Hard Lessons Learned
You can do everything right and still get screwed.

By Jeff Harbaugh

 This is the industry. Snowboarding. Some are in it to make a buck, some because they love the sport and just want to make a living doing what they love. Occasionally, the two collide and the Golden Rule prevails: the one with the gold makes the rules. When there's a business lesson to be learned that might help others, I get involved. My name's Harbaugh. I carry a keyboard.

I was working day watch out of the precinct office, when the phone rang. The boss' name is Stouffer. My partner is O'Brien.

The story you are about to hear is true. The names, places, and details have been changed to protect the innocent.

I Thought There Was No Way I'd Get Screwed !

"The fact is, I thought I had everything covered. I thought I was on-the-money with that letter of credit. I thought there was no way I'd get screwed."

I was talking to the victim. Let's call him "Ralph."

Ralph thought he finally had it made. All he really loved to do was build stuff. When he learned to love snowboarding, and found that he could make money building boards, he thought it was all coming together.

Not that it was easy. Ralph's snowboard company (which we'll call Burp) had the usual start-up cash-flow challenges. It was 1994 when Ralph took a salary for the first time, a meager 25,000 dollars. That year the company produced less than 5,000 boards with fifteen employees, one press, and a simple production line. The factory ran for six months. A little over a thousand boards were manufactured under the company's own label; the rest were OEM for other brands.

The Big Break

It was in 1995 when Ralph's big break arrived -- or so he thought. It was an order worth more than a million dollars for nearly 10,000 OEM boards. Buoyed with confidence from the deal, Ralph was convinced that Burp was finally over the hump and beginning to pay off. He was so sure that he turned down an attractive offer to sell it.

"I was completely ready," he says. "I had the manufacturing process down, and knew how I wanted to grow the company. All I needed was the volume for a constant flow through the shop." I figured, "Hey, get it to that point, and get it running smoothly, and I'll be able to concentrate on growing my own brand."

Ralph went into high gear and manufactured the first portion of the order -- 5,000 boards -- which he shipped and was paid for. However, there was a hitch. The buyer said there was a problem with the inserts. So, Ralph took responsibility for the 75,000 dollars needed to fix these 5,000 boards.

Before making the rest of the boards, however, Burp had built four samples (with the insert problem corrected) that showed the buyer how the remaining boards would be made. These samples were approved by the buyer, in writing, and Burp geared up to produce the remaining boards to that newly agreed-upon standard.

Things Go Wrong

It was at this point that the buyer tried to cancel the remainder of the contract. However, with the materials bought, this really wasn't a viable option for Burp. Tensions appeared, and it took the buyer a month to get things back on track. The remaining order was increased by 1,000 boards, and a shipping schedule was agreed upon. Burp once again started to produce.

The first 400 boards were shipped and paid for with no problem. The second 500 were ready to ship on time and on schedule, when the buyer said, "Hold it, we don't have an address for you to ship them to." A week later, Burp finally got permission to ship these boards to the buyer's warehouse.

But Ralph was starting to get nervous. He'd been shipping these boards -- and getting paid under a letter of credit.

A letter of credit is an agreement whereby a bank agrees to pay the beneficiary (in this case, Burp) a certain amount of money based on the presentation of specifically prepared documents -- usually indicating shipment by specified means of certain goods. If any detail is incorrect, the account party (in this case, the buyer) can refuse to honor the letter of credit, and the beneficiary isn't paid. Incorrect details are called discrepancies.

I can't recall ever seeing a letter of credit without a discrepancy. Ralph was new to the letter-of-credit game, and didn't know about them. Most discrepancies are minor, but the buyer has the right to refuse payment when any discrepancy exists. As you will see, these discrepancies would become the buyer's rationalization for not paying Ralph.

The Clock's Ticking

Because of the buyer's delays, Burp had only fifteen days left to ship the remainder of the product and present the necessary documents before the letter of credit expired. It could only be extended with the cooperation of the buyer, and Ralph wasn't feeling too confident that the buyer would be willing to do that.

Another thousand boards went out the door. At this point, the buyer owed Burp 350,000 dollars. Another week went by, and another 500 boards were ready to go. However, things got really sour. Ralph's bank told him he hadn't been paid for an earlier shipment, and the buyer's bank informed him that there were discrepancies in the letter of credit.

"I called [the buyer] and asked what was up," says Ralph. "We exchange phone calls for three or four days, and I did't get an answer. At this point, I had stopped manufacturing, because I didn't have any money to pay my guys for the two weeks of work they had already done. This all happens three weeks before Christmas, and it's clearly a very bad scene. We were located in the heroin-user capital of the world, and I had some burly-ass dudes working for me. In fact, 38 of them. And when you tell them they can't get their paychecks, and it's three weeks before Christmas, you're talking about some pretty pissed-off guys."

Next, the buyer claimed that the inserts had only two-and-a-half turns instead of the industry standard three. Ralph didn't know what the hell the industry standard was, but says he was producing the boards to the same specs as the four samples that the buyer agreed to in writing.

Nevertheless, he ended up putting the extra half turn on the boards remaining in his warehouse at his own expense.

Shucking and Jiving

For the next few weeks, Ralph was the beneficiary of an education that's not in the curriculum at any business school. For reasons Ralph had a hard time figuring out, the buyer's head honcho got involved and pressured Ralph to ship the remainder of the product, but wouldn't pay what was already owed. This person said he was going to seize Ralph's home through some mysterious legal mechanism that was never made clear. Endless conversations, attempted negotiations, and confrontations went nowhere. People showed up from the buyer with a truck on three separate occasions to pick up the boards, but they had no authority to pay for them. The trucks went away empty.

When December 31 rolled around, the head honcho suddenly disappeared from the picture. There was no resolution, and no decision-maker for Ralph to talk to. He was 550,000 dollars in the hole, his business was on the verge of collapsing, and he had nowhere to go.

Having run out of options -- and with his company and personal assets on the line -- Ralph filed a lawsuit against the buyer for 4.8-million dollars. His attorney said he'd win, but it might take three-and-a half years. Both he and his company would almost immediately be in bankruptcy. Ralph was unwilling to let this happen.

His attorney went back to the buyer and made a deal. The buyer got the product, Ralph got some money -- both parties signed mutual releases and went their separate ways. Unfortunately, the money wasn't enough to cover Ralph's debt.

His only solution was to sell the company. There was plenty of initial interest, but when the smoke cleared, there was only one buyer interested. Let's call this company ABC.

ABC was willing to buy Burp's assets and pay the creditors 45 cents for each dollar the creditors were owed over three years. Ralph's job was to convince these unsecured creditors to accept the deal's terms. The deal was worth nearly 400,000 dollars to Burp, but if even one creditor didn't go along with it, the entire negotiations would crumble.

Unfortunately for Ralph, he spent six months unsuccessfully trying to convince a few holdout creditors that this was the best solution. They remained unconvinced, and ultimately ABC pulled out of the deal. At that point, the major secured creditor -- the bank -- stepped in and foreclosed on Burp's assets.

It was only a few weeks later when Ralph was notified that ABC has purchased Burp's assets -- including the Burp name -- from the bank for a mere 85,000 dollars. The unsecured creditors got nothing, and the bank got less than it would have if ABC's original deal went through.

The Aftermath

"If everything had worked out -- if I had made the product, shipped it, and [the buyer] accepted it, I would have been in the black," says Ralph. "Not substantially in the plus column like I thought I'd be, but I would have made some money. I would've paid my trade debts with no problem, and would've been halfway strong going into the next year. Instead, I was sitting there with 350,000-dollars' worth of debt.

"I learned a valuable lesson, and still have time to be successful," he continues. "It was a lesson more expensive than getting an MBA, but I'm still young. If you're 50 years old and this happens to you, you'll have a tough time getting anywhere in the future. While this puts me back exactly where I started, I guess I'm just happy to be there and a little wiser."

Jeff Harbaugh works with companies in transition and helps them avoid this sort of mess. Reach him at: .

Sidebar

Hard Lessons Worth Remembering

1) Letters of credit are gnarly documents.

2) Agreements are only as reliable as the people you make them with.

3) Nothing ever works out quite the way you expect it.

4) There isn't always time to learn; know what you don't know.

5) A bank's decision-making process can be hard to figure out.

6) When all is said and done, all you've got is your integrity, your ethics, and the relationships you build with people.