In October, the heat of the summer breaks and “toe meets leather” on fields and in stadiums across the country. It also ushers the return of the master of the cliché, the head football coach. As the games play out, we hear the litany of coach-speak: “the staff is taking things day-to-day”, “it’s a process”, “we are trying to play our brand of football” and so on. Nowhere is coach-speak more prevalent than surrounding competition: “the job is open for competition”, “competition breeds success”, “healthy competition”, “he’s a tough competitor”, etc.
Being a football coach is also the ultimate Survivor-Victim profession! At the end of the season, the coach either survives to coach another year, or is out of a job.
We estimate that 90% of what a football coach says in a press conference is a combination of evasiveness, obfuscation and, depending on the coach, a dose of general contempt for sports journalists. Is the constant drone of coaches talking endlessly about competition just background noise or is it an indication of something deeper? Anyone who has played any sport, or any game for that matter, would likely agree that competition makes you better and sharper. If all football metaphors translated perfectly in business, it would follow that all business competition is good and makes your company stronger. This is one football metaphor whose application to the business world depends on your perspective.
Imagine you own a gas station in a one-station town and the next closest station is 25 miles away. If you’re not interested in making too many friends, you could set your price at what that nearest competitor sells gas for plus a premium roughly equal to what it would take the average driver to drive the 50 miles round trip to fill up. With no real chance at savings, drivers will pay your price, giving you fat margins. Now, if you had a competitor, you would likely have to ditch your pricing scheme and compete on price, service, hot dogs, beer, or in other words: whatever it takes to win. At the end of the day, gas is gas; it’s virtually impossible to tell the difference in gas from one station to the other. It is a commodity, uniform in almost every way.
Home building is not a commodity business. Builders sell differentiated products, delivered in very different ways. The 4P’s of marketing (product, price, promotion and placement) matter to consumers and that makes a difference in the success of home builders. If you asked a builder to name the commodities they use to build a home, they could list hundreds, ranging from lumber to drywall. However, there's one critical commodity most would leave out … capital.
What is capital? A commodity. How is it a commodity? It is uniform in nature; money from Bank A will buy the same goods as an equal amount from Bank B. If money is a commodity, then why is everyone so worried about capital? During the Great Recession, homebuilders were like the drivers in the one gas station town. There were not very many options, so they took what they could get and paid the price offered. Times are thankfully changing and more capital providers are getting back into the game and starting to compete for business again.
If you replaced your CFO with a football coach, what role do you think he would take–survivor or victim? Would the football coach be content with the mindset that simply having a bank that lends you anything is a victory? Or will he begin to figure out how he can get banks to compete for the business? It becomes a simple distinction, survivor – proactive; victim–reactive.
While capital is a commodity, the ideal capital structure for any home building company will be unique and is based on a set of factors. They include its planned growth rate, how quickly it can turn its inventory, the complexity of its product offerings and the owners’ tolerance for risk. Before restructuring the balance sheet, it is critical that the builder have an objective, fact-based understanding of how much growth its existing capital structure can support, how sensitive it is to variation in sales and costs, and how outcomes would change under different scenarios.
From that analysis, the builder should develop various contingencies and plans. For example, what is the right course of action if the business plan requires an additional $10 million to invest in lots, but the company lacks the capacity to make the investment with its current capital structure? Given the choice, the builder could forego the investment and accept lower growth or find new sources of capital outside of its traditional funding relationships.
Taking new capital will most likely be more expensive than current funding and it may or may not be the best course of action. The key to take away from these two contingency examples is not that one or the other is the better strategy. It is that the underlying realities of the builder’s existing capital structure, business goals, operating constraints and capabilities must be objectively analyzed, understood and considered in the context of how to capitalize the business for current and future needs. Making a choice that is a poor fit with these realities, however, can definitely cause significant problems for any builder. Survivors understand and implement this concept. Others fall victim to inefficient and expensive capital structures that drain profitability and hamper their growth plans.
The typical privately held home builder uses construction loans from commercial banks as a primary funding source. This makes sense, as it is almost always the least expensive option. Consider a hypothetical builder, BuildCo, which has room under its overall construction line, but has very little excess in their Acquisition and Development line. BuildCo’s management determines that it needs additional capital to fund a new subdivision that will not work under the A&D line. BuildCo can line up as many banks as possible to compete for the construction line, but it may not move the needle enough to make a meaningful difference to grow its business. If BuildCo has already put together the materials for a competition amongst the banks, it has everything it needs to contact other capital providers to fund its growth.
BuildCo has many different choices in terms of where to find capital for its growth. It can look at project financing options, possibly at JVs with established funds or it could look to fund the overall enterprise through mezzanine debt or equity investments from well-heeled investors or established private equity funds. There are pros and cons for each investment type, though no matter which capital source is right for BuildCo, one fact remains – a well-orchestrated competition between sources will yield better results for BuildCo and its shareholders.
Banks are re-entering the market and are looking for new customers. Funds have been raised and investors are looking for opportunities to achieve strong returns. The question is how builders will handle the situation. Will they handle it like a victim, reacting to banks that may or may knock on their door? Or perhaps they will handle it like a football coach, setting the stage so banks and capital providers have an open competition and the rules of engagement fit the builder’s unique requirements for capital. After the competition has been held, they can watch the film, analyze the statistics, and then decide who makes the team.