In classical turnaround theory, an advisor/consultant/chief restructuring officer (CRO) arrives on the scene of a cash-strapped troubled organization armed with expertise in preparing and analyzing cash-flow and income projections, organization assessment tools, rationalization processes, and other arrows in the quiver. These are textbook protocols well-known to most turnaround professionals. The “softer” side of turnarounds is not as well-understood or practiced. This article explores six areas that tend to enhance the chances of a successful turnaround.
Unfortunately, few financially challenged organizations reach out for professional help. Typically, lenders demand in a forbearance agreement that the organization seek help. Also unfortunate is that scenario puts the turnaround professional in a bit of a dilemma: Who is the client?
Is the client the lender who gave the referral (and potentially more referrals in the future) or the organization that retained the professional and is paying the fees? Often, lenders consider the professional their inside person. Aware of the relationship between the lender and the consultant, the client is often suspicious of the consultant’s agenda. This suspicion is not always without basis.
In a particularly egregious insolvency situation, the debtor-in-possession (DIP) lender asked a consultant to ensure that a financial covenant was violated. A $500,000 covenant violation fee this commercial lender was eager to charge was at stake.
The lender, who had referred the consultant to the debtor and more or less insisted on his retention, asked if the consultant understood. The consultant said he did. Left unsaid was that what the consultant understood was that his fiduciary, moral, and perhaps legal obligation was to the debtor’s estate, not the lender, and that he would continue to do his best to make sure the debtor did not violate any of the arrays of DIP loan covenants. The consultant succeeded on that score.
On the other hand, what if the client has taken or plans to take an action that is morally wrong or, worse, illegal? Most situations in which the author has encountered unacceptable client behavior pertained to chicanery with borrowing base certificates (BBCs) for asset-based loans. Examples include:
The consultant needs to bring such client trespasses to light and quickly resolve the issues, first with the client and then with the lender. If the client opposes informing the lender, the consultant needs to resign. Usually, however, a threat to resign results in a path to resolution.
A few years ago, a consultant received a call on a Friday afternoon to provide expert testimony for three lenders that had secondary loan positions on a long-haul auto carrier that had just filed Chapter 11. The consultant needed to review the situation, meet with the potential DIP lenders on Monday, and be ready to testify on Tuesday.
Among the items reviewed were a turnaround plan and financial projections prepared by a major consulting firm. The turnaround firm had been working with the debtor for several months, and the plan was supported by a lengthy narrative. After reviewing the plan and other material, it was clear to the consultant that the turnaround plan would not work, the debtor was not viable, and any DIP financing was too little, too late and would just add to debt, burn cash, and forestall the inevitable for a few weeks. This determination did not stem from a eureka-type revelation—it was readily discernable to anyone analyzing the situation dispassionately and objectively. The debtor had a lot of problems, but two major issues are worth highlighting.
First, the debtor had no real strategic levers—e.g., closing unprofitable business units, selling unused, unnecessary assets, or financial reorganization. Instead, the turnaround plan consisted of a large number of disparate, hoped for cost reductions that had to be executed flawlessly and completely to have a notable impact.
Second, even if all of the cost-reduction initiatives were achieved, the debtor could not generate sufficient cash to support even a reduced debt level, or more importantly to keep its aged and dilapidated rolling stock, which was already significantly beyond the normal useful life, from further decay.
After a spirited courtroom battle among several opposing constituencies, the court mandated a conference, hoping the opposing sides could reconcile their differences. Ultimately, the DIP loan was approved. The consultant was not called to testify and advise the court that the emperor had no clothes.
The debtor burned through the DIP loan in less than three months, 30 percent of which went to professional fees, and then converted to Chapter 7.
What went wrong? Such a scenario is not atypical. Managers want to keep their positions, equity stakeholders want to save their perceived equity value, senior and other lenders want to get paid, and turnaround professionals want to do what their mantra implies—turn around the company. Perhaps the turnaround firm did sound an alarm—the nonviability was obvious—that fell on deaf ears.
All professionals involved in a difficult turnaround want to put up a spirited effort. But knowing “when to fold them” rather than circle the wagons and fight heroically until the bitter end, while capital and remaining value is destroyed or substantially diminished, is important. In the face of all counterarguments, a turnaround professional must emphatically insist that recognizing, accepting, and acting upon reality is paramount.
It is said that if there are two people in an organization, politics will be in the decision-making mix. Nearly all companies have political dynamics and drama at work. In a distressed situation, particularly an insolvency situation, business advisors, two or three different sets of attorneys, investment bankers, shareholders, private equity groups, and others, all with differing agendas (outcome, control, and influence), are added to the boiling stew.
There is no magic bullet to get constituencies to work together toward an agreed upon goal. In many cases strong-willed professionals all vie to establish dominance. The antithesis of political drama is well-documented, dispassionately analyzed and disseminated information. Here are some steps a turnaround advisor can take to build political strength:
A turnaround professional coming into a distressed situation, even with the apparent authority of a senior interim executive or CRO, faces a number of roadblocks and/or speed bumps that can inhibit progress—e.g., organizational culture, internal political dynamics, xenophobia, disgruntled employees, fear of change, threats to egos, etc. Even a well-conceived and rational turnaround plan might not succeed in the face of such headwinds
In one case, during a first encounter between the consultant and the company’s director of marketing, the director said: “I have been here 25 years; I don’t need someone telling me how to do my job.” Upon meeting the consultant, the company’s vice president of sales barked: “What have you ever sold?” In another situation, one of the sole shareholder’s children was working behind the scenes to undermine the initiatives the consultant was implementing. In that case, the person had considerable power regarding how the company was managed (rather poorly) before the consultant came on board and was unhappy with his diminished status and influence after the consultant arrived.
Most people want to do a good job and be recognized for it. In a turnaround situation, a consultant needs to harness the abilities of key employees to salute the flag and take harmonious action to save the organization. Often this is not an easy task. Here are several actions that may enhance employee support and focus:
The phrase “culture eats strategy for breakfast” might be something of an overstatement. But corporate culture is important for getting things done. How important? One interim chairman of a major corporation lamented soon after resigning, “There was nothing I could do to change the culture.”
A good definition of culture is the combination of patterns of behavior, mental models of the external world, repetitive habits, strongly held beliefs, informal organizational structure, and internal political dynamics that determines or strongly influences how an organization makes decisions and reacts to external stimuli, and it sets the context of the organization’s personality.
Transforming the culture of a dysfunctional organization into a strong, vibrant culture is not an easy task, and there is no silver bullet for achieving such a conversion. Actions that may help include:
Depending on the relative size of the organization and its unique character, some of those actions will work better than others.
Infrastructure is the sum total of an organization’s cadre, capital assets, intellectual capital, processes, and systems. With a strong infrastructure, a company is generally able to achieve good financial results under most circumstances. A company with a weak infrastructure might do well in moderate to strong markets, but will fail when trouble comes.
A family-office investor hired a nationally known consulting firm to provide a strategy on what to do with a troubled portfolio company bleeding cash. The firm produced a detailed report designed to make the company a world-class, dominant provider of its products. The plan was supported by several binders consisting of step-by-step instructions on how to make this goal a reality within a year. The consulting firm did not provide management support but helped recruit a new CEO. The ambitious plan was funded with an $8 million investment from the family and a $2 million equipment term loan from the existing asset-based lender.
Two major bedrock initiatives of the plan were the installation of an enterprise resource program (ERP) and the purchase of eight expensive, complicated, highly engineered, and automated production units and systems. This equipment, together with the ERP system, was expected to dramatically increase capacity, lower cost, and improve quality.
Eight months into the plan, implementation losses accelerated and execution of the plan was not out of the starting gate. The company needed more capital to continue operations. The family office was hesitant to fund, but asked the company’s lender to provide a sizable temporary overadvance.
The lender (which had good loans outstanding with other companies of the family office) asked a consultant to take a look at the situation.
The report presented to the family office and the lender included the following major points:
The plan failed because of the company’s weak infrastructure. In this case, the operating cadre was not sufficiently skilled to implement such a complex plan, particularly with outdated information systems and weak processes and systems in place.
The family-office representative concluded that neither alternative was worth the risk and the company should cease operations. Unfortunately, this company might have survived if the new capital provided by the family office had been used to enact a turnaround plan with more modest and achievable goals.
No less a management guru than Peter Drucker opined that “most turnarounds don’t.” Today, the success rate is much higher since the issues plaguing troubled companies have been studied extensively, and scores of turnaround and restructuring professional specialists have established processes, protocols, and strategies to address the ills of failing organizations.
That said, an effective, sustainable turnaround of the business fortunes of ailing organizations is not easy and is never a sure thing. Internal and external politics and organizational culture and behavior all need to be addressed effectively to give a turnaround a chance to succeed.