High emotional engagement of the executive management can flaw the assessment of the situation of the firm and the decision, to discontinue an ineffective strategy. Yet, the lack of adaptability has been identified as a major reason for bankruptcy. This is intuitive, understanding, executives are maneuvering through vast uncertainties every day. In situations of rapid change, where the dynamics of a transformation process are accelerating, executives cannot always build decisions on data, but often rely only on a vision and their professional experience, hence, intuition. It is not disrespectful, to challenge the intuitive decisions of the current management if a company is in turmoil. But also, when it comes to turnarounds, executives should ask some questions, before engaging in a corporate turnaround assignment:
- Is this battle ours to fight?
- What difference will winning this battle make in the long term?
- What happens if I lose this battle?
- If I don’t fight this battle, regardless of whether I win it or lose it, will I be able to live with the result?
Choose your battles wisely.
(C. JoyBell C.)
Turnaround processes are known to last on average 12 months. Easily they can stretch to a period of 30 months or more. Rule of thumb suggests, shareholders are advised to be prepared, to double the initially calculated budget. Before starting a turnaround effort, thorough due diligence is required, to be sure, the value of the asset in distress is worth the effort of preservation. Potentially it is a better decision, to let go and divest through a fire sale, wind up the company or transfer operations to a new entity and start over again.
A quick death of the firm, can be better than a long struggle.
Bankruptcy is not hitting a firm by surprise. The distress situation is the result of a process of diminishing returns, continuous inefficiencies, accumulating financial losses, eroding the trust of stakeholders, the better part of the workforce leaving, and an increasing gap between the actual products and services of the firm and market demand. The actual bankruptcy is the last step in a long-lasting tragedy.
Bankruptcy is an avalanche in slow motion
In OECD countries, every year about 8% of companies file for bankruptcy, destroying about 10% of the jobs in the economy. The Turnaround Management Society reports, only 12.5% of companies, applying for Chapter 11 survive. Chances for survival increase up to 93%, if Turnaround Professionals are engaged.
Are Turnaround Professionals really doing magic, or are they simply picking cases, with better chances for survival?
Turnaround Professionals, bring a specialized skill-set and an outside view to the table. Yet, despite the economic severity of a distress situation, the willingness of the investors, non-executives, and the management, may fail to meet the required turnaround decisions and actions.
Doom or success is created among the stakeholders
To succeed in a turnaround attempt, all resources and stakeholders must be aligned. The dynamics, for doom or success, are created by the social dynamics between the different levels and partners of the firm. Shareholders, Non-Executives, executive management, and employees must find strong common ground, to commit to the turnaround process.
Anyone with an attitude must be removed without parole. Individuals, with a legacy to the distress situation, should be removed from a decision-making position. When engaging in the Turnaround process, no liabilities within the team should be carried on.
“Do or do not, there is no try.”
Once started, a turnaround process does not allow to turn back. The executive team will face, increased workload, harsh decisions, scarce resources, little appreciation, and very little error margin. Chances for turnaround success diminish if legacy liabilities consume future resources and management attention. The shareholders and the management must be willing, to conclude and execute also harsh decisions. Finding acceptance for these calls can be challenging, as often close relationships are formed at the top of the firm, and also, specifically in SME firms, leadership and control may not be separated. E.g. the CEO, who failed in the past, might be a (major) shareholder in parallel.
Whereas the turnaround strategy is technically often not of high complexity, deployment and execution are the areas to make or break.
(Kyle Reese, The Terminator)
Removing legacy liabilities has been proven being effective. A sound assessment of the financial & legal conditions of the firm is mandatory, but also the relationships to various stakeholders of the firm are of high relevance:
- Shareholders – “unfinished business” among shareholders, activist shareholders, instability and power struggle can create significant uncertainty and instability to the organization.
- Corporate governance – messy commercial registers, incomplete board minutes, chaotic cap tables… weak governance can cause critical problems in later stages of the process.
- Regulatory authorities – pending cases, expiring licenses, intense assessments, from legal authorities can be time and energy-consuming but also create uncertainties, that may escalate the situation.
- Management & employees – exhausted, disengaged, or misaligned human resources can be a huge liability to the organization.
- Debt owners – uneasy debt owners, in the mood to terminate credit lines, can trigger immediate escalation.
- Customers/suppliers – downturns in the relationships to external stakeholders can cause severe risk.
Abandon all hope!
Under the normal course of operations, planning ahead is balanced between enforceable contracts and the trust and hope in informal handshakes. With thorough market knowledge and integer stakeholder relationships, this is functional. Yet, in distress, hope and trust are fatal.
Hope and trust will kill! Only confirmed facts lead to survival.
The management’s hope for a turn in the market, hope for new customers just arriving (and paying) in time, hope for accounts receivables being balanced in time – has been observed and been disappointed. Also, customers, deferring intentionally payments, hoping, the company will file for bankruptcy, are heard of.
No bad apples in the basket!
Under going-concern conditions, applying combined costing models, and invest profits from one business-line into R&D and growth initiatives is considered best practice. In situations of distress, slack resources for investments are scarce. Also, the margin for inefficiencies does not exist. Hence, unintentional subsidies of business processes must be identified, to stop cash leaking. For executive management, it is paramount, to understand the cost structure of the firm and its processes in detail, to foster financial performance and address potential inefficiencies.
Fix it now, or disown it quickly.
In the absence of slack resources, abandoning inefficient and non-value creating processes is a question of survival. Cutting of limps is another hard decision, yet inevitable in situations of economic distress.
“What got you here, won’t get you there!”
Failure is inevitable if the future is pursued with the same methods as the past. Yet, changing processes may call for a redirection of decision rights, entering into new relationships, etc. – hence, authorities and culture must be changed. This can turn out to be challenging for the leadership.
The essence of this is simple: A turnaround is a fundamental transformation process, under heavy resource constraints. Breaking this down to the core pillars of business transformation highlights the crucial areas for performance:
- Value creation: As the legacy business model has proven to provide insufficient profitability, Business Model Innovation can be required. To perform under the turnaround conditions, a new Business model must deliver returns quickly.
- Resources: Under the rule of a distress situation, slack resources are scarce. Tight control over costs and investments is crucial. Though change and transformation require time and resources, OPEX and CAPEX constraints are limiting the potential of the firm to (re-)innovate.
- Leadership: 79% of transformation processes are observed to fail. Reasons for failure include inadequate resources or budgets (14%), employee resistance to change (39%), and management behavior not supporting the change (33%). In turnaround situations, also dysfunctional communication behavior within the management team is observed.
Top 10 – The quick check, if to engage into a turnaround
- What is going to be rescued? Why is it worth to be preserved? What costs and efforts are fair for this?
- Are the key stakeholders aligned and committed?
- Are the key employees mentally prepared to withstand the demands of the turnaround process?
- Are sufficient funding and other support secured? Also, to cover for unexpected critical situations?
- Is a strategy available to extend the runway of the firm?
- Are all legacy liabilities resolved or at least transparent?
- What was the staff turnover of the organization in the past 12-18 months? Is still sufficient talent available?
- How long is the decline ongoing? How big is the product market gap of the organization already?
- Is the organization willing and able to adapt to new business models and processes?
- Is a cultural change welcomed by the organization?
Take away – A turnaround is a transformation on steroids.
Best practice, to stay on course in a transformation process includes the inclusion of different levels of the firm, diversity in the team, structured processes, sufficient time, and funding et al. Yet, transformation under the rule of a distress situation equals to maneuvering through a minefield. The process is ruled by time and resource constraints and easily compromised by unexpected stress tests. Changing relationships to stakeholders, leaving key employees, materializing risks can escalate the situation immediately. Success can only be obtained, if legacy liabilities are resolved, prior to initiating the actual turnaround process.
Kolja A. Rafferty, MBA, IDP-C, CTP