where almost immediately after the deal was done the directors went out and bought brand new top of the range Porsches at their companies’ expense.

Now I have nothing against Porsches – I even had one myself before my wife deemed me too old to drive one – but mine was second hand and I paid for it out of my own pocket. However, it is the attitude of mind, putting status and pleasure before the business that was the point. In each case this management flaw became increasingly apparent and the relevant people were moved on from the company concerned.

This would also apply to a management team obsessed with their own salary package and add-on benefits, even if the company couldn’t afford it at the time. Greed is OK if the company is robust but good judgement says there is a time and place – normally on the back of success.

Building the air miles
Excessive travel by managing directors to overseas conventions or business trips, particularly where the flight time is over eight hours, is not necessary. Travelling by the sales director is a totally different thing and is to be encouraged, but an MD who is constantly travelling is, in most cases, bad news. If he is not running the business he is most probably hiding the real issues that need to be dealt with back home in boring old Macclesfield or wherever.

Tied up in meetings
Really long management meetings where you are told, as an investor director, that the MD, FD, or anyone else who can tell you anything about how things are going, just cannot be disturbed. This might be OK if it’s a three-hour meeting but all day? No – good management gets back to you quickly. Well-run companies don’t need a catalogue of one-day strategy meetings or else the business has a real identity problem.

Watch out for the finances
The accounts also tell their own story. Things like a large increase in debtors or stock not properly explained or profits that never seem to really translate into cash. Slightly more oblique would be to watch the companies using invoice discounting or factoring and who are tight on cash. There is a tendency for sales to be inflated by adding additional items from a third-party supplier (that is, hardware) just to get more cash upfront. This is dangerous because when the debt gets paid you also have to pay the third-party supplier and you may have a cash crunch that you were just not expecting.

And remember the old City adage – profit warnings come in threes. Don’t assume that the worst is over too soon.

Extra signals for a public company
When it comes to public companies there are a number of anecdotal warning signs. A director selling shares does not by itself mean trouble, but illogical sales do. In other words, the sale of a disproportionately large percentage of a director’s holdings is a warning sign, regular small sales are probably not.
Beware changes of accounting year-end and advisers resigning for no good reason. And companies that make announcements or hold AGMs at ridiculously inconvenient times such as August Bank Holiday, Christmas or New Year are just taking the mickey.

Ossification is setting in
There is much debate about the Higgs Report and the recommendation that non-executive directors should retire after nine years. But what about executive management? Watch out for companies where senior management has been there forever, 20 years or more, say, and in the same position. There is a tendency for these companies to get behind the business curve. Too much rigidity enters into the companies’ culture. GEC and IBM would be good examples at various stages of their development.

Management disagreements and fallouts
This is the biggest and possibly most dangerous ticking bomb – notably when it involves founders.

Team disputes can be very difficult to pick up, particularly if you are only attending monthly board meetings. So keep a close watch on body language and talk to a number of people less senior in the organisation to get a feel for how staff morale is. It is also a useful idea to talk to senior people who are leaving the company – they may well be more able and willing to give an independent view.

And sex, of course
Last but not least – the MD having an affair with someone in the same company is a sure sign of danger. Damaging on all occasions but especially so when the object of desire is younger. It’s the classic case where the leader really lets his or her attention wander (off the business at least) and starts re-evaluating the meaning of life.

Senior management affairs can also be pretty bad on office politics, particularly where the more junior person is promoted at the expense of better-qualified colleagues. In one of my companies, an office affair was a main reason the CEO ended up being replaced – but his inamorata was a truly gorgeous Californian blonde and I’m not sure he really regretted it. Perhaps I was just a tiny bit jealous!

Michael Jackson is chairman of Elderstreet Investments, the leading technology venture capitalist which he founded in 1990. He is also chairman of Sage, the FTSE-100 accounting software group which he has been closely involved with for the last 20 years, since its unquoted days. Michael is an entrepreneur and legendary investor in his own right.

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