Fatal Flaw: Complacency

As the builder lay sleeping in the forest, a clever centaur stole away with his toolbox."Help! Help!" he cried. "I have been robbed." But none came to help. Best Defense: Never Rest.

No Safe Harbors

Although most builder vulnerabilities still lie in weak administrative skills, other threats, including consolidation and insurance problems, are coming on strong.

By Matthew Power

The paper trail of failed building companies has much to teach us about why builders go under. Several factors (covered in more depth in this story) give special cause for worry, including excessive debt (often linked to land purchases and spec homes), operating expenses that eat into profits, and insufficient capital, a problem that has been aggravated by the purchasing clout of big builders. In recent years, merger mania has teamed huge national builders with huge national banks, compounding the threat.

Dennis DuRoff, owner of Seattle-based Universal Business Design, and a senior consultant with E-Myth (the "E" stands for "entrepreneurial"), says most of builders' problems can be traced to their roots. "We hear every possible reason for failure--undercapitalized, never saw it coming, hit by a bigger company--the usual stuff. But we consider those the symptoms. The entrepreneurial myth is extremely prevalent among home builders. They think of themselves as entrepreneurs, but they're not. They start with a belt on, and instead of taking it off and owning a business, they create a job for themselves that's the worst job in the world. They just don't have the perspective to get out of the day-to-day task of doing it, doing it."

"Most builders don't have a strong financial foundation," concurs Trellis. "Often, they're not good planners. Most have never been trained in managing money."

DuRoff notes that small builders can take a hands-on approach and survive but only with the right systems in place. Most important, they must delegate rather than abdicate. "Delegating requires a system, standards, and a feedback loop, so you know work is done on time, as expected," he says. "But abdication is the way almost everything is done. You pray the work gets done correctly.

"About 90 percent of the builders I work with spend 90 percent of their day as a technician," DuRoff continues. "There's no leverage there. You're trading your time for dollars. On the other hand, a managerial position is full of leverage. We try to help them turn that ratio around."

Even the best management plan, however, may not protect builders from some of the market forces gaining steam, most notably consolidation, insurance woes, and defect litigation.

"Small builders may make up the majority of companies, but they're down to building only 60 percent of the homes," notes Trellis. "If you're small, you can't just join them because you don't have the resources they want.

"This used to be a highly leveraged business," Trellis adds. "That doesn't happen as much. To survive, you have to be what [competitors] are not. And that means you have to keep changing because they're right behind you all the time. It's easier to turn a small ship around. They can't kill you if they can't find you."

"If I'm competing with a privately owned builder for a piece of land," Ryland Homes' Chad Dreier told builders recently, "I know that he probably has to go to the bank. I don't. I can write a check in a heartbeat."

Size also gives big players buying clout with suppliers. For example, Dreier says he has a national contract on 52 percent of his construction costs, with rebates of $1,150 a home. He thinks he can eventually get that to 80 percent or $2,500 a home.

Another potential business killer is gaining steam daily: obtaining affordable, adequate insurance. An avalanche of class-action defect lawsuits has snowballed, as legal bounty hunters join in on such issues as mold, termites, and foundation damage.

Insurers take a dim view of the builder's role in all this. According to The National Underwriter Co., of Erlanger, N.Y., some insurance insiders attribute the lawsuits to shoddy work done during the housing boom of the 1980s.

The National Association of Independent Insurers, based in Des Plaines, Ill., reports that California's wave of class- action lawsuits, which had spread to Arizona, now has reached Nevada and mid-Colorado, along with Texas and the Carolina coast.

The insurers' response: Not only must you now pay more for insurance, but it includes clauses, waivers, and small print that throw serious liability back in your face. No coverage for mold-related damage. No coverage for foundation cracks. No coverage at all for homes in high-risk coastal zones.

What about simply improving building quality to the point where lawsuits dry up? Can it be done? Will insurers adjust their rates for builders with a track record of few callbacks?

Probably not. Read on.

Myths of Bankruptcy

A national postmortem study of the impact of business bankruptcies on company owners in the 1990s exposed many misperceptions.

Myth: Owners with bankruptcy failures typically have little work experience.

Reality: Owners had an average of 14.5 years in the field.

Myth: Bankruptcy has devastating financial consequences.

Reality: In most cases, bankruptcy filers recovered quickly, especially those who became wage or salary earners.

Myth: Bankruptcy means the end of one's career.

Reality: Only 12 percent of those with failed businesses left the work force. Fifty-three percent soon owned another business.

Myth: Most bankrupt business owners regret that they started the failed business.

Reality: Absolutely not: 61.4 percent would do it all again; 73.2 percent want to start another business.

Source: Small Business Administration, "The Function of Failure," by R. Fullenbaum and M. McNeill, 1994