Sure, plenty of Los Angeles entrepreneurs are enjoying success right now, with the local economy chugging along at a healthy clip.
But what happens when the numbers start slipping and the current business cycle slips into a recession, as it inevitably will?
Those who prepare themselves and their businesses properly will weather the storm just fine, and might even emerge stronger than before, say several local experts.
Those who don’t will sink.
For Tom O’Malia, director of the Entrepreneurship Program at USC, bad economic times are the test of a true entrepreneur as well as a staging ground for business opportunity.
“The great opportunity is the downturn. It just opens up all the avenues,” he said.
Economic downturns offer “points of ambiguity, uncertainty and change, and all that points to the greatest opportunity,” he added.
In bad times, “niche” opportunities still appear, often providing outsourced services for companies that have downsized.
“Even if the general economic climate is poor, you are having a roaring success because the niche is something that people demand,” said William C. Cockrum, a professor at the Price Center for Entrepreneurial Studies at UCLA’s Anderson School.
Take the last recession, for example, when show business, trade and technology did relatively well in Southern California while other sectors such as real estate and manufacturing flagged.
Gary Post, managing partner of Ambient Capital Group Inc. in Los Angeles, pointed out that not all downturns affect all industries equally.
“It’s been quite a while since a general downturn affected all industries at once. A housing recession has nothing to do with an Internet company,” he said.
Companies that own few assets are least vulnerable to a downturn, said O’Malia. He referred to such companies as “virtual,” meaning they rely more on human capital and relationships and ideas than on capital equipment and real estate. “Virtual” companies often use outside contractors for major portions of their work.
In fact, two of Southern California’s fastest-growing industries entertainment and high-tech could both be described as tending toward the “virtual” end of the spectrum.
Entertainment companies can be considered virtual because they rely on people who are not their direct employees for many of their services, such as screenwriters, film directors and crew, according to O’Malia.
Home health care agencies and “temp” employment agencies are also good examples of virtual companies.
Local high-tech and consumer electronics industries became more virtual during the last recession, when many of them relocated their manufacturing operations offshore.
But companies need not become “virtual” to protect themselves; they can instead merely travel light. According to O’Malia, they can make sure they are not carrying undue burdens in capacity or overhead. They also must make sure the payroll is not too heavy, and may be obliged to lay off unnecessary workers even in good times.
Maintaining cash flow is fundamental for businesses in good times as well as bad. “The very first thing we teach is, never run out of cash,” said Cockrum. Cash flow, he said, “determines the value of the enterprise. Cash flow is the grease that lubricates the machinery of the organization, by paying salaries, buying inventory, and so on.”
Ambient Capital’s Post agreed. “Keep pinching pennies, even while the cash is coming in,” he advised entrepreneurs. “What you want is as much cash as possible, should orders dry up.”
To conserve cash, “you have to take strategic moves that are going to protect the cash flow of the business so that it stays cash-positive,” Cockrum said.
That may mean reducing inventory, cutting back on production or purchases, paying obligations more slowly, or collecting receivables more quickly, such as requiring down payments.
Keeping cash positive also means coming to terms with some unpleasant decisions. “It’s not easy, but you have to do it. You can’t waver,” Cockrum said.
Identifying potential partners is another good strategy in case of a downturn, according to Post. If times are lean, companies in similar businesses can merge or existing investors may be willing to advance more cash.
Bad management, however, is more to be feared than a bad economy, said O’Malia.
“More business failures are caused by over-capitalization and people trying to grow into bigger firms than they started out to be,” he said.
In short, getting too big, too fast, can cause big problems. That situation, of course, is not limited to small companies, as evidenced by the recent problems at Boeing Co. and Union Pacific Railroad. But for smaller companies, the situation can be fatal, especially if that expansion is funded by the assumption of a heavy debt load, sources said.
Ultimately, successful enterpreneurship means being always “in balance” with the market, and knowing how to react to any market condition, O’Malia said.
“You can all learn to make money when the market is good. (But) you must learn to make money in good and bad economies alike,” he said.