Strategic Management to Avoid Distress
The negative impact of the 2008 financial market decline and the 2008 and 2009 recession pushed many entrepreneurial controlled companies’ into the “zone of insolvency.” Although no clear test exists to establish when any company has entered the state of distress, the determination involves a combination of legal and financial tests. Let us not quibble over when a company entered the zone, a violation or close to violation of financial default covenants clearly indicates the company is in trouble.
For many entrepreneurs, access to working capital and permanent capital through traditional channels is extremely difficult, such as commercial loans, asset-based lending facilities, leasing, or private equity. The challenge is the ability to finance investments in new technology, facility infrastructure, and new products and/or services, which are essential to thrive even in difficult times. The restoration of the balance sheets will be required. This will be neither an easy nor quick journey. To source new investments, other companies whose financial conditions are much stronger may face similar difficulties in raising fresh capital.
The response to this slow economic recovery depends on the specific financial circumstances of each company, basically the organization’s financial position (the balance sheet). While many entrepreneurs are embarking on a journey to restore their company’s balance sheets, others—including many who are enjoying their best financial performance in recent years—are playing offense by opportunistically acquiring distressed assets and investing in markets where competitors are struggling to keep pace on access, service and quality. Still others are attempting to follow a “sustainable bet” strategy by leveraging areas of excellence that positions their companies for long-term financial viability.
Leveraging turnaround strategies are more important than ever to consider. While the sense of urgency is greatest among those companies operating in the distress turnaround strategies are applicable to all entrepreneurs irrespective of their current financial condition. Following the status quo of all business models must be challenged and companies, whether small or large, should reassess their strategies for continuing relevance and likelihood of facilitating sustainable financial performance.
Implementing dramatic changes in operations, financing, service and product lines, and people will be essential, including innovation, to sustaining financial performance and mission-driven success.
The Entrepreneur Distress Avoidance Journey
Business owners should start the task of accelerating their financial recovery by assessing their companies’ situation and objectively answering some tough questions:
Once these answers are explored and known will the entrepreneur, the management team and the employees understand the magnitude of the change required to position the company for sustainable financial success. Clarity on the requirements for success will begin to form and a picture should emerge about the level and manner of change needed in the way the enterprise operates.
Financial restructuring mandates rethinking the usual turnaround strategies. Taking a comprehensive perspective and approach to creating and implementing turnaround solutions should be done, beyond just concentrating on financial tactics i.e., debt modifications. Know that not all turnaround strategies fit all, however each strategy has its own merits for consideration. Keep an open mind and willingness to reject the status quo. For a company’s financial position to be restructured to levels expected by creditors, a serious evaluation of the turnaround strategy should be undertaken. The following are some potential turnaround strategies for consideration. Some are tested while others may not be frequently implemented and as you shall see others may be more innovative and emerging.
While the restructuring should not be limited to financing tactics, companies should vigorously pursue certain financing strategies. In a turnaround, all areas of the business should be evaluated as a potential source of capital. One area is working capital. Reviewing the payroll cycle. If the company is on a weekly payroll cycle change it to a bi-monthly cycle. This lessens the financial burden of financing payroll. Leverage certain assets as sources of capital such as receivables, inventories, and other unencumbered assets. Keep in mind fixed and certain intangible assets such as patents and trademarks. Historical precedent should not hamper the search for unencumbered resources.
Think “outside of the box”. Value exists all around the company. Recognize its existence and capitalize on its potential. The emerging Capital can be sourced from all assets, both tangible and intangible. Stated otherwise, all assets should be in play as a potential source of generating fresh capital.
The Way Forward
The financially distressed or at-risk companies must consider a planning process that will achieve consensus on the company’s baseline financial performance given current environmental factors and strategic priorities. This baseline should identify capital deficits and gaps in performance compared with credit market financial benchmarks.
Next, the company must develop a set of tactical options, encompassing the vital strategies to work toward achieving sustainable financial performance. Utilizing scenario planning with a combinations of options as well as varying assumptions responsive to key planning variables will enhance the decision making process.
Finally, a strategy map, based on the results of the scenarios, should be developed to return the company to sustainable financial performance. The strategy map must address the risks, related critical success factors and key performance indices (KPIs) to achieving the improved financial performance. This will form the basis for the development of change management strategies, including a communication plan.
Sustaining for the Future
Question the sustainability of a strategy is always critical. Action is most important:
Crisis or Opportunity
While the financial crisis and recession impaired the financial condition of many entrepreneurial controlled companies, it created the opportunity to step back and rethink the business model. The disruption in the financial markets and bank’s unwillingness to lend also made it imperative to be able to access credit on the strength of the organization’s own creditworthiness. This is the time to embark on a journey of financial restructuring. Unfortunately this will take time and patience, but the turnaround can be accomplished. The old saying of “no margin, no mission” is now “no financial strength, no access to capital.” These strategies can help achieve the financial strength necessary to be able to access to fresh capital, which will make it possible to fund investments as a means of achieving sustainable financial performance.
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Many papers and books have been written to study the origin of business distresses, its causes, consequences, and eventually, the best way to manage these organizations to avoid failure. The best way to learn how to manage a business turnaround is to study how mistakes were committed and what strategies were used that resulted in a turnaround success. Knowing what factors, including internal and external forces, that resulted in financial distress and crisis, as well as, how to avoid future business failures are critical.
Some companies experience traumatic pain, whereas other companies attempt to change direction to lessen the impact to land between the extremes of success and failure. Depending on the level of distress, the turnaround intervention will differ. Every company has a unique set of conditions that serves as serious problems to overcome.
Based on the pie chart[i], common reasons of business distress come from two forces, internal causes and external causes. Figure 1, shows some of the common reasons for business distress. The reasons are not ranked in accordance of severity, however to highlight some of the common threads the caused most distress situations.
During any stage of the business life cycle, potential failure is a threat that businesses normally face. A key is to recognize signs, the signals that the business may need to be restructured in order to turn around the situation. Each situation tends to be unique, but have common elements.
Inept Leadership/Management Caused Business Failures
What is the most important responsibility of leadership? Simply put, leadership is to identify the biggest challenges to forward progress and to devise a coherent approach to overcome them. This rule includes providing vision and motivation and to act as the change agent. Sounds nice. But in today’s competitive and volatile business climate, one cannot afford poor leadership, as business is not as usual.
Let us strip away at the excuses, explanations, rationalizations, and justifications for business failure; in the majority of cases it is because of management. In an honest analysis, it is plausible to say, “poor leadership” can lead towards corporate insolvency. Leaders will accept the kudos of business success; however most will not take the blame for business distress, which goes with the territory.
As a restructuring professional, it is plainly true that the number one cause of business failure is management. And in most cases it is because the leaders are “in a state of denial.” The common leadership reasons for business failure, and the roles and responsibilities they play are as follows:
Consequently, the characteristics of the leader and that of his/her key management play an important role in the decline of the business. Be it pure incompetency and/or the lack of interest in the business can lead to distress. Five principal factor for business distress include:
Also know that hubris on the part of certain leaders have led companies down the wrong path to insolvency. Pursuing inappropriate, or high-risk strategies based on false premises, have brought down some of the most highly thought of companies.
[i] Richard P. Remelt, “Good Strategy Bad Strategy” Crown Business 2011.
[ii] James E. Schrager, Ed. “Turnaround Management: A Guide to Common Restructuring.” Institutional Investor 2002.
First, there is no hard rule or definition as to what constitutes a corporate turnaround or a corporate restructuring. The generic term is a company or firm or business unit that exhibits financial performance that in the foreseeable future, unless short-term corrective action is not taken, may fail. Let us say:
A corporate restructuring or turnaround may be simply defined as a company’s existence is threatened as it moves from economic performance to decline or zone of insolvency. The decline or bankruptcy may take several years, however when extreme events take place, a shorter time frame may put the enterprise into peril.
In some circumstances the term may mean a financial restructuring by reorganizing and/or cleaning up the balance sheet using financing methods that changes the capital structure of the organization.
Surprisingly, a turnaround can be a situation where a company may exist without having a cash crisis. When measuring a company’s performance, as measured by return on capital employed, the turnaround candidate can be an organization that is performing below what is expected for a business in which it is engaged. It is about recognizing that a company often displays symptoms of failure prior to any crisis beginning. It could be businesses with underutilized assets and poor management. Many companies have survived or stagnated for years in spite of ineffective management. If such stagnation does not change, the crisis situation will succeed because management has not taken the necessary steps to turn the situation.
Crisis situations are often in stable and mature industries and sometime with competitive advantages. Such companies are also firms that are closely held or family controlled. To avoid placing the enterprise in a crisis, it is about early instituting turnaround and restructuring strategies to avoid company trauma. Too often even a growth-oriented company that has grown too fast and is very profitable may experience a severe cash crisis. Alternatively, a company can report a loss in one year does not constitute a turnaround issue. Such a loss may be expected in executing a competitive strategy. However, a loss in one operating unit may place the whole company into a death spiral.
A company can become insolvent if management takes no corrective actions. Even external events may postpone the inevitability on insolvency, but it will not avert it. The outcome of management’s corrective action either will be successful or unsuccessful in which case the insolvency will lead the company into bankruptcy.
Generally, a corporation’s life cycle can be looked at as a humped curve of four stages. From (stage-1) start-up the company grows to a point of (stage-2) maturity then begins to (stage-3) decline until it reaches (stage-4) the “zone of insolvency“. Not all businesses follow such life-cycle curve, since organizations can be reborn or transformed anytime. Some companies, in fact, institute competitive strategies that change the shape of the curve to an S-Curve to progression. The corporate turnarounds logically addresses two issues:
Defining turnarounds on the basis of profitability (return of assets or return on investment) alone is problematic. The accrual quality of the turnaround company’s accounting may be low and result in manipulated earnings management. Companies gradually lose competitiveness, but this is often not reflected in deterioration in profitability. Rather, earnings flat line then plummet or the time lag between competitiveness and earnings improvement exist. With management’s “window dressing” a lag in indices showing a distressed state, the signals of impending trouble can be masked.
Simply put, the framework of the turnaround is to avoid the company moving into the “zone of insolvency” and then ultimately into bankruptcy. Taking proactive strategies to control the business is the objective.
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