It’s a nightmare that has come true for many of us at one time or another. You set up a great long-term advertising or sponsorship deal with an online media property that seems to be in perfect health. A couple of months into the deal, you get a call from your sales rep, who tells you that the site is shutting its doors. This is becoming all too common in the era of the dot-com crunch, and it’s a big headache.
The branding and association aspects of online advertising are becoming more important, and you can see how an aborted partnership like the one described above can be detrimental to your client’s brand. While some of these Chapter 11s can seemingly come out of left field (“But they have 2 million unique users! How can this be?”), the key to minimizing risk in this regard is to scope out any potential partners for signs of financial problems.
While it may make things a little uncomfortable to have to ask a sales rep about the financial condition of his or her company, consider the alternative: You could spend hundreds of thousands of dollars building up an association with the site and developing a relationship with its users, only to have a good portion of the value of that relationship go down the tubes when the site elects to shut down.
Worse yet, you might never see a refund on upfront sponsorship fees, or you might get a check for pennies on the dollar if you have to pursue a refund through the bankruptcy proceedings. Doesn’t sound like much fun, does it?
There are a few basic “banking questions” you can ask in order to better understand your potential partner’s financial condition, and you might be able to weed out some of the companies that might find themselves shutting down in the coming year.
- How is the company funded? If the partner organization is a public company, you can very easily check its financials online. You should also check on the history of the company’s stock price. Stocks that trade at less than $1 for an extended period are in danger of being delisted from the exchange that carries them, which can be financially disastrous for a public company. Privately held companies are a little harder to read. If your potential partner is privately held, you want to know who is providing the funding, how much funding is being provided, and how much is actually committed (i.e., how much is in the bank).
- What is the burn rate? How close is the partner to profitability? Once you know how much cash a potential partner has on hand, a logical next question would be “How much does it spend on overhead, salaries, and the like?” When you know this, you can gauge how long the company has to become profitable or secure the next round of funding. Obviously, a company that shells out $1.5 million in salaries monthly with only $4 million left in the bank and $300,000 in revenue from advertising should send up a red flag. But if the company has been consistently bringing in several million per quarter in revenue, even in this economy, things should be fine.
- How dependent is the partner on advertising as a revenue stream? Any partner that depends on advertising as its only revenue stream is overly susceptible to fluctuations in the advertising market. Such a company can be in big trouble if its top clients pull budgets back. It’s better if your partner can derive revenue from other nonadvertising sources (e.g., access fees, affiliate commissions, e-commerce, etc.). While there are some good ad-supported plays out there, know that the more your partner site depends on ad revenue, the less attractive it is to investors, especially now.
- Are there any pending lawsuits, or has there been a string of negative press? For publicly traded companies, it’s usually pretty easy to see if there are any such issues that might affect its ongoing business. Check for patent-infringement lawsuits, payment defaults, or any press about your partner’s business model. Negative press can affect not only a partner’s financial condition but also consumer confidence and a number of other important factors that contribute to that partner’s success or failure.
If the above questions result in any red flags, you might want to consider how that affects your long-term advertising deal. Your company’s CFO or accounting department might also be able to help you evaluate the risk associated with such deals.