It can be very difficult if not impossible to determine the status of a company by its financial statements alone, especially in circumstances where the company is in its initial product development phase. All of the normal financial indicators, that are normally utilized to determine a company’s status, such as sales, gross margins and inventory values are totally meaningless.

The question then becomes how does an investor determine if a business is on track if it is not expected to have any product sales at this time.

In general entrepreneurs are extremely optimistic and self-assured individuals. They have an undying belief in their product or service and what they are doing or trying to do and they have sold you, the investor, on the potential success of their business. Because of this, it becomes very difficult and embarrassing for the entrepreneur to admit, even to himself, that the business is not progressing as planned or advertised. The entrepreneur also generally believes that the problems are nothing more than hick-ups (the optimism) and that things will correct themselves over time, they believe that there is no need to put the investors into panic mode nor do they “need” to have the investors “hounding” them about the “small” problems that they are encountering. “After all the investors don’t have a true appreciation for the creativity and development involved to get the product to this stage, all they care about is making money.”

Over the years, I have taken note of what I consider to be a number of non-financial indicators that can provide you the investor, in advance of meaningful financial information, a suspicion that there may be a problem within a business.

Please bear in mind that not all of the indicators will appear in all of the cases. All of the items are based on change. If an entrepreneur has always operated in a specific manner then the fact that he is doing so now is probably a sign that things are proceeding along well. It is a change in operating style that could be the indicator of potential problems.

Operating changes that should raise a red flag include:

1. Middle management seems to have a high turnover rate:

Senior managers generally have a “commitment” to a company and to see a project through from start to finish. There is a level of professionalism and personal ego involved. Middle managers do not, as a general rule, appear to have the same commitment to an organization. Middle managers seem to be aware of problems instantly and are the first to look for new employment if they feel that their job security is threatened.

2. Monthly reports are delivered earlier or later than normal or skipped:

If the entrepreneur feels that the investor group is suspicious of a problem a report may be forwarded earlier than normal. It would appear that the mental justification is that having the report early will quell any suspicions of problems and build confidence within the investors.

If a report is filed late, I have found that it is because the entrepreneur experienced a problem and was hoping to have a resolution to the problem prior to sending the report out.

Overall, I have found that a report filed earlier than normal, without any other justification of why it was filed earlier, is a more serious red flag then a report filed late.

In some cases a report may be skipped completely, besides the fact that this is a bad habit to indulge, it could be a sign of problems.

3. Monthly reports show very few negatives:

Every business experiences ongoing problems and challenges, whether they are internal or external. How problems are dealt with is the key to a successful business, not whether or not the business has problems. Reports to investors that do not identify any problems are unrealistic and should be questioned.

4. Monthly reports show very few, if any, failures and/or threats:

This is very similar to point number three. Every business experiences failures and threats of failure, whether it is a deadline not met, the loss of a key employee or a joint venture that didn’t come to fruition. Businesses that do not experience failures and threats of failure are not realistic operations. No failures, no threats, red flag!

 

5. Monthly reports do not provide continuity:

For instance, a report one month shows an opportunity and the opportunity is not mentioned in any manner in the next months report. The same situation applies to threats. A threat to the business is reported one month and the following month it is not mentioned at all.

6. New opportunity conversations:

Conversations with the entrepreneur, whether in person or by telephone are always centered around or directed towards “new” opportunities in the form of additional products and/or markets, with little if any conversation about the original product or market.

7. Abnormal working hours:

The entrepreneur, and other senior management are working more hours and weekends.

8. Less contact between company directors/investors and staff:

If the entrepreneur always invited other staff members to board or investor meetings (with the consent of the board) and now he deals with the board and the investors on his own, it is a signal that there are problems within the organization.

If it was common for board members and/or investors to have a tour of the facilities and talk with other employees, when there was a meeting, and those tours seem to have disappeared it could be a sign of problems.

9. Change of meeting venues:

If meetings were held at the company’s facilities and the entrepreneur has suggested utilizing a hotel or other outside meeting facility it should raise a red flag.

10. Telephone calls/email messages:

If the entrepreneur generally took your telephone calls and now has someone take a message and/or if you used to get a response to an email message in a short period of time and now that doesn’t happen it is an indication of a change within the business that may not be for the better.

11. The entrepreneur cancels or does not take a scheduled vacation:

I have found that one reason that an entrepreneur cancels a vacation is because he is concerned about what is going on within the business and does not have the confidence in his staff to continue without him. Secondarily the entrepreneur may be concerned that you will call during his absence and speak with someone else in the organization.