Article : When Should a Turnaround Consultant be Hired?

This question will face all business managers, lenders and investors during their careers. There is no easy answer to this important question, but the factors that should be considered are as follows:

Are the owners not satisfied with the company's performance? A few of the more common indicators are:

  1. The company's revenue growth lags that of the industry, indicating market share loss.
  2. Sales may be increasing, but margins are declining.
  3. Financial leverage is increasing.
  4. Important projects are not accomplished because the owners and senior managers do not have the time or capabilities to handle them.
  5. Lack of strategic direction.

Are other stakeholders getting nervous? Lenders to a company will generally send signals that they are concerned about the performance of their borrower.

A borrower must be sensitive to what the lender is thinking. Some of the clear signals that the lenders are not happy are:

  1. Loan defaults: This does not have to be a payment default, but could be "technical defaults" such as performance covenant violations.
  2. More restrictive loan terms. Implementation of a borrowing base advance formula is a common response by lenders when significant credit deterioration occurs.
  3. Reduction in loan availability. Perhaps the line of credit was renewed for a reduced amount. This is a clear sign that the lender is not comfortable with their previous credit exposure level.
  4. Higher loan pricing. Lenders price their loans based upon credit risk levels. Higher pricing means that the lender's view of the borrower's prospects has deteriorated.
  5. Extension of the line of credit for a shorter period than has been customary. A short-term extension of a matured loan is a clear sign that the lender is not comfortable with their borrower. The lender is hoping that either the borrower will refinance the debt with another lender, or that some event will occur in the near term that will improve the credit risk situation. This event could be improved borrower performance, conversion of an asset to cash so that debt can be reduced, etc.

Once company management, owners or lenders realize that there is a problem, how soon should an outside consultant be brought in to help? In all situations, the sooner the better. There are many problems that occur when companies wait too long to seek outside help. Some examples are:

  1. Typically, the troubled company is incurring losses, burning through cash, working capital is shrinking or leverage is increasing. Each day that goes by reduces the company's financial flexibility. Without financial flexibility, companies are forced to make decisions based purely on short-term considerations, but these decisions often in fact hurt the company in the long term. As an example, if liquidity is tight, then costs may have to be slashed in order to ensure survival of the company. The company may survive, but damaged employee morale and lost personnel skills may not allow the company to be a strong competitor going forward. In contrast, when the financial condition of the company is still satisfactory, then cost cutting decisions can be made that should increase long-term profitability.
  2. If a company takes the initiative to hire a turnaround consultant, then they will be able to choose the firm that has the best skills, pricing and personal fit with management's style. This will ensure that the company owners' and managers' interests are met by the engagement. Alternatively, if the company waits too long, the lender will eventually require that a consultant be engaged. This consultant will typically have to be someone that the lender is comfortable with, but may not provide the best service from the borrower's perspective. This can result in an improvement of the lender's position, but often at the expense of company owners.
  3. Once a borrower is managed in the "workout department" (or "special assets", etc.), the lender's relationship with the borrower changes dramatically. The lender will attempt to reduce or eliminate loan exposure, or have the company's financial condition improve to the point that it can be moved out of the workout department. Unfortunately, the vast majority of loans do not move out of workout departments. As a result, the workout officer must do all they can to reduce or eliminate their loan exposure with their borrowers. At this point, the lender's interests are often vastly different from that of the company owners and managers. Once again, the company is forced to take actions that are not in the long-term best interests of the company. If a turnaround consultant is hired when the loan is not handled in workout, then a plan can be developed which will be in the best interests of both the lender and the company. It is truly a "Win / Win" situation.

There is nothing to be gained by delaying the decision to hire a turnaround consultant. Those companies or lenders that take the initiative to improve a deteriorating situation will have a much better chance of success. If the consultant finds that no major adjustments in strategy or execution are required, then a valuable validation of the company's plans is achieved. If, on the other hand, significant issues are discovered, and solutions are developed, then the company will be able to accomplish their goals when they are in a strong position to do so.

© Copyright David W. Kellogg 2002. All rights reserved.


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