Successful Turnarounds

Successful Turnarounds

Surprisingly often, it seems management of a troubled company is late to acknowledge a problem exists let alone recognize their role in both contributing to the challenges and the eventual decline of the company resulting from ignoring a pending crisis until it is too late.  The Association of Insolvency and Restructuring Advisors, recognized professionals in Turnaround Management, have identified the leading cause of business failure (52%) as “internally generated problems within management’s control.”  An additional 24% of the causes are a balance of internal and external factors that, although not under management’s control, are the responsibility of management to identify and address.  15% of the causes are internal problems triggered by external factors such as changing economic or market conditions and regulatory changes.

The message for managers of these statistics is that in a vast majority of business crisis management was either partially to blame for the troubles or, at best, remains at fault for a failure to detect and react to changes in the company’s situation.  Opportunity windows to turnaround a troubled company can quickly close when management ignores the early signs of trouble, misplaces blame, refuses to seek professional help, or procrastinates in taking necessary steps to address the problems. 

Picture of a Failing Company

Analyzing the four Stages of Corporate Failure shown in the accompanying diagram - Stagnation, Underperforming, Significant Performance Impairment, and Crisis - serve well to understand how to detect trouble early, deal effectively with causes of the problems, and the concept of closing windows of opportunity as a pending crisis approaches.

Picture of a Failed Company

The Stagnation Phase (Stage 1) is identified by the following characteristics:

● Operating margins and other key ratios falling behind industry averages

● Appearance of cash flow or liquidity challenges

● Period-over-period revenues flat or declining

● Increased inventory write-downs

● Lack of (or misguided) product investment

● Problems with integration of acquisitions

● Problems associated with business mission critical technology

Changes in the environment (e.g. economic, competitive, or regulatory) combined with internal shortcomings (e.g., poor, fraudulent, or inattentive management) can cause a company’s problems to grow during this stage.  Frequently, the Stagnation Phase is characterized by management being “in denial” on the severity of the problems and the need for immediate attention.  Simply persevering, waiting patiently for a change in circumstances, operating on momentum, more of the same, ignoring the problem, or hoping for an improvement are all ineffective strategies for dealing with challenges at this stage.  Yet all too often we find that these are the strategies employed by management of stagnating companies.

The time for action is now!  Careful and objective examination of the business can identify internal and external causes for the challenges surfacing now.  Early focus on and correction of weak controls and reporting systems, increased emphasis on and attention to more profitable lines of business and products, improved understanding of customer needs and buying motivations, early attention to cash flow and liquidity challenges, more effective management of the supply chain and suppliers, objective evaluation of management actions and capabilities, attention to organizational culture, identification and retention of key employees, rightsizing the workforce to match demands, elimination of unnecessary expenses, closer attention to inventory management, examination of pricing strategies, and competitive analysis are all early steps which should be taken.  Most importantly, NOW is the time to ask for help from a team of professionals available to the business – legal, finance, accounting, and tax advisors, as well as specialized turnaround professionals are all sources of important assistance and advice.  Outside advisors often bring needed objectivity, professional and seasoned experience in your line of business, and in assisting in turnaround and workout situations.  Qualified advisors can save the company much more than their cost and preserve value for all stakeholders through early and effective action.

Inattention to turnaround activities early and effectively in the Stagnation Phase will result in further declines in the business as it moves into the Underperforming Stage (Stage 2).  This stage is characterized by:

● Significant declines in revenue and/or EBITDA

● Assets are not sufficiently liquid and cash flow challenges increase

● Underutilization of fixed assets

● Needed capital is tied up in receivables and inventories

● Management attention is diverted from traditional functions due to cash shortage

●Changes in banking relationship marked by frequent overdrafts, changes in borrowing patterns, missed financial reporting deadlines, and requests for waivers of loan provisions

This is the time to keep the brush fire from turning into a forest blaze.  However, management often continues to be unwilling to accept that problems exist, appreciate the severity of the situation, or acknowledge their role in creating or addressing the problems.  If effective action plans are not put in place quickly, needed outside assistance sought and advice heeded, it may soon be too late to save the company without the pain of a bankruptcy reorganization, or sale of the business.

The next stage of the Corporate Demise Curve is the Significant Performance Impairment Stage (Stage 3).  This stage is marked by many of the following characteristics:

● Credit and merchandise shortages occur

● Cash and credit difficulties become apparent to both insiders and the general business community

o   Creditors become unwilling to advance further credit

o   Suppliers may refuse to ship altogether or require payment in advance

● Increased risk of loan covenant defaults, if they have not already occurred

● Potential loss of key customers and/or suppliers

● Potential loss of key employees

● Lenders begin to move quickly into workout scenarios

o   Review credit documentation

o   Compliance with loan covenants is audited more closely

o   “Strict Compliance” letter sent by lender

o   Waiver of covenants accompanied by “Forbearance” letter to protect lender and lender’s position

● Tax lien and judgment searches performed by creditors

● Communication commences amongst creditors

● Management often develops “siege mentality” in this stage

Without proper controls and forecasting, and as a result of management denials, severe cash shortages occur at this stage and may be the first time management acknowledges a problem.  However, at this point it may be too late for independent management action to deal with the problems.  The sleeping giant in the form of the senior lender has now been awakened.  Indeed, an outside turnaround professional may now be imposed on the business by the senior lender or a creditors’ committee.

At this stage the chances of the business’ survival as a going concern under present management is increasingly unlikely and the least painful outcomes may be a bankruptcy reorganization or sale of the business.

The progression of stages to this point may have been relatively gradual with the cycle taking as much as twelve to eighteen months.  This timeframe may accelerate due to 2005 changes in the US Bankruptcy code.  Those changes may encourage creditors to take action more promptly forcing progression through the stages more quickly as cash demands accelerate on the business and creditors move more quickly to tighten controls.  However, early management attention to the building signs of trouble in the business can head off problems before they grow to crisis proportions.

The final stage or late stage is the Crisis Stage.  The Crisis Stage generally includes almost all of the following:

● Company cannot pay obligations as they come due

o   Inability to service either short or long term debt

● Overall payables growth with delinquent payables becoming significant and unmanageable

● Actual loss of key customers and/or suppliers

● Actual loss of key employees

● Actual or appearance of insolvency

● Public acknowledgement of business failure

● Current management may no longer remain in control of the business

● Value of the business and its assets begins a rapid decline

● Bankruptcy may be unavoidable

At this stage the only remaining options may be a distressed sale of the business or liquidation.

The message here is that sound monitoring and controls, and management focus on key ratios and performance metrics of the business will result in early detection of problems.  Once problems are detected, management should be eager to seek objective outside analysis and advice.  The cost of inattention to building problems will far exceed the cost of professional advisory services and assistance.

© Harbour Bridge Ventures, Inc., 2009, All Rights Reserved