Featured Article – 2009 December

Managing the Turnaround – Creditors and Customers
by Chris Todd

When we get the call to help a foundering business, we often encounter a wary management team that hopes to survive by exhibiting a strong measure of false bravado.

All too often we hear upper management protest, “if the bank would just give me a little more money and a little more time, I’ll work my way out of this.”

However, when the bank is unwilling to offer neither time nor money, it’s the responsibility of the turnaround professional to demonstrate some unique skills and to show the business how to make good use of an attribute it thought it had lost when its profitability disappeared — its leverage.

That’s right — a struggling company actually possesses far more leverage than its worried owners might believe it has; the challenge is to create a business environment that permits the company to use that leverage to maximize the likelihood of recovery.

Managers of troubled businesses, being unaccustomed to hard times, often can’t recognize the leverage opportunities they have. Turnaround professionals, who deal with these situations regularly, understand how to work with creditors and customers to give the business a better shot at survival.

The business environment we seek to create is one where the company’s managers once again have a good handle on their finances — knowing how much money is coming in and how much is going out — and are able to communicate that information, accurately and honestly, to their creditors. When they can achieve that objective, they’re able to manage expectations and, then, rebuild their own credibility —an essential step in rebuilding the business itself.

The first step to regaining control of the company’s finances is to develop a 13-week cash-flow projection. This involves pretty much starting from scratch — reviewing all accounts, projecting orders and expenses, determining who pays (or gets paid) in 30 days, in 45 days, and so on. Once we know how much cash is coming in, we can figure out how to cope with the liabilities.

Armed with that projection, management is positioned to meet with the banker and outline realistic expectations for recovery. That, of itself, is not enough to warrant new extensions of credit, but it will provide the bank with a benchmark for assessing progress. We will, of course, provide the bank with regular updates. Ideally, actual cash flow will closely track the projections; if it doesn’t, it’s crucial that we’re able to explain any discrepancies.

Now it’s time to start thinking about how to apply some leverage. Let’s look at some situations as they apply to ordinary and unique suppliers, secured creditors and customers and see how they might play out under the guidance of an experienced turnaround professional. To make the examples easier to follow, let’s assume that our troubled business is a manufacturer of specialty hoses that are sold to manufacturers of various pumps.

For example, let’s say the hose manufacturer has been buying $10,000 in couplings monthly from a vendor and can no longer make full payment within 30 days. The manufacturer tells the vendor it will pay in 60 days, or even 90. Since the manufacturer could find another coupling supplier without too much difficulty, the vendor’s options are limited. If the vendor refuses to make future shipments, the manufacturer can order couplings elsewhere, causing the vendor to lose a customer. On top of that, if the manufacturer is no longer dealing with the vendor, it will move payments to that vendor to the bottom of its payment schedule — freeing up cash that can be used to pay more urgent bills or to use in negotiating a better price for similar couplings from a different vendor. Bottom line: in most cases, the couplings vendor would rather be paid a little bit later than a lot later — or not at all, and he’d rather keep the business, even if payments are delayed, than lose it altogether.

Because some vendors provide items that aren’t available anywhere else, unique suppliers hold significant leverage over the troubled business, and that, in turn, can give the business some leverage in dealing with its creditors, even secured creditors. The reason: while creditors want to receive what they’re owed, they realize they’re more likely to collect if the company stays in business. And that means showing some patience while the company reworks its financial arrangements with its unique suppliers.

Keep in mind, though, that we must negotiate carefully with secured creditors because they do have the power to shut the business down. Secured creditors will be looking at the company’s balance sheets and cash-flow projections. If they’re going to “feel the pain” by restructuring a payment schedule, they’ll want to see that the unsecured creditors are feeling just as much, if not more pain.

How those agreements are reworked depends in part on the unique supplier’s position, especially if the struggling business is one of their major clients. Consider this scenario: The hose manufacturer has a single source for a high-grade reinforced vinyl, which it molds to custom diameters and cuts to different lengths, depending on its customers’ needs. Rather than tie up working capital in paying for the vinyl, the hose manufacturer negotiates to get the pump manufacturers to pay the vinyl manufacturer directly for the raw materials. Since the molding and custom cutting is where value is added to the product, the hose manufacturer can still maintain his profit margin, even if he loses the markup on the reinforced vinyl.

Making new arrangements with customers carries its own set of perils, and how much leverage the business has with the customer will depend on how much the customer depends on what the business provides. In this example, the tactic can be successful because the pump manufacturer needs those special reinforced vinyl hoses to keep its business going. However, if the pump manufacturer has other sources for hoses that meet its specifications, the tactic is less likely to be effective. That’s why, in many situations, it’s not a good idea for a troubled company to let its customers know of its difficulties., lest the companies decide to take their business elsewhere.

The arrangements vary case by case, but the principles we follow are the same, regardless of whether we’re working on a 13-week cash flow plan, or the one-year, three-year or five-year plans that come along later.

If we succeed in improving collections, reducing expenses, increasing operational efficiency and stretching our payment schedules, we’ll restore management’s credibility and get the business back on track.

(Next: Our Exit Strategy)