The Wisdom of Using Your Gut Instinct
by Gregory S. Dowell
February 29, 2020
A local business had taken an ownership position in a distillery in the Midwest. The distillery was the brainchild of one man, and he came to the concept of micro-distillery at exactly the right time. The industry was not set to explode for a couple of years yet, so he was an entrepreneur who was in the right place and the right time, just as the demand curve was accelerating. The distillery business was exciting, and was piggy-backing on the buzz of the microbrewery boom that had taken place. By virtue of knowing my client, the entrepreneur was also fortunate to have the right investor – someone with deep pockets and industry connections that could help the distillery get to market quickly. The plan, as articulated to the investor, was to expand, expand, and expand, selling as many barrels as possible to gain a foothold, then to sell out to one of the big distilling houses.
Everything was rosy during the “dating” stage; the investor was enamored with the entrepreneur and vice versa. However, it wasn’t long before the flow of information from the investor slowed to a trickle. Sure, he was always there with plenty of verbiage and marketing hype, but he didn’t like to put hard, cold financial information in front of the investor. At the same time, there were always capital calls that needed to be made within a tight timeframe – maybe it was a great opportunity to buy supplies or product, or maybe it was a too-good-to-pass-up chance to expand with more equipment, but the demands for cash were always immediate and significant. When the investor had enough of the financial demands and the dancing around, he contacted our firm. He was several million into the deal. The task sounded deceptively simple: Figure out if the distillery was making money. If it wasn’t, what was the reason, and what realistically was the rate of cash burn for the foreseeable future?
The entire experience can be summed up from the initial meetings that were held. From the moment of our first interview with the entrepreneur, we were uncomfortable. He was less than forthcoming when we asked pointed questions about the financials. He said he couldn’t let us look at the accounting records immediately because they had fallen behind with the recordkeeping. Later, he indicated that they lacked the ability to accurately track their expenses and cost of goods sold. Our team of CPAs went on-site to one of their locations (they had two), with the express intent of seeing what data might or might not exist – we were kicking the tires and looking under hood. The visit was planned well in advance, and the business had plenty of time to prepare. From one perspective, the day on-site was wasted, as there was a lot of standing around while the entrepreneur and his internal accounting team attempted to pull the records together. From another perspective, that day told us volumes about the business, re-affirming our initial gut reaction to the business and the entrepreneur. When we finally received information, it was a nearly useful blend of excel spreadsheets and handwritten notes.
This engagement lasted several weeks, with many more delays caused by the entrepreneur and many more reams of bad data. All the while, however, the entrepreneur continued to pressure the investor for another capital infusion. The paradox, of course, was that the entrepreneur could not show that he had been a good steward of what had been entrusted with him, and yet he wanted more. While we were saddled with bad data and an entrepreneur who was interested in obfuscating the truth, our team of CPAs persevered. Using forensic accounting techniques, we pulled together the most reliable financial data possible, so that we could ultimately give our client a sense of the real financial condition of the business, as well as where it was headed. After sharing the results and our insights, it was clear that our investor needed to find an exit strategy, or at least limit any further financial damage. From our perspective, we look back on this engagement as a reminder of the power of doing the fundamental things right in a business. All of the talk and hype may sound clever and mesmerizing, but eventually what counts is financial performance. Transparency is important; when business partners cease being transparent, let the buyer beware.
