Corporate Turnaround Artistry: Fix Any Business in 100 Days by Jeff Sands was a timely read as we entered the coronavirus crisis because it outlines a number of valuable lessons on managing through a tough situation and what it takes to fight for a company’s survival. The book focuses primarily on the process of turning around a business that is suddenly unable to make its debt payments, therefore prompting the bank to seek action. Oftentimes, a corporate turnaround specialist is assigned to help the company get things in order.
Author Jeff Sands, whose own misadventures in a failing business (impacted by Hurricane Katrina) and subsequent career as a turnaround specialist lends him a great deal of credibility, offers straightforward information on what to expect during a corporate turnaround.
I’ve whittled down the 70+ highlights I made throughout the book and grouped these into themes with commentary on how I found these relevant to my own business.
Turnarounds are often like a corporate illness; sometimes a person or business just gets a bit of malaise and they need a little pick‐me‐up to regain focus and motivation. Sometimes the underlying issues are more serious, like flattening sales, where we just need to get the top line growing again. Turnarounds get interesting as the problems stack up; combine your malaise and softening sales with growing overhead. Throw in margin compression and factory bottlenecks and you start needing some real turnaround expertise. The problem here is that the entrepreneur or CEO has probably never been through this before and probably doesn’t really understand the balance sheet as well as they should (I didn’t). So, the CEO bravely tinkers with the business but doesn’t move out ahead of the problems.
I thought about this illness analogy in light of the coronavirus pandemic. The unfortunate thing about this crisis is that even well-run businesses have suddenly been impacted and forced into situations they never could have imagined. For those already suffering from various problems prior to the crisis, it’s likely the coronavirus shock accelerates the need for a turnaround.
There are only two types of turnaround: (1) income statement turnarounds or (2) balance sheet turnarounds. Both necessitate positive cash flow. The former involves running out of cash from losses and about to stall mid‐flight. The latter may involve a stabilized business with suffocating levels of debt.
My company Barrel came close to being an income statement turnaround some years ago (see my post bout 2015 being a bad year) when we suffered from executing our work unprofitably and carrying costly overhead without the sales to support it. We lucked into natural attrition and sales picking up to get out of it.
Leadership During a Turnaround
Good leaders never let a crisis go to waste, while poor leaders are overwhelmed in a crisis, often losing control (and their jobs). How a leader responds at the moment of shock magnifies the results going forward.
This line has stuck with me throughout these days as we’ve navigated, like many businesses around the world, adjusting to remote work, loss of revenue, slow sales, and uncertainty about when things will get better. I’ve written about some of the responses we’ve made at Barrel during this time (see post).
If there is no natural crisis but the leader is authentically ready for a change, then sometimes a shock needs to be created. When you tell people they need to change, they hear you but usually don’t really take it seriously. When you fire their boss or shut down a division and then tell people things need to change, they usually pay attention. The critical first step in any crisis is to establish control. Control of your thoughts and your reactions first. Control of cash, customers, and employees next.
Crisis leadership requires quick and decisive action because bringing control to chaos is the highest priority. Although an inclusive, open management style is usually the best way to guide a stable business, turbulence requires strong and unyielding resistance. The hotter the turbulence, the more authoritarian your opposing leadership needs to be. As a leader, you need to be out in front, leading the charge and showing people what is possible. There is no such thing as leading from behind.
As a leader, you must be the one who shines hope through the dark stormy night. You must tamp down your own feelings of despair, because if you don’t, no one else will, and all could be lost.
I agree with Sands here on the need to take control and act decisively. This comes in handy in any type of crisis situation, natural or manufactured. One thing not mentioned here but worth remembering is that how a leader takes control and makes decisions also has lasting impact: being respectful, caring, and empathetic even while making tough decisions will go a long way in building trust with employees and customers.
Following the Money
A typical first call with a business owner starts with them telling us how they have a $100 million business, but when they send the financials, the current run rate on revenues is about $70 million. “Well, it was $100 million a few years ago and that’s where we need to be” is the explanation we usually hear. The entrepreneur is slowing tapping his feet waiting for the business to recover to $100 million. In those situations, I usually see a $50 million business that makes a lot more sense; it is protected with high margins, real expertise and loyal customers. Although I want to quickly shrink to sustainable profits and a business with great core strength, the owner struggles to give up the big number that sounded so great but never really worked for them. “You went from $100 million to $70 million. What about $100 million (other than your dreams) sounds sustainable to you?”
I must admit we’ve been in such a situation where, having hit a certain level of revenue, we felt we were a business of a certain size even if sales trended down and we would have benefitted from a quick right-sizing vs. trying desperately to pump sales through, even at eroding margins. I think it’s a combination of ego and willful ignorance: you don’t want to admit that you’ve regressed as a business (especially with a vanity metric like top line revenue) and you’d rather not dig deep to see why you’re struggling (most likely rising costs, inefficient execution, and low pricing).
Although you can trust your cardiologist with your heart or your legal issues with your lawyer, you absolutely cannot trust the numbers of your business to anyone. Ever. It’s your airplane, you are the pilot, this is your control panel, and you must fly the plane with those controls. It’s the only hope you have to overcome the long‐odds of entrepreneurship.
Over the years, my co-founder Sei-Wook and I have come to regard the management of our company’s finances as one of the most important activities. During the pandemic crisis, we’ve upped our vigilance in monitoring the flow of cash in and our of the company as well as our handle on the company’s runway, cash balance, and performance metrics like profitability and utilization. I can’t imagine running the business and being in the dark about the finances although things weren’t always this way.
The first question we need to answer is where the biggest cash drains are and make them smaller – pretty simple really. The problems are easy to identify when you’ve been in enough businesses and industries. Declining sales are an obvious problem. My second question is what the GPM (gross profit margin) is and then benchmark that against what we know of the industry and business model. Low GPM means the company’s either not charging enough or is very inefficient in what it makes or provides. If the former, they probably have a timid sales department. If the latter, they have either not reinvested in production technology or they have a weak production culture. The third question is overhead (if my GPM is solid, what’s eating up the profits?). The biggest categories are going to be labor, insurances, facilities, interest. They probably all need work, but figure out which are the biggest holes.
I love how Sands breaks down the possible problems of a business in such a succinct and simple way.
The turnaround plan should be complete and presentable as a draft within 30 days of formal turnaround work beginning. The turnaround plan details what’s working and what’s not in the business, what activities/products/investments will be grown, which ones will be fixed, and which ones exited. The expectation is that the business will become accrual‐based profitable the month the turnaround plan is enacted. When you can bring stakeholders a plan that requires no additional cash and fixes the business in 30 days, it’s hard not to get support. This plan may include a shared sacrifice program between employees, customers, vendors, and lenders but the key is identifying and detailing how the company can stay open.
The concept of a “turnaround plan” has been helpful to think about as we’ve had to clearly outline for our team the steps we were taking to stabilize the business amid lost revenue. We’ve since refined and added specific sales goals to our plan, especially in light of receiving a Paycheck Protection Program loan from the government which has given us some breathing room.
What It Takes to Turn Things Around
I appreciated the unadorned way Sands lays out the approach to helping a company recover from its tough situation. It begins with a critical look at the business model and then getting to work on the really core fundamentals of the business. I’ve pasted three paragraphs that lay out Sands’s core approach. The bolded emphasis is mine.
To find our way out of this problem, what we fix first is the business model. If we’re losing money, then our model is broken, simple as that. Do we have competitors who are profitable? What’s better about them than us? Are they charging more, servicing better, have economies of scale, better customers, do they pay less, are they shrewder, what do they have that we don’t? That’s the difference. If we have five competitors and three are making money and two doing okay, then what’s unique about them? How do they make money? We can also consider our past to see if the business had ever been profitable. When was that and what’s different now? If a company has a historical profit that it can point to, then the odds of a turnaround are high. Even with sales sawed in half, there is probably a fundamental model that works and some muscle memory that can take us back there. If we can get our percentages of revenue to match for each cost category, then why can’t we restructure the business like that? This is the land of 1,000 questions. Our only hope of saving this business is fixing the model. Sometimes it’s easy and obvious; other times it is harder than a Rubik’s Cube.
The bottom line is that a turnaround will be some formula of raising prices, cutting costs, streamlining operations, and fixing bad habits. Those are the internal management issues. Our job is to control them, and we will develop a thoughtful plan to improve them immediately and then permanently repair them over the next several months.
Increase gross profit margins. Short term, this means price increases and cost cutting. Longer term, it takes the form of product design and courageous pricing.
Fending Off Creditors and Collectors
Receivables are automatically worth less in a liquidation because they become harder to collect when the customer–vendor relationship is ending. Collectors also need access to clean and current accounting records, which can be hard to come by in a liquidation. Also, customers use the liquidation as an excuse not to pay, and they don’t like paying banks. Although the cost of collection goes up, results decline, and this reduces the recovery on this most‐liquid asset.
This is useful to understand because it also explains why creditors would prefer a restructuring versus a liquidation. Sands also points out earlier that one way to scare creditors is to refer to your lawyer as a “bankruptcy lawyer” and the same person can also be called a “restructuring attorney” if the goal is to calm the creditor down.
Bankruptcy at its core is about disclosing to the world the machinations of your business and revealing all the mistakes you have made – so it takes fortitude.
Before filing, you must ensure that if you put aside legacy debt, the business will cash flow. If not, don’t waste your time. Additionally, you’ve got to finance this period of time while paying absurd professional fees. Loans are possible and they are called debtor in possession (DIP) loans. They enter the debt stack at superpriority position, above all other creditors provided the secured creditors agree to be subordinated.
Sands spends a lot of pages walking the reader through the bankruptcy process and what to expect. It was really interesting to read through the steps, how the government gets involved, and what kinds of outcomes are possible.
Future cash flows are not balance sheet items, meaning they can only service debt if the business can be made profitable. That is why a successful restructuring, no matter how deep the losses are, is usually preferred over a liquidation.
Explained this way, it makes a lot of sense to understand the difference between a Chapter 11 restructuring bankruptcy vs. a Chapter 7 liquidation bankruptcy and why creditors will work to exhaust the possibilities of the former option before resorting to the latter.
Even without a personal guarantee, many corporate collection agencies will go right at the entrepreneur, making them feel personally liable for the debts. This works because entrepreneurs, especially the smaller, less sophisticated ones identify with their business and its debts personally. An effective method of collecting is to go right for the throat and scare the business owner into paying.
We’ve sent collections agencies out to clients who’ve ghosted us in the past and never paid their invoices. Unfortunately, we never collected on these. Sands, giving advice to those who can’t pay, provides scripts on ways to keep collectors at bay by reminding them that they are junior to any senior debt and to call the bluff on threats many unscrupulous collectors may make about “being on the steps of a courthouse” or any other nonsense.
Throughout the book, Sands touches on different things you might come across during a turnaround situation. I enjoyed these gems and made this book more instructional than if it had been a biography.
After cash, collateral, and regulators, the next thing to preserve is going concern value. This is the unquantifiable soft value of the business over and above the hard asset values. It’s your customer list, your vendor relationships, employee skill, backlog, brand, reputation, and so forth. No one calls a pile of assets to place an order, but even in the worst businesses the phone still rings. There is a value to that going concern and it needs to be protected. This is mostly through communication and handling. You have to smile and promote nondeceitful confidence even when the bank is strangling you – and oddly, they expect it of you.
Lesson here: keep the business running, even when it’s looking really bleak. There’s value in this and the business has to be a going concern if it’s going to have a chance at a turnaround.
Credit cards are personally guaranteed by personal assets (this is often unknown and usually by the majority shareholder, whoever signed the credit card application and supplied a social security number), which means that, if a company defaults, the shareholder is getting sued personally for collection. All of a sudden assets like your house, car, paycheck, and savings can be in play.
This is something I never really gave thought to. I know Barrel’s line of credit is personally guaranteed but I never thought about business credit cards this way. Will definitely have to be careful in inventorying any credit facilities that are personally guaranteed.
There are two types of factoring: (1) recourse, where if the customer doesn’t pay the invoice, the factor can come back to you for the money. (2) Nonrecourse where the factor “buys” the receivable from you and it’s 100% their responsibility to collect.
I had heard of factoring and know of friends and clients who use factoring partners, but I wasn’t familiar with the two types.
When layoffs can generate cash, do them. Go deep and quick with your cuts, then focus on recovery with the survivors. It’s far better to do one deep cut than several small middling ones that lack courage.
I’ve heard this advice elsewhere as well and it’s something that’s been at the back of my mind as we’ve had to explore and plan for contingencies in the event we can’t fully recover from the losses due to the coronavirus pandemic and need to size down.
Life insurance is often one of an entrepreneur’s smartest investments. The money can go in pretax and protects the company (and heirs) from the sudden loss of its founder or a key person. This is called “key‐man” life insurance and your bank wants you to have it. So you take out a large key‐man whole life insurance policy, fund it from the company and build up a significant cash value. The investment may be considered an exempt asset and protected in bankruptcy. Additionally, life insurance expense is often buried in the income statement amidst all the other corporate insurance expenses so it’s never obvious how much you’re socking away from the company for your benefit. In a turnaround, you can either just keep quiet about your large and protected cash balance (and keep funding it) or you can borrow or use that cash balance to help fund the company turnaround. Consult a lawyer.
I’d rather never find myself in a situation where I have to bank on my key-man life insurance for cash, but this is a pretty sneaky way to funnel company money into a sort of haven.