Privately held middle-market companies have unique characteristics that distinguish them from the rest of the business world. Yet there are two common ingredients found in every financial distress scenario.
- Early Warning Signs. The warning signs are always there, but unless someone looks beyond the numbers to properly identify the underlying cause-and-effect relationships, they are easily misunderstood or ignored. For example:
- A revenue decline could indicate a tough new competitor has taken away market share, a major customer relationship has been damaged or the overall market has declined.
- Aggressive price-cutting could cause a squeeze on margins but that could also be due to supplier cost increases, operating inefficiencies or an awkwardly high ratio of fixed-to-variable costs.
- Deterioration of receivables aging could reflect late deliveries, customer cash flow problems, or delivered quality faults.
- The Leadership Question. A turnaround may be the most difficult transition any company goes through. It requires decisive and confident leadership with a willingness to change, yet these attributes are noticeably absent under most distressed circumstances. Instead, the following traits are more commonly found:
- Management either lost sight of the company's core strengths or lost touch with changing times.
- Incumbent managers tend to resist change, having presided over the status quo, or they underestimate how bad things can get.
- Management loses key stakeholders' confidence, both externally (bankers, customers and suppliers) as well as internally (employees, shareholders, and even management itself)
- Management time is in short supply when it is most in demand, leaving important matter unattended.
In reality, these two common traits are closely interrelated and offer important insight into a turnaround. It is not uncommon to find that top management is part of the problem and needs outside assistance to interpret the meaning behind the numbers, regain its bearings, restore confidence and execute a turnaround.