Operational Turnarounds

The ICU Of The Corporate World

(What You should know, and why you should care)

By Milton A. Parissis

When faced with operational or financial challenges, proactive CEOs understand the need for immediate action to reconfigure their business. Early action reduces costs and the need for dramatic changes while providing more strategic options. It also buys time to fine-tune the pivot of a business. More importantly, it doesn’t “spook” employees, suppliers, customers or investors.

Under normal economic conditions, approximately 68% of all businesses in Canada face challenges that could lead to serious decline and possible failure at least once within their lifespan. Additionally, 2 out of every 3 businesses will need to be repositioned and refinanced at some point in time. Other businesses may endure years of stagnation that limit their competitiveness or growth. All businesses are most vulnerable under conditions of rapid growth, expansion to a higher level of performance, diversification, internationalization, mergers or technological shifts that are specific to their industries.

There are times when a business falls off the rails. It can stagnate for a long time, then suddenly take a swift downturn due to specific circumstances that put it into a decline that is both scary or difficult to reverse. Although just about every business will face such crises at least once in their existence, it is surprising that most CEOs, directors, creditors, or investors are completely unaware of the conditions, process, and value of an operational turnaround. They often can’t recognize the early symptoms of a business requiring a turnaround, visualize the possible outcomes nor calculate the time and costs to right-size it…let alone the costs and diminished options of letting the business continue to decline.

Sadly, many business leaders, creditors, and investors (both traditional and non-traditional), wait too long to take action. This limits them to one option: Formal restructuring under Chapter 11 in the U.S. or CCAA, BIA or CBCA in Canada. This is a restructuring in the zone of insolvency and it is often, too late for a successful turnaround of a business. Based on our experiences, the turnaround of a troubled company under formal proceedings is successful only under 15% of the time. Formal restructuring often “buys time” for a gradual, or “orderly” windup, or perhaps the divestiture of a business as a “going concern”.

By the time a business requires formal restructuring, it’s in a state where drastic actions are required. The sharks are circling their prey. By then, the company’s suppliers are bolting, the customers have moved on, and the good employees have found alternative, secure employment. The work in this space is performed by insolvency professionals. They are not operational turnaround professionals, and by the time they are called into a business, it’s often, really too late to save it. By then, a business is on “life support”, and they are, de facto, “palliative care” workers. They will salvage what they can from the business so as to reduce incurred losses of an investment. In all truth, by this time, the focus is on “minimizing the haircut” for those exposed.

So, if you are a lender or investor to businesses (private or institutional), here are insights to keep in mind:

1. All businesses, irrespective of size or industrial sector, when they begin to decline will go through four distinct stages of decline. They begin with noticeable market pressures and end with the need for court-supervised remedies.

2. The earlier that owners, management, creditors, investors and other stakeholders identify the symptoms of decline and swiftly address them, the better. As operational circumstances deteriorate, the greater the level of pain, cost, effort and time will be required to fix a business. Moreover, the greater the speed of decline or the more advanced the stage of decline, the fewer options to remedy the situation will exist, and the more dramatic they will be to be to address the issues at hand.

3. In general, if a company has experienced losses for 2-3 years, has a shrinking order book or is facing significant staff turnover, it is probably in need of a turnaround. Suffice it to say, that every business is unique (even within the same industry), and requires individual assessment. However, depending on the level of decline, there are specific “red flags” to be noted.

4. In a turnaround situation where a company has been stagnating or declining over a period of time, it is a mistake to assume that ownership, management or the board of directors can fix the business. Why? Because if they could fix the business, they would have done so already…and, they would have done so quickly. Sadly, given human nature, pride, ego or denial often prevails. Moreover, while it is sometimes thought that “those who grew a business can also stop its decline”, the opposite is actually true. Management usually finds it difficult to make hard, objective decisions quickly, and they are not trained to “manage” troubled businesses back into profitability. This is because the critical and urgent nature of leadership and decision making is completely different in declining business circumstances.

5. Operational turnaround professionals are not consultants in the traditional form. They do not go into a business, analyze the situation and write a report. Rather, they take a C-level operational position within a business and work shoulder-to-shoulder with owners, their board of directors and employees. They lead from within. They work on location and are there daily within the business until all goals are met. More importantly, they become the key contacts with creditors, investors, shareholders and the board. They become full C-level representatives of the business. A typical engagement can be anywhere from 1-3 years in tenure. Their unique expertise is in understanding declining businesses, and on how to pivot them. They work within fixed timelines to provide “options”. Turnaround professionals are the ICU of the corporate world. They don’t control the “state of their patient”, but their goal is to achieve optimal or “best case” outcomes given the unique challenges they face.

Why do operational turnaround professionals have to work for such prolonged time within a business? Well, let’s be frank: Have you ever heard of anyone trying to fix a business via Skype? By parachuting a consultant into a business once a week to make “recommendations” without being accountable for the outcomes? Or succeed by generating a report and handing it over to the same management team who tanked the business and expecting them to effectively implement transformation? Is this viable, even after their employees have lost respect of their leadership? Really? Would such actions possibly address the “root issues” impacting a business?… and if they did, could it happen in a timely fashion before the business took a “deep dive?” Probably not.

The irony of the turnaround space is that the greatest impediment to a successful turnaround is human “denial”. Unfortunately, business leaders in denial are not facing enough pain at that moment in time to implement meaningful remedies. The sad part, is when they decide they are ready to take action, it could be too late, too costly or even impossible to salvage their business.

In Canada, just over 1million businesses are privately owned with under 99 employees. These businesses represent over 95% of the market. They consist of what we call the SMEs (Small to Medium Sized Enterprises). These businesses are hungry for capital and for engaged investors. They are a volume market for many traditional investors. In reality, only about 2-3% of the remaining Canadian businesses are public or large private companies with over 100 employees.

In today’s environment, sophisticated investors know how to source and pick winners, and they know how to manage deal flow. They live and breathe EBITDA growth, Purchase Price Multiples, IRRs, ROI and Leverage. They make money on multiples and deal flow and don’t get stuck in the weeds. Imagine now, that an investment has stalled or is underperforming. Suddenly, it requires close attention. Perhaps the business that possesses unique technologies or has been steadily growing and was considered a star, has precipitously “hit a wall”. Now management is telling you that its underperformance is “just a bump”, “one transaction away” or due to “market shifts”. Or perhaps the niche business you’ve invested in is not yielding the multiples, but you are faced with explanations that make you feel as though your concerns are unreasonable or overblown.

Under such circumstances, if your gut tells you that something “is not right”, it might be time to consider bringing in a turnaround professional who can review the operational, financial and managerial issues of your investment. As niche operational professionals in the stagnating, troubled, or declining space of the corporate world, they will be able to assist in providing insights into a business that are unique, prior to you having the need to call an insolvency professional into a file.

A “Looksee” or review under certain business circumstances can provide investors with insights, options and viable solutions. Consequently, an investor or dealmaker who is not an operator can make strategic decisions quickly and with minimal pressure. Given the tendency of human nature to protect personal ego, the power of denial, the gravitational pull of vested interests, careerism and the desire to preserve personal life styles, turnaround expertise is another option for active investors to consider adding to their toolbox.

This article was first published in the Spring 2018 issue of The Private Investor