Working With Turnaround Professionals
An Overview of the Profession
Strategic Management Partners
A nationally recognized turnaround management firm
specializing in interim executive leadership, asset recovery,
investing in underperforming distressed troubled companies.
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The turnaround of a business in financial distress involves managing the business and its problems. The process is time consuming and requires a special set of skills. The problems of the business are often compounded by owners or management who are facing financial distress for the first time and who are reticent to change. This is where the turnaround specialist brings his/her art to the process.
The identity of the client must be clear. The client's identify may appear clear at first glance, but it can quickly become blurred. For example, the owner of a closely held business may be as concerned about personal guarantees as about the survival of the business. In addition, if the lender has referred the specialist, the specialist must make it clear to all parties whether the lender or the business is the client.
Turnaround specialists generally are either interim managers or consultants. Interim managers will replace the CEO, take the decision-making reins of a troubled business, and guide it through its troubled waters, hopefully to safety. Turnaround consultants advise existing management without taking an operating role within the company. Although some specialists are willing to act as either an interim manager or a consultant, most prefer to act as one or the other.
A troubled business may also need the help of an experienced general manager or an expert in a particular aspect of the business. A troubled business often has a unique problem that requires an industry-knowledgeable expert rather than a experienced general manager. Naturally, this determination depends upon the particular company, industry, and problems involved. Keep in mind, however, that industry knowledge is not the same as turnaround management knowledge. A skilled turnaround specialist can often revive a company using his/her turnaround talents despite initial unfamiliarity with the technical aspects of the business.
Many turnaround specialists also concentrate on varying stages of business decline. While some practitioners work with clients in or on the edge of bankruptcy, others concentrate on only those in an early stage of decline.
Before this question can be answered, it is important to understand why businesses fail. The answer is usually mismanagement. The following is a summary of many internal and external factors controlled by management:
Management is often prone to blame the misfortunes of the business on external factors ostensibly beyond their control rather than to be held accountable and correct the situation. Some of these external factors include:
What are the warning signs of a business heading toward trouble? This is one of the most frequently asked questions of turnaround specialists. Trouble comes from a variety of causes. The obvious signals are rarely the root cause of the problem. Losing money, for example, is not the problem, but the result of other problems.
The warning signs listed below are not all inclusive, but may provide some insight as to why the company is facing difficulty.
Signs relating to a company's financial performance include:
Signs connected with a company's operational performance include:
Signs associated with poor utilization of assets include:
These signs are symptoms, not the problem. The signs are simply the evidence that a problem exists, and it is the problem rather than the symptom that must be identified and remedied.
Several formulas exist to predict failure. One widely known formula is the Z-Score, developed by Professor Edward Altman of New York University. By weighing various financial ratios, the Z-Score attempts to predict whether a manufacturing company is a bankruptcy candidate. The formula:
Z = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E
A second statistical method developed by Jarrod Wilcox, a former assistant professor at MIT's Sloan School of Business, is known as the Gambler's Ruin Prediction of Bankruptcy. This formula, designed to predict possible bankruptcy for both manufacturing and retail companies up to five years in advance, is as follows:
Liquidation Value = Assets - Liabilities
If these computations indicate negative amounts, the company is considered a candidate for bankruptcy.
Given the market forces of capitalism, all businesses are as vulnerable to trouble as they are to the lure of success. We live in a world of wildly changing technologies. Even with these changes, a business that is managed properly will continue to prosper. However, some industries are more susceptible to trouble than others due to various factors and characteristics.
The fortunes of companies in cyclical industries often depend upon forces outside their control such as commodity prices or weather conditions. Those most likely to withstand the effects of these forces are the ones that learn to adapt. They either sufficiently diversify without losing sight of their primary business or which are able to control fixed costs in unstable conditions. The ability to adapt is key.
Companies in newly deregulated industries face having to learn to survive in a competitive environment without the legal protections previously enjoyed. Deregulation is generally accompanied by an anticipated shakeout of the weakest businesses as competitive forces take hold in the marketplace.
As the United States has evolved from a primarily manufacturing driven economy to an economy increasingly driven by service-oriented industries, management must recognize that its most irreplaceable assets are employees. Managing human resources is more important than ever.
Companies lacking a proprietary product, or "me-too" companies, are subject to attack from every direction. Examples of these companies are retail businesses and non-licensed service sector businesses. They face low entry barriers both with respect to capital and expertise and a multitude of competitors.
Many entrepreneurial companies and start-ups are single-product and single-customer companies. In order to succeed, these companies usually must develop new products or diversify to compete and satisfy customers. Few are able to maintain their start-up success, but instead struggle to compete with existing competition and new market entrants. Reaching maturity takes years during which the company is vulnerable.
Rapidly growing companies are often driven by entrepreneurial zeal and by an overwhelming emphasis on sales growth. Often, inadequate attention is given to the effects of growth on the balance sheet. With huge sales increases and significant investments into R&D, these companies suddenly find themselves in a situation where the balance sheet simply cannot support the growth.
Highly leveraged companies have so many factors that must converge to be successful that they are often most susceptible to the external uncontrollable causes of business failure, such as interest rate fluctuations or an increase of raw material costs.
Closely held businesses and family owned businesses, by their nature, select leadership based not upon managerial talent but by virtue of family or close personal relationships with the shareholders. More than in other businesses, owner/managers link their personal psyche to that of their business. To the owner/managers, business failure is often perceived as a personal failure. Owner/managers often believe that they are irreplaceable or are afraid to admit that they are not. They want to maintain control, and consequently, they fail to either develop a management team or a plan for transition of management. These owner/managers are reluctant to acknowledge the early warning signs of failure and are also apt to ignore them.
Perhaps declining industries face the most difficult task of all. Declining industries are those in which total industry-wide unit shipments are declining. Maintaining market share involves shrinking. Maintaining volume involves increasing market share (i.e., taking business from competitors). Management which refuses to admit that the industry is declining or bets its future on the industry recovering is the most prone to failure.
Approximately 70% of entrepreneurs and start-ups fail within two years. Entrepreneurs do not necessarily come from managerial backgrounds. They have visions of what the future will look like before the rest of us know to invent the better mouse trap. Their modus operandi is to capitalize on their head start as a way to convert their vision to a profitable reality. The same skills that keep an entrepreneur focused on an idea, regardless of obstacles, can make him oblivious to the competition on his heels or to new changes in the market. Ultimately, the market does catch up forcing the entrepreneur to compete in a mature industry rather than in an emerging industry. As entrepreneurs survive the transition to professional management and new technologies gain a stronghold on the economy, emerging industries are born.
Before seeking a turnaround specialist, a business should attempt to understand its desires and needs and it should be willing to face the reality of very difficult issues. With statistics generally pointing to mismanagement at the root of most crises, the business should be aware that the turnaround specialist will perform a quick study of management capability. Management must be committed to participate in the recovery, agree that the turnaround specialist is the catalyst to the recovery, and undertake to learn as much as possible so that it can better manage the business at the conclusion of the turnaround engagement.
Thus, before calling a turnaround specialists, management should ask itself some hard questions: Can a turnaround be realistically achieved? Is management aware that a true turnaround can take years to accomplish? What can be reasonable and realistically expected from the turnaround specialist? Have business issues been isolated from personal issues? Or, is the primary goal of hiring the turnaround specialist to protect the owner from personal guarantees and preserve personally owned assets? Is management willing to admit that the lousiness' problems are, in all likelihood, the result of mismanagement? Is management willing to become, if necessary, the student rather than the teacher or the follower rather than the leader? If asked to give up the controls of the business, is management willing to do so? Is management willing to face its own shortcomings and to face facts that may reflect on its ability? Since the turnaround specialist is often a temporary fix, is management willing to change? Can management learn to function in a highly controlled environment, subject to being monitored by outsiders? Is management willing to accept the business' failure since some are simply unavoidable and not savable? Is management willing to agree to a turnaround specialist's engagement if the only realistic expectation is to maximize liquidation value even if the ultimate result is the failure of the business? Is management willing to sell control and become both a minority shareholder and an employee of a new board of directors if necessary to attract the capital to preserve the company? Is management, in the case of smaller businesses particularly, willing to face the stigma of bankruptcy?
Owners should be cautious and deliberate in selecting a turnaround specialist. Retaining a turnaround specialist has been analogized to having a heart transplant, an experience few would undertake without much trepidation. But just as heart transplants are necessary to save the life of the patient, corporate turnarounds are very often what is needed to keep a business alive.
Interviews and Background Checks
Owners should do their homework before interviewing any turnaround specialist. Resumes and references should be requested and checked in advance. Owners should not be misled by professional affiliations and should avoid hiring unneeded skills. Beware of an unemployed CEO or CFO masquerading as a turnaround specialist. Simply having a background as a CEO does not mean that the candidate will possess the needed skills to be a good turnaround specialist. Lawyers, accountants, bankers, and financial advisors should be consulted for their opinions and advice.
Several specialists should be interviewed. Despite their hopes, owners should neither expect miracles nor be misled by unrealistic promises or guarantees of success. What the turnaround specialist offers should be weighed against what is realistically achievable.
Be introspective, as the questions above suggest. But when the turnaround specialist arrives, answer his/her questions, help him/her find his/her answers, and above all, listen. Do not forget that owners and management must work together as a partner with the turnaround specialist. Existing management is a key resource for the turnaround specialist and should adopt an attitude that it wants to learn as much as possible so that it will have the skills necessary to run the business when the turnaround specialist's engagement has been completed.
Time Commitment of the Turnaround Team
Ask the turnaround specialist about his/her work schedule. Meet the entire turnaround team, particularly those who will be on the company premises. Obtain commitments regarding the turnaround specialist's personal involvement. Understand what functions he/she will perform and what will be delegated to his/her staff. Ask about the interplay between the company's management, the company's staff, and the turnaround team.
Select an Individual
The personal chemistry between the turnaround team and management is critical to the success of the recovery. Thus, select a person, not a firm or a reputation. A turnaround is a very personal and highly sensitive operation. Management should select the specialist it thinks can do the best job, not a firm because it has a good reputation. The reputation will not turnaround the company. An individual might.
Learn about the turnaround specialist's relationship with your lender, other potential lenders, trade creditors, and alternate suppliers. Make sure the specialist brings credibility. Companies in trouble often need access to product and to funds. One of the resources the turnaround specialist brings to the engagement is credibility to lenders, and consequently, enhanced access to credit. A troubled business often needs more money than its existing lender will supply, and therefore, management assumes a successful turnaround will involve a new lender. This logic, however, often ignores the relationship between the company's operating problems and its lender. It is unreasonable to anticipate that a new lender will be more lenient. In fact, a new lender will likely extract stricter covenants and restrictions, charge significantly higher fees because of the risk of going into a troubled situation, and monitor the loan much more closely. Therefore, the "old" bank may be the company's best source of new money if credibility can be re-established.
Obtain a Written Proposal
Always obtain a written proposal from the turnaround specialist. That proposal should address the turnaround specialist's initial findings, expectations from you and your staff, professional fees, anticipated use of the company's staff, a time line overview, who will be assigned to the engagement, how much time the turnaround specialist expects to commit to the engagement, whether the turnaround specialist will be on hand to implement the plan, at what point the turnaround specialist would expect to withdraw from the engagement, the complete fee structure, and how the turnaround specialist will assist in whatever management changes are necessary. Finally, insist upon and enter a written engagement agreement prior to engagement.
Regular Written Reports
Ask for regular written reports from the turnaround specialist. These reports should be concise and timely. They will force the turnaround specialist to organize his thoughts, get to the essence of what has happened in the reporting period, not require a significant amount of his time, and make it clear that he works for the company.
Involvement in Company's Operations
Expect the turnaround specialist to involve the company's staff in the daily operations of the business. Seek from the company's staff an evaluation of the performance of the turnaround specialist. Although the initial engagement of a turnaround specialist can be unsettling, management and staff should be made to understand that their jobs are linked to the turnaround effort. Share those evaluations with the turnaround specialist.
Confidentiality and Accessibility
Most importantly, demand and expect both confidentiality from and accessibility to the turnaround specialist. Though the turnaround specialist may be brutally honest with the client, he must present the client in the best light possible to others. Given precarious circumstances, the company must have as much access as it needs to its turnaround specialist.
The turnaround specialist offers a new set of eyes, skills and understanding of troubled situations to independently evaluate the company's circumstances. The turnaround specialist very quickly must face a series of questions that existing management may never have asked:
The turnaround specialist must gather information, evaluate it for accuracy, and analyze it quickly so that those initial questions can be addressed openly and honestly. That process generally focuses upon the following issues:
The turnaround specialist should discuss those questions openly with his client, and if it is determined that the answer to any of the above questions is "No," the parameters of the engagement should be reexamined. Should a specialist still be engaged? What kind of plan is needed to otherwise minimize the losses and to maximize the value of the business for the benefit of his client.
The process of recovery undertaken by the turnaround specialist involves several stages.
Turnaround specialists immediately focus on cash flow since it is often a cash shortage that causes troubled businesses to seek help. The turnaround specialist's first goal is to stabilize the cash flow, to stop the hemorrhage. The turnaround specialist usually performs a quick analysis of the company's sales and profit centers and of its asset utilization.
In many cases, these factors indicate that the business may have lost focus of its core. To remedy the cash shortage, turnaround specialists generally analyze which assets are available to generate a quick infusion of cash and which operations could be terminated thereby stopping the cash outflow. These are difficult decisions since they intrinsically involve down-sizing the company and eliminating some jobs. On the other hand, it has the effect of saving the good parts of the company and many jobs.
After the turnaround specialist has been engaged and a business plan has been designed, the turnaround specialist plays many roles. Since many troubled businesses often lose much of their credibility with lenders, trade suppliers, employees, customers, shareholders, and even the local community at large, retaining a turnaround specialist is often the first sign to outsiders that the company is taking positive steps toward both recovery and rebuilding damaged relationships. The turnaround specialist usually serves as a liaison or intermediary with these outside constituencies to calm troubled waters and to present bad news as a preamble to a plan for recovery.
Because management's credibility is often strained, the turnaround specialist actively assists in the preparation of a viable business plan and advocates its approval and adoption by the various constituency groups whose cooperation is necessary for implementation. The turnaround specialist is experienced in negotiating both with lenders and with trade suppliers in the midst of a crisis. The turnaround manager brings his/her personal integrity, his own credibility, and his track record to the table in contrast to that offered by existing management which finds itself in a downturn.
The turnaround specialist often directs communication for the troubled company with outsiders and with the employees of the company. The job of the turnaround specialist is objectively to determine what is in the best interests of the business, regardless of any other agendas. The turnaround specialist must take into account the objectives of the assignment and approach difficult decisions without the weight of historical expectations on his back.
The effective turnaround specialist is a teacher and knows that it is critical to success that a capable management team with acute awareness of its goals must be left behind. If management is deficient, the turnaround specialist has the very delicate task of communicating that message, identifying the appropriate role for existing managers, and facilitating a transition.
Special skills the turnaround specialist may also bring to the engagement include knowledge of sources of de nova financing or familiarity of trade relationships necessary to assure the flow of product the company needs to fuel its recovery.
Given the difficult questions that a troubled business must face, there is often some tension between owners, management and employees of the company and the turnaround specialist. One of the main problems is that businesses in trouble will often postpone action because their own owners no longer can tolerate jarring change and an uncomfortable transition to something new. Despite statistics indicating otherwise, owners and management may generally believe that its particular situation fits within those minority of cases in which the decline is attributable to uncontrollable external factors.
A variety of misconceptions and myths abound which make businesses leery about hiring a turnaround specialist.
Because the number successful corporate turnarounds has been steadily increasing during the past few years, the increased visibility of the industry has attracted operators masquerading as qualified turnaround specialists. The expression "READY, SHOOT, AIM!!" (that's no misprint; the words are correct) rings all too familiar. TMA cautions businesses seeking management assistance to carefully consider each turnaround candidate.
Always insist upon a written engagement agreement to outline the terms of the engagement. Provisions that should at least be considered include:
While most owners of distressed businesses believe that access to more money would solve their company's financial problems, turnaround specialists recognize that the shortage of capital is often only a symptom, rather than the primary problem facing a distressed company. Although sufficient and available financial resources are necessary to implement turnaround plans, a successful turnaround must first attack and solve the business problems which produce the cash crisis.
Financing is an integral part of a troubled company's plan of reorganization. An effective financing plan will stabilize the company's cash position during the crisis, provide the necessary capital base to allow the company to return to profitability, and restructure the balance sheet so that it can support the company into the future.
Financing strategies differ from situation to situation according to the liquidity and viability of the distressed business. Initially, turnaround specialists attempt to maximize the liquidity to provide sufficient time to evaluate the viability of the business. In addition, the turnaround specialist is likely to implement cost reduction plans and attempt to renegotiate the terms and covenants of existing financing arrangements to a level the company can live with during the recovery period.
When necessary, the turnaround financing plan can involve a recapitalization, or a restructuring of the right side of the company's balance sheet. This involves changing the relationship between existing financial stakeholders through a combination of debt and equity conversions, exchange offers, stock rights offerings, and the addition of new financial stakeholders. Obviously, the more sever a company's situation is, the more difficult it is to work out an arrangement with existing trade creditors, lenders, and equity holders, and the harder it is to attract new stakeholders.
Turnaround financing specialists provide financially distressed companies a number of financial resources and expertise to draw upon. Capital resources and the range of services differ widely among lenders, equity investors, and purchasers of securities and claims of distressed companies.
Historically, asset based lenders have been the primary source of loans to distressed businesses. These loans are often made at premium rates while the lender requires an enhanced security position. More recently, with the increasing number of Chapter 11 bankruptcies, debtor-in-possession lending departments have emerged in many large commercial banks and investment banks. Debtor-in-possession loans are made to a company after it files for bankruptcy protection. To encourage these lenders to undertake the risks, the law provides a super priority status for repayment of their loans.
Actually, because of this superpriority status, some companies must file a bankruptcy case to provide the lender with the level of security it seeks. Ironically, many lenders prefer the control aspect of the bankruptcy process. Without the court's protection and supervision, in a non-bankruptcy environment, these same lenders may well lend to a distressed company but with restrictive covenants and fees that may seem burdensome. In addition, taking into account the higher fees and rates, coupled with other restrictions to be anticipated in a distressed situation, management flexibility is limited and higher interest rates often slow the recovery. Therefore, the turnarounds financing plan is only effective if viewed on a long term basis and if it ultimately helps the company achieve recovery.
When a distressed company is unable to find a suitable lender, management should consider turnaround equity investors who will infuse equity capital into the business. As one would anticipate, equity funds are also an expensive alternative. Equity investors typically require a controlling interest in the company in exchange for their capital and in consideration of the abnormal risk. Equity investors often specialize in particular industries, company sizes, investment minimums and maximums, and anticipate varying management roles. Since investors bring different capabilities to the table, management should determine whether the company would best be served by financial or strategic assistance.
Financial investors often have turnaround management and bankruptcy experience and are able to assist management through the complexities of the reorganization process. Investments are typically made at a significant discount compared to the business's underlying asset value. While most financial investors remain involved only at the board of directors level, they occasionally fill top management positions if necessary to protect their investment.
While some financial equity investors have funds committed and immediately available, most act as financial intermediaries receiving an equity position in the company as their compensation upon completion of the investment. These investors act as a "gate keeper" between the financially distressed company and the alternative sources of financing. While many financial intermediaries are skilled financial advisors and have a wide network, management should be aware of possible conflicts of interest between the advice they receive from the financial intermediary and his compensation arrangement. Full disclosure should be sought to assure that the primary motivation for putting the deal together is not the fee involved.
Alternatively, strategic equity investors are identified by their specific industry or geographic requirements and generally provide specialized experience and knowledge with their investment. These investors often acquire financially distressed companies to consolidate with their existing companies and typically become involved in the management of the acquired business at a senior operating level. Since the passage of time usually works against a financially distressed company, the strategic investor may provide the company with a more timely, or occasionally, the only solution.
Regardless of the type of equity investor, the financially distressed company will often benefit from the increased negotiating leverage with its constituencies that a credible new investor brings to the turnaround. Once new equity funds are infused into the business, the company's existing lender may be more willing to modify the loan agreement if they feel that their loan is protected from further impairment. Trade creditors may agree to credit terms more favorable to the troubled business if they believe that future payments have become more certain and if no trade creditors are being preferred over others. A local government may be more willing to provide tax concessions and financing if it believes jobs will be saved so that the business can continue to contribute positively to the local economy. Of equal importance, employees may be more willing to consent to concessions if they believe that the company's survival is at stake, that their jobs are in jeopardy, and that they are an integral part of the recovery process.
Purchasers of securities and claims of financially distressed companies do not infuse capital directly into the business. However, management should be aware that these investors can have a tremendous impact on the company's turnaround efforts through their purchase of securities and claims from the company's existing financial stakeholders. Investments are typically made in company's debt, since in a bankruptcy, debtholders have a higher priority status than equity holders and are able to influence management's reorganization efforts through participation on the creditors" committee. In some cases, these investors will infuse equity capital into the business as part of the plan of reorganization to increase the returns on their investments.
This growing number of investors look for opportunities to purchase securities and claims at significant discounts from financial stakeholders who prefer immediate liquidity rather than the uncertainty of recouping their investment over the long term. They believe that their investments will yield considerable returns upon the successful reorganization of the financially distressed business.
It should be mentioned that the entire area of bankruptcy investing known as "trading claims" is perhaps the most significant bankruptcy legislative issue today. There is concern among a growing number of bankruptcy judges and professionals about investors who are not creditors of a distressed company suddenly gaining control or significant influence over the bankruptcy proceeding by virtue of their investment. These investors purchase the bankruptcy claims of the debtor's creditors. Those creditors, often trade suppliers, did not enter the bankruptcy proceeding voluntarily, need the cash that their sales to the debtor was intended to supply for their business operations, and are not equipped to handle the legal hardships of the bankruptcy process. The investors provide immediate liquidity to the debtor's creditors who simply want to resume their normal business activities. These newly-minted creditors have generally never provided and are unlikely to ever supply goods or credit to the bankrupt company. Instead, these investors have identified the claims of bankrupt companies as an investment opportunity in which their goal is to achieve a profit from the ultimate liquidation of their position. Consequently, the focus of these creditor/investors is not upon a successful reorganization of the company's operations, but upon maximizing the value of their investment. This approach to reorganization can undermine the fundamental policy considerations behind Chapter 11.
Experienced turnaround specialists also have networks to assist their clients to find the funds necessary to fuel the recovery.
Do Not Expect Miracles Overnight.
The turnaround itself can take years of hard work to achieve, and the turnaround specialist can only be a catalyst to the change. Difficult decisions must be made by owners to enable this process to take place.
Ultimately, the success or failure of a turnaround rests upon the shoulders of a business" most valuable assets, albeit not shown on any balance sheet: its turnaround leadership, its owners and lenders, its management and its employees all dedicated to turning around the company. It is upon their effort, performance, credibility, and commitment that the turnaround specialists, lenders and creditors, and the marketplace, ultimately rely.
This article was used as a basis for the Turnaround Management Association's Directory of Members and Services section titled Overview of the Profession from 1992 through 1996. It was written by John M. Collard, and utilized excerpts from TMA's prior Directories written by John M. Collard, David B. Post and Steven 1. Hochberg. Other sources include articles from TMA's Newsletter of Corporate Renewal; various articles published under the title "Are You at Risk? Early Warning Signs Pinpoint Troubles" by John M. Collard. While that section has been condensed in later versions, many excerpts still are used. Excerpts are also being used as part of the Training Course offered by TMA to teach Loan Officers the value of working with turnaround professionals. Mr. Collard is an authorized instructor.
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