How to turn around a troubled business: a comprehensive study
Signs of a Troubled Business
Business owners who encounter corporate distress often go through the same emotional stages as dying people: denial, anger, bargaining, depression, and finally acceptance. The last stage is when most company’s hire turnaround professionals, unless they are forced to do so earlier by a lender, equity partner, or bankruptcy court.
Executives who recognize and acknowledge the signs of trouble and get help in the earlier stages have a much better chance of a successful recovery for their company.
Most businesses in distress display more than one of these external and internal signs of trouble:
An Ineffective Style of Management. A president or founder of a company often is reluctant to delegate authority or refuses to do so. No decision, big or small, can be made without this his/her blessing. As a result, the rest of the management team gains no solid experience or feeling of vested ownership in the business. Dishonesty or fraud may exist yet go undetected or unreported. The board of directors may be non-participative and ineffective. In such situations, if the president suddenly becomes incapacitated or dies, the entire company is in danger of collapse due to the resulting leadership void.
Over diversification. The business has yielded to pressure to diversify to reduce risk. However, too much diversification may cause a company to spread its managerial, financial, and competitive resources too thin. As a result, the business becomes vulnerable to loss of market share to better competition.
Weak Financial Function. A company with excessive debt, stringent covenants, and inadequate working capital is operating with little or no margin for error. Credit is overextended, inventories are at high levels, and fixed assets are underutilized. The introduction of better working capital policies and improved capacity utilization decisions are clearly warranted in such cases. Yet, the current management team will instead often engage in counter productive attempts to grow the company out of its problems.
Poor Lender Relationships. A weakened financial condition has led to the company developing an adversarial and unproductive relationship with its lending institution(s). Fearing that its loan relationships and facilities may be in jeopardy, the company tries to conceal financial information from its lenders. Telephone calls from the bank are not returned. Interim financial information is not forwarded to the loan officer. However, since money is the lifeblood of any business, this kind of a lender relationship only lead to more trouble and compounds the difficulty of managing the declining business operations.
Lack of Operating Controls. The company is operating without adequate reporting, accountability, and responsibility documentation. This is tantamount to flying an airplane without an instrument control panel. Management decisions based on inadequate, untimely, or inaccurate information can make a bad situation considerably worse.
Loss of Market Share. Changes occurring in the marketplace have not been recognized, thus leading to, decreasing sales, which lead to a declining market share. For some businesses, the source of the problem may be its technology; their equipment or products and services have become obsolete. For others, the problem lies in sales and marketing; the company hasn’t kept pace, doesn’t recognize the needs of the marketplace or have the ability to ship its products effectively to its customer base.
Rapid Growth. The business is growing rapidly. A business that is successful at $5 million in revenue a year can become a dismal failure at $10 million. Companies achieving fast growth from concentrating on increasing revenue often overlook the effects of that growth on the balance sheet and the cash requirements of funding it. Growth often carries very high capital investment requirements, which may call for significant investments in R&D, capacity, and working capital. Leveraging a company to meet these increased funding needs typically means that the management team must operate with little or no margin for error.
In addition, this growth has led to overwhelming the capabilities and effectiveness of the management team and the employees alike. The staff is not able to work successfully at the new level. For example, management of engineering operations for a company with 12 plants is much different than managing a similar business with perhaps one or two plants. The same challenge applies to others in key positions in marketing, sales, operations, and manufacturing. A company can grow beyond its ability to manage its growth.
Customer Mix The business relies on a few big customers for most of its revenue. If a manufacturer selling to large retail chains has two customers representing 60 percent of its business, the company obviously is vulnerable to the financial condition of these customers or the possibility of new suppliers taking over the relationship. The loss of just one of these key customers could put hundreds out of work and send the business into bankruptcy.
Family vs. Business Matters. Family issues can cause business decisions to be made on an emotional basis rather than on sound business principles. Sibling rivalry has ruined many privately held companies. Deciding which relative should run the business after the founder’s retirement or death can be one of the most difficult challenges a business can face. Divorce can also shatter a business, leaving it in fragments. Nepotism can cause bright, skillful managers who aren’t part of the family circle to take their talents elsewhere.
Operating without a Business Plan. Armed with 15 or 20 years in the business, the management team often operates a growing company by intuition or by the seat of its pants. Its plan may change overnight because it is based on the management teams own “feel” for the market. In some cases, the business plan exists in everyone’s head rather than in writing. The result is that plans are carried out according to individual interpretation. Moreover, plans are inadequately communicated to employees.
Stages of a Turnaround
Stage One: Changing Management
A management change can begin only when company leaders have decided that changes are necessary. Since most CEOs or company presidents do not relinquish power easily, the motivation for management change must often come from the board of directors. Even if the current mangers are willing to implement changes in an effort to turn a company around, they often lack the credibility or objectivity to do so because they are viewed as having caused or contributed to the problems in the first place.
During this stage or after Stage Two—situation analysis—steps are taken to weed out or replace any top managers who might impede the turnaround effort. This may include the CEO, CFO, or also weak board members.
Stage Two: Analyzing the Situation
Before a turnaround specialist makes any major changes, he/she must determine the chances of the business’s survival, identify appropriate strategies, and develop a preliminary action plan.
This means that the first days of an engagement are spent fact-finding and diagnosing the scope and severity of the company’s problems. Is it in imminent danger of failure? Does it have substantial losses, but its survival is not yet threatened? Or is it merely in a declining business position? The first three requirements for viability are analyzed: one or more viable core businesses, adequate bridge financing, and sufficient organizational resources. A more detailed assessment of strengths and weaknesses should follow in the areas of market position, engineering and R&D, finances, marketing, operations, organizational structure, and personnel.
In the meantime, the turnaround professional must deal with various constituencies and vested interest groups. The first and often most vocal group is angry creditors who may have been kept in the dark about the company’s financial status. Employees are confused and frightened, and spend more time worrying about their own job security than fixing the business. Customers, vendors, and suppliers are wary about the future of the company. A turnaround specialist must be open and frank with all of these groups.
Once the major problems are identified, the turnaround professional develops a strategic plan with specific goals and detailed functional actions. The individual must then sell the plan it to all key parties in the company, including the board of directors, the management team, and employees. Presenting the plan to key parties outside the company—bankers, major creditors, and vendors—should restore confidence that the business can work through its difficulties.
Stage Three: Implementing an Emergency Action Plan
When the condition of the company is critical, the plan is simple but drastic. Emergency surgery is performed to stop the bleeding and enable the organization to survive. At this time emotions run high. Employees are laid off, and entire departments may be eliminated. Having sized up the situation objectively, an experienced turnaround leader makes these cuts swiftly.
Cash is the lifeblood of the business. A positive operating cash flow must be established as quickly as possible. In addition, a sufficient amount of cash to implement the turnaround strategies must be sourced. Often, unprofitable divisions or business units are sold as a means to raise cash. Frequently, the turnaround specialist will apply some quick corrective surgery before placing these businesses on the market. Units that fail to attract buyers within a given time frame may be liquidated.
The plan typically includes other financial, marketing, and operational actions to restructure outstanding debt obligations, improve working capital management, reduce operating costs, improve budgeting practices, correct product line and customer mix pricing, prune product lines, and accelerate high-potential products.
The status quo is challenged, and those who change as a result of the turnaround plan should be rewarded while those who don’t are spoken to. In a typical turnaround, the new company emerges from the operating table as a smaller organization that no longer is losing cash.
Stage Four: Restructuring the Business
Once the bleeding has stopped, losing divisions have been sold, and administrative costs have been cut, turnaround efforts are directed toward making the remaining business operations effective and efficient. The company must be restructured to increase profitability and its return on assets and equity.
In many ways, this stage is the most difficult of all. Eliminating losses is one thing, but achieving an acceptable return on the firm’s investment capital is quite another.
The financial state of the company’s core business is particularly important. If the core business is irreparably damaged, the outlook is bleak. If the remaining corporation is capable of long-term survival, it must now concentrate on sustained profitability and the smooth operation of existing facilities.
During the turnaround, the product mix may have changed, requiring the company to do some repositioning. Core products neglected over time require immediate attention to remain competitive. In the new and leaner company, some facilities might be closed; the company may even withdraw from certain markets or target its products toward a different niche or market segment.
The “people mix” becomes more important as the company is restructured for competitive effectiveness. Reward and compensation systems that reinforce the turnaround effort get people to think “profits” and “return on investment.” Survival, not tradition, determines the new shape of the business.
Stage Five: Return to Normal
In the final step of a turnaround, a company slowly returns to profitability. While earlier steps concentrated on correcting problems, the final stage focuses on putting an emphasis on profitability and return on equity, and enhancing its marketing program.
For example, the company may initiate new marketing programs to broaden the business and customer base and increase market penetration. It may increase revenue by carefully adding new products and Improving customer service. Strategic alliances with other organizations may be explored. Financially, the emphasis shifts from cash flow concerns to maintaining a strong balance sheet, securing long-term financing, and implementing strategic accounting and control systems.
This final step cannot be successful without a psychological shift as well. Rebuilding momentum and morale is almost as important as returning to profitability. It means creating a positive atmosphere and transforming negative attitudes to positive, confident ones as the company looks at its future.
When evaluating the decision of whether and when to introduce a turnaround professional into a company, several important questions should be considered:
- For how long will the services of a turnaround specialist be required?
- Can the company pay the turnaround specialist’s fees?
- Will the turnaround manager bring in other specialists?
- Is the existing management team willing to work with the specialist?
- What exactly is expected of the turnaround specialist, and are the goals in writing?
- What are the chances of success in turning around the company?
- Is the company willing to let an outsider liquidate or sell key units of the business if necessary?
Key Factors and Considerations
Reputation. No turnaround company can expect to succeed without quickly gaining the confidence of creditors, as well as accessing new sources of credit. A company considering hiring a turnaround professional should check the candidate’s reputation with leading bankers, attorneys, accountants, financial advisors, factors, and trade creditors.
Managerial Skills. As the leader and implementer of new strategies, the turnaround specialist must be an organizational leader. You should look for a person of action who has entrepreneurial instincts, “hands on” experience, and interviewing and negotiating skills.
Net Profit, Inc. is a full service Management Consulting Firm. Contact Jim Huntsman, President, at firstname.lastname@example.org or call him direct at 330-620-2761.
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