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Reversing the Slide
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Reversing
the Slide
A Strategic Guide to
Turnarounds and
Corporate Renewal
James B. Shein
Copyright © 2011 by John Wiley and Sons. All rights reserved.
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Library of Congress Cataloging-in-Publication Data
Shein, James B., 1942-
Reversing the slide : a strategic guide to turnarounds and corporate renewal / James B. Shein. —
1st ed.
p. cm.
Includes index.
ISBN 978-0-470-93324-4 (hardback), 978-1-118-00845-4 (ebk), 978-1-118-00846-1 (ebk),
978-1-118-00847-8 (ebk)
1. Corporate turnarounds—United States–Management. 2. Corporate turnarounds—
United States—Case studies. 3. Working capital—United States. 4. Strategic planning–
United States. I. Title.
HD58.8.S4798 2011
658.4'06—dc22
2010050247
Printed in the United States of America
?rst edition
HB Printing 10 9 8 7 6 5 4 3 2 1
Introduction: Conditions and Causes of Distress ix
Box 1: Typical Covenants Tripped by Downturns xxviii
1 The Phases of Decline and Early Warning Signs 1
Box 2: The Effects of Financial Shenanigans 17
2 The Turnaround Tripod 29
3 Leadership in a Crisis 58
Box 3: Governance and Leadership Issues
in Family-Owned Businesses 80
4 Cash Not GAAP 93
5 Downsizing Is a Tool, Not a Goal 121
Box 4: Other Legal Issues in Announcing Layoffs 130
6 The Bankruptcy Process as Sword and Shield 152
Box 5: State Laws 156
Box 6: DIP Financing 159
Box 7: Committee Formation 162
Box 8: Plan Con?rmation 181
7 Managing International Turnarounds 203
8 Turnarounds at (Intentionally)
Nonpro?t Organizations 231
Box 9: Chapter 9 Bankruptcy 257
9 Turning Duds into Dreams 259
Box 10: Additional Issues in Valuing
Distressed Companies 278
Contents
v
vi Contents
Box 11: Fiduciary Duties of Directors in
M&A Transactions 300
10 A Different Fresh Start 306
Notes 313
Acknowledgments 325
About the Author 327
Index 329
Dedicated to my wonderful sons, Justin and Jered, for their
encouragement, their senses of humor, and for teaching me
what’s important in life
ix
Employees at Rhodes Plastics in Linden, New Jersey, trudged
through another dreary March day. The plant received its raw
materials and supplies at one end of the building, converted them
into sterile packaging for the food and drug industry, and shipped
them out the other end. The of?ce workers were the ?rst to reg-
ister shock and confusion when armed sheriff deputies stormed
in and ordered everyone out of the building.
“ You will take nothing, not even the family pictures on your
desks! ” one of?cer shouted. “ Not until the bank ?gures out who
owns what. ”
While locksmiths arrived to change all the locks, the plant
workers were ordered out and told to leave even their own tools
behind. Unbeknownst to everyone there, the company ’ s top of?-
cers had failed to convince the company ’ s lenders that they could
turn the company around. Unpaid suppliers and customers with
un?lled orders would soon share in the employees ’ shock.
Although your problems may not be as dramatic, chances are,
at some point in your career, you will participate in a turnaround.
No matter how pro?table you have made your business, or how
recession - proof you consider your industry, you will ?nd yourself
dealing with a troubled company. Perhaps your own company will
need to reinvent itself to deal with new competitive realities, or
perhaps a valued customer will begin paying you later and later
due to its own internal distress. You may even serve on the board
of a nonpro?t organization that requires its own strategic, opera-
tional, and ?nancial initiatives to remain viable. Whatever the case
may be, you will — with near 100 percent certainty — be party to a
turnaround at some point in your professional career.
Introduction: Conditions
and Causes of Distress
x Introduction: Conditions and Causes of Distress
A turnaround is any effort to revitalize and make a clear change
in the direction of a struggling business of any size. It also applies
to improving a business that has simply underperformed its com-
petition. Understandably, many executives are reluctant to admit
that their ?rm needs a turnaround, so I began using the term
corporate renewal almost a decade ago; they seem to ?nd it a bit less
threatening. These terms can apply to an entire company, a sub-
sidiary, or just a division.
The turnaround ?eld relates to companies and nonpro?ts
with clear problems, but also to those who should question
whether their employers, customers, or suppliers are on the wrong
track. Years ago, I met with the CEO of Siemens Corp., a $100
billion company based in Munich, Germany. The CEO has 700
internal consultants, but still pays out tens of millions of Euros
per year on outside consultants, none of whom could prevent the
fact that at any given time, at least one of his business units would
invariably be performing poorly. He asked me very frankly what
“ turnaround consultants ” do differently than the big consulting
?rms. This book will answer that question.
Bob Johnson, the highly successful entrepreneur and founder
of BET (Black Entertainment Television), asked me to speak to
his executives. Although I usually meet with companies in trouble,
I met with his staff while they piloted one of the most successful
and pro?table companies in the country. BET wasn ’ t in trouble —
far from it — but Johnson was smart enough to want to know why
so many similarly successful companies got into trouble, and he
wanted his entire senior staff to recognize the warning signs
and avoid similar pitfalls. The saddest cases are those that fail to
heed the many early warning signals that they are in trouble, or
that a customer or supplier is in trouble, until the damage is
irreparable.
I have told my students at Northwestern University ’ s Kellogg
School of Management as much for the better part of the last
decade in my “ Managing Turnarounds ” class. The course draws
on my three decades of experience helping salvage troubled com-
panies and returning them to pro?tability, and this book codi?es
the lessons I have learned in that time and applies them to a
broader audience that will surely need them in volatile economic
times. I also teach “ New Venture Formation ” at Kellogg, a pairing
Introduction: Conditions and Causes of Distress xi
that strikes some executives and students as unusual. However, as
I explain in the very ?rst class of Managing Turnarounds, turn-
around situations often resemble startups in the demands they
place upon management. Effective turnaround managers must
often become much more entrepreneurial in their approach to
any turnaround, and entrepreneurs also should heed the lessons
here.
Turnarounds as Entrepreneurship
As already mentioned, one need not work in the ?eld of turn-
arounds and restructuring to apply the lessons of this book.
Turnaround CEOs face many of the same challenges faced by
entrepreneurs. In fact, the following ten conditions most fre-
quently encountered by turnaround professionals are also char-
acteristic of entrepreneurial startup situations.
Lack of Cash
Most entrepreneurial ventures fail due to undercapitalization,
which prevents a company from gaining suf?cient working capital
to fund its operations until it can create positive cash ?ow. Even
rapid growth can exacerbate this problem, for as Figure I.1 dem-
onstrates, the gap between cash outlay for salaries and supplies
that occurs later in a company ’ s life (G2) typically exceeds that
same gap earlier (G1).
Such a cash crunch also rears its ugly head during turn-
arounds, for it is precisely the lack of working capital that brings
a company into crisis. In both cases, turnaround managers and
entrepreneurs must carefully scrutinize any expenditure requir-
ing a cash outlay. Both types of managers must quickly and accu-
rately determine which expenditures are absolutely critical to the
company ’ s ongoing operations (payment to key suppliers or
payroll taxes) and which can be delayed (a new machine or
holiday party). Both types of managers must also ?nd short - term
projects that generate cash, such as the sale of nonproductive
assets. The successful execution of such projects not only frees up
incremental liquidity but also restores credibility with suppliers,
customers, and employees. Cash is an issue for large as well as
xii Introduction: Conditions and Causes of Distress
small companies. One of my students, a young entrepreneur
who developed a new energy - bar business, found himself runn-
ing out of cash despite a truly phenomenal growth in new orders.
He wound up on the ABC television show Shark Tank to raise
money from a rather nasty panel of ?nanciers of ventures. He
succeeded in procuring ?nancing for his small business, but most
do not. At the other end of the spectrum, it was a critical cash
shortage that caused Flying J — an $18 billion company — to come
to a screeching halt. Best known for its truck stops, they missed
payroll only days before Christmas, forcing them to ?le bank-
ruptcy on short notice. They failed to monitor true cash avail-
ability, relying instead on “ book ” earnings, a subject discussed in
more detail later.
Analytical Needs
In a crisis, a turnaround manager often must focus on near - term
problems with near - term solutions, typically those related to the
cash issues discussed previously. Similarly, entrepreneurs make
investment decisions based heavily on the timing of cash out?ows
Figure I.1. Cash Flow Timing Across the
Organizational Life Cycle
C
a
s
h
O
u
t
l
a
y
/
R
e
c
e
i
p
t
s
Age of Organization
Cash Expenditures
for Labor and Supplies
Shipping of Goods or
Provision of Services
Cash Received
from Customers
G1
G2
Introduction: Conditions and Causes of Distress xiii
to ensure that the ?edgling enterprise can remain viable long
enough to turn pro?table. As a result, entrepreneurs and turn-
around executives both have little use for widely used Generally
Accepted Accounting Principles (GAAP), as the accrual methods
of accounting that they prescribe are irrelevant if a company
cannot continue as a going concern. One subtle difference is that
turnaround managers frequently must “ shock ” accountants or
chief ?nancial of?cers out of their historical reliance on GAAP
accounting methods, whereas an entrepreneur rarely encounters
such problems, if only because of the realization that every dollar
is their life blood to survival.
Aside from its manipulability, GAAP provides little value to
these managers because it provides an incredibly detailed account
of the company ’ s historical performance at a time when the only
thing that matters is the accurate forecasting of each of the next
thirteen weeks. Both types of executives require up - to - date infor-
mation about how various strategic decisions — increasing a start-
up ’ s advertising reach, perhaps, or selling a division of a troubled
company — will affect the company ’ s cash balance. The accrual
accounting methods of GAAP often mask the cash effects of such
decisions, and its assumption of “ smoothed ” and “ matching ” of
collections and disbursements can project a break - even ?nancial
quarter when in fact the company ’ s cash balance will turn nega-
tive in a matter of weeks. As such, managers in startups and turn-
arounds alike have no use for the historical analysis tools provided
by GAAP — they must take more of a pragmatic forecasting
approach to ?nancial analysis. This concept is discussed in depth
in Chapter Four .
The J.A. Jones Construction Company was a highly successful
contractor based in Charlotte, North Carolina, with billions of
dollars of massive construction projects under way around the
world. Jones appeared pro?table, because income and expenses
were booked according to GAAP. Their projects, including eight
new U.S. embassies, hotels, airports, hospitals, and of?ce build-
ings throughout the world, all came to a halt when the company
ran out of cash and declared bankruptcy.
One should not confuse executives ’ manipulation of earnings
reports allowed under GAAP with fraud. When CEO Garth
Dabinski changed the depreciation and other schedules at
xiv Introduction: Conditions and Causes of Distress
Cineplex Odeon to make earnings look deceptively strong, those
moves were technically permissible under GAAP. While the
accounting changes allowed him to show a $40 million pro?t, in
reality the movie theater chain bled over $50 million in cash that
year, because he focused on ?nancial engineering instead of on
the turnaround tripod discussed in Chapter Three . Dabinski later
fraudulently changed accounting records at LiveEnt Company,
for which he is now serving a seven - year sentence.
Hiring Dif?culties
Entrepreneurs and turnaround managers also constantly face the
problem of recruiting and retaining quality employees. Employees
naturally gravitate toward stability, something neither a startup
nor a distressed company can offer. The entrepreneur must
recruit new employees without any guarantee that the company
will thrive suf?ciently to pay their salaries, while the turnaround
manager often ?nds a staff whose most quali?ed members have
already departed, leaving only those employees unable to ?nd
employment elsewhere, often an indication of their productivity.
In both cases, the use of equity incentives proves very useful in
overcoming this incentivization problem, as employees can typi-
cally receive restricted stock or stock options at a low valuation,
indicating signi?cant ?nancial upside if the new venture takes off
or the distressed company returns to pro?tability and increased
equity value.
In addition to the dif?culty of attracting full - time staff, entre-
preneurs and turnaround managers also have trouble paying for
legal, information technology, marketing, and advertising ser-
vices. Just when such services can prove immensely valuable, man-
agers in both situations can least afford them. As a result,
turnaround executives and entrepreneurs often have no choice
but to perform those crucial tasks either themselves or with
minimal support.
Disbelieving Customers
Customers also crave stability, not wanting to jeopardize their
company or their career if a supplier fails to deliver an order on
Introduction: Conditions and Causes of Distress xv
time, reliably, and of the promised quality. Without a track record,
entrepreneurs struggle to convince potential customers that they
can deliver, whereas a turnaround manager must overcome a
recent negative track record caused by the distressed company ’ s
failure to meet customer expectations. One venture capitalist has
opined that a successful high - growth startup must offer a tenfold
improvement in quality or other important product features over
existing alternatives to convince prospective customers to risk
relying on an unproven venture. A troubled ?rm ’ s competitors ’
salespeople often try to add to potential customers ’ fears with
implicit threats to purchasing executives along the lines of “ we ’ ll
only supply those who buy from us now ” and “ you ’ ll look foolish
when they don ’ t deliver. ”
As a result, both entrepreneurs and turnaround professionals
?nd that they can only earn business from less creditworthy cus-
tomers and those who shop exclusively based on price, thus exac-
erbating the company ’ s problems with low - or no - margin buyers.
Less price - sensitive, more creditworthy buyers can simply wait
until the struggling company stabilizes itself by using the advice
found in this book. Chrysler faced such problems in 1980
and again in 2009, when consumers and large ?eet buyers post-
poned Chrysler purchases until they could feel comfortable that
the company would survive long enough to honor its warranty
obligations.
Time Sensitivity
Both startups and troubled companies face a rapidly shrinking
time span during which a new opportunity can be exploited or
disaster can be averted. With employees working long hours,
managers must run meetings focused on speci?c, detailed “ to do ”
lists rather than as a chance to discuss the company ’ s problems
in general. Lacking the luxury of time to conduct detailed analy-
ses, managers must make decisions quickly, often relying on a
“ Ready — Fire — Aim! ” decision - making philosophy. This frenzied
pace forces managers to walk a delicate tightrope; they must at
once create the sense of urgency necessary to spur an often com-
placent workforce into rapid, aggressive action, but they must
do so in a manner that assuages employee anxiety rather than
xvi Introduction: Conditions and Causes of Distress
exacerbates it. Such a balancing act requires a unique blend of
charisma, competence, and credibility on the part of the entre-
preneur and the turnaround practitioner, shown primarily
through how one makes and implements those timely decisions.
This concept is discussed in greater detail in Chapter Three .
Steve Miller, author of The Turnaround Kid and professional
turnaround CEO of six companies, uses this approach.
1
He warns
his employees of “ paralysis by analysis, ” whereby they keep study-
ing an issue rather than making much - needed decisions.
Centralized Decision Making
Startups lack organizational structure, thus making it dif?cult for
the entrepreneur to turn to resources inside the company for
consultation or delegation. Conversely, such organizational struc-
tures may be in place for the turnaround manager, but those same
structures ’ complicity in causing the company ’ s distress makes
them an unattractive source of such support. As a result, both situ-
ations require a strong, centralized leadership structure rather
than a democratic process of decision making until the organiza-
tion is on an upward course. One need not go to the extreme of
“ Chainsaw ” Al Dunlap, who belittled everyone around him when
he took charge of Scott Paper, or “ Queen of Mean ” Leona
Helmsley. Helmsley frequently shouted obscenities at employees
just before ?ring them, and made them beg on their knees for
their jobs even for the slightest mistakes, while Dunlap told long -
term Scott employees that they were “ stupid ” for staying so long;
both approaches are foolish and short - sighted. Strong manage-
ment requires at least a short - term focus on centralization which
eases as the organization changes course, but leaders must boost
morale in the process. Better role models include Jamie Dimon
at Bank One, Selim Bassoul at Middleby, or Michael Jordan at
EDS, each of whom is discussed elsewhere in this book.
Scarcity of Knowledge and Risk
Both startups and troubled companies operate in an environment
of bounded rationality, with limited information and a great deal
of uncertainty. Startups lack an organizational history to guide
them, while troubled companies are typically troubled precisely
Introduction: Conditions and Causes of Distress xvii
because the lessons of their own histories have limited value (see
under the heading “ Causes of Distress ” ). Both types of companies
lack the institutional knowledge necessary to deal with the problem
appropriately, thus making planning and forecasting dif?cult
while increasing the risk of failure. Relying on poor institutional
knowledge has caused the downfall of many executives, such as
Rick Wagner, the CEO of General Motors, who relied on GM ’ s “ If
we build it they will buy it ” mentality, even in the face of plum-
meting market share. It wasn ’ t until the U.S. government forced
him out that the board faced up to the fact that change was
needed. It didn ’ t help much when a longtime GM executive, Fritz
Henderson, was named as the replacement, but he only lasted
eight months on the job.
At a company that made appliance parts, the CEO ?nally
agreed to a detailed list of steps to return the company to pro?t-
ability. Months later, when the board of directors confronted him
as to why he had not yet implemented any of the steps, he
responded that he had split the list in two. They assumed he had
created short - and long - term goals, but he took a more practical
view of the two lists, declaring that the lists were “ those things I
don ’ t know how to do and those that I can ’ t bring myself to do. ”
He chose early retirement, and his replacement turned the
company cash ?ow positive once again.
Supplier Problems
Competitors ’ sales and marketing personnel will invariably extol
the weaknesses of a new venture or distressed company, telling
potential or existing suppliers that they would be “ foolish ” to
supply such ?rms given the likelihood that they will not survive
long enough to pay for the goods or services provided. Suppliers
often feel disinclined to alienate their established customers by
selling to the startup or distressed company, requiring an entre-
preneur or turnaround manager to exercise almost mystical forces
of persuasion to overcome their objections without leverage in
terms of price, delivery, or quality. In particular, both the entre-
preneur and turnaround practitioner must try to avoid the
dreaded “ cash in advance ” demand from suppliers.
This is a particular problem when there are critical, key sup-
pliers. Fannie May Candies faced this when Bloomers Chocolate
xviii Introduction: Conditions and Causes of Distress
Company demanded cash in advance on all orders. Only Bloomers
could produce the exact chocolate mix Fannie May needed to
make its well - known Mint Melt - a - Way ’ s ™ . Unable to pay Bloomers
in advance, Fannie May had no choice but to declare bankruptcy
when it couldn ’ t come up with the cash.
Lack of Credibility with Lenders
Lenders generally will not extend credit to startups, for they lack
the assets necessary to collateralize a revolving or term loan.
Similarly, distressed companies have already stretched their
lenders to the limit, going so far as to exceed their loan advance
rates on accounts receivable, inventory, and other collateral,
thereby forcing lenders to enter into an “ over - advance. ” Such a
situation allows the debtor access to working capital in excess of
the company ’ s collateral in order to ?nance its turnaround, but
it implies that a lender has taken on equity - like risk without equity -
like returns, for it stands to lose the entire uncollateralized portion
of its advance. Eventually, a lender will require a forbearance
agreement or waiver of its foreclosure rights, which typically
imposes new restrictions on the company, increases the debtor ’ s
effective interest rate, and may even mandate the hiring of turn-
around professionals to rectify the over - advance situation.
One company that leased railroad boxcars, coal cars, and
containers received multiple waivers on debt defaults from its
lenders. When cash ?ow problems persisted, the lenders, suppli-
ers, and lawyers met to reach an agreement. The meeting started
poorly when an argument between the lawyers for the two largest
lenders escalated into a full - on ?st ?ght, as both began grappling
on the ?oor over who got to talk ?rst. Each wanted to show every-
one how tough they planned to negotiate with each other and
with the borrower. It became clear that the company executives
probably wouldn ’ t get any additional relief from their creditors.
Great Chance for Equity Gains
When companies start up, it ’ s clear that the equity values are very
low, with great opportunity for capital gains. The risk of failure is
high, but so are the potential rewards.
Introduction: Conditions and Causes of Distress xix
Similarly, the stock of troubled companies is valued very
cheaply. The difference, of course, is that the stock of a poorly
performing company is low because the company is in ?nancial
and operating distress. A successful turnaround can thus bring
substantial rewards to those who acquire equity even when risk
is high.
In the case of the railcar leasing company mentioned above,
all the employees who helped with the turnaround received shares
valued at ?fty cents each. Four years later, the company was sold
for fourteen dollars a share: not bad, but there are many stories
of investors in troubled companies doing even better, which are
discussed in more detail in Chapter Nine . It is interesting to note
that one of the lenders represented by the battling lawyers became
more cooperative, and was paid in full plus a premium, while the
other remained contentious and had his client sell its loan for ten
cents on the dollar after months of ?ghting, thinking he had
outsmarted everyone.
In summary, both turnaround managers and entrepreneurs
face crisis situations that require the skillful management of mul-
tiple, often con?icting constituencies. This requires incredible
persuasion and salesmanship in order to overcome their objec-
tions and get all of the company ’ s stakeholders working toward a
common goal. Ultimately, the two primary challenges are the
same: conserving and raising cash, and establishing trust both
inside and outside of the organization. Doing so requires a very
different skill set than that required of a traditional manager, for
mere competence and con?dence will not suf?ce. Startups and
turnaround crises demand a certain charismatic zeal
2
in the face
of overwhelming adversity to inspire the con?dence necessary
to invigorate cautious employees and build the trust necessary to
assuage nervous suppliers. Therefore, this book is every bit as
much about entrepreneurship and innovation as it is about reor-
ganization and corporate recovery.
Causes of Distress
It is important to diagnose the causes of organizational distress,
both to help avoid it as well as to repair it. Companies may ?nd
xx Introduction: Conditions and Causes of Distress
themselves in distress from a variety of sources, which can be
broken down into the two main categories — internal and external
causes.
External Causes
As the name suggests, external causes represent exogenous shocks
to all or a signi?cant part of the company, sending management
into a tailspin. Here are some common external causes of com-
panies ’ declines:
Economic Downturns
Economic downturns such as the one recently plaguing world
markets can undermine even the soundest businesses. For
example, Saks Fifth Avenue ’ s pristine brand equity and strong
retail presence in critical markets has historically afforded it sig-
ni?cant bargaining power against vendors.
3
Combined with its
effective use of technology to streamline its inventory manage-
ment, this put Saks in an enviable competitive position against
other high - end luxury retailers. But even Saks began to struggle
in the face of a nationwide collapse in discretionary consumer
spending following the macroeconomic crisis of 2008; it watched
its gross margin fall an unprecedented sixteen percentage points
from the fourth quarter of 2007 to the same period in late 2008.
Such downturns could also come in the form of troughs fol-
lowing waves of ?nancial liquidity. That same macroeconomic
crisis of 2008 came on the heels of a tightening in credit markets
that kept even healthy companies from ?nancing that could have
carried them through. Companies with suf?cient foresight, luck,
or both to raise funding while credit markets remained loose
could ride out the storm, while companies who came too late to
the party found themselves unable to close ?nancing.
When Flying J failed to make payroll, they could not raise
additional capital on short notice in the face of falling oil prices
and frozen credit markets. Similarly, when Circuit City could at
last borrow no more to cover the problems it never ?xed, it too
?led for bankruptcy.
Not all downturns are as far - reaching as the crisis of 2008 and
2009, but regional, or even local, downturns can have a negative
Introduction: Conditions and Causes of Distress xxi
impact on businesses. For example, the closing of the Fore River
Shipyard in Quincy, Massachusetts, represented a devastating
external cause of distress for the nearby restaurants and bars that
catered to the shipyard ’ s employees coming off shift from build-
ing submarines and tankers.
Industrywide Issues
Industrywide issues, particularly structural ones rather than cycli-
cal ones, may affect not an entire national or regional economy,
but instead focus on one industry or vertical. Such changes could
come in the form of industry consolidation — such as how the
explosive growth of Wal - Mart gave it disproportionate bargaining
power against its vendors of clothing, cosmetics, and children ’ s
toys, thus crippling supplier margins — or the emergence of new
competitive products, such as the eventual devastating effects
margarine had on butter producers, or the growing competition
steel producers faced from plastic in products ranging from con-
tainers to automobiles. Weather can represent another industry
issue, as it did when a severe drought devastated coffee manufac-
turers throughout Brazil in 1999, wiping out some 40 percent of
the crop. Changes in commodity prices can also affect entire
industries on both the top and bottom lines. For example, sugar
processors such as Imperial Sugar faltered in the wake of increased
sugar prices in the 2001 – 2002 timeframe, as they struggled to pass
along such cost increases to customers.
4
Similarly, tumbling oil
prices in late 2008 slashed revenues at major oil companies, which
subsequently rippled through the drilling and exploration indus-
try because it had become less pro?table to drill for new reserves.
Finally, litigation — particularly class action toxic tort litigation
such as that which prompted dozens of bankruptcies among man-
ufacturers with asbestos in their products from the 1980s through
today — can represent a widespread external cause of distress to
an entire industry.
Shifts in Consumer Demand
Shifts in consumer demand can unexpectedly erode a company ’ s
revenue growth. For example, the explosion in popularity of low -
carbohydrate diets such as the Atkins, South Beach, and Zone
diets weakened many fast - food restaurant chains, notably donut
xxii Introduction: Conditions and Causes of Distress
maker Krispy Kreme, which cited the diets ’ popularity in explain-
ing its expected lower pro?ts to Wall Street in 2004.
5
Similarly,
Chapter Nine will demonstrate how Schwinn ’ s failure to recog-
nize the growing popularity of lighter, more agile mountain bikes
over its traditionally heavier cruising bicycles presaged its dwin-
dling sales and eventual bankruptcy ?ling.
Changes in Technology
Changes in technology have disrupted many industries, from the
iconic business school example of the buggy whip industry falling
in the face of the automobile to signi?cantly more subtle, com-
plicated technological shifts in computing architectures. Today ’ s
information technology products and networks have grown so
interdependent between software and hardware products and the
standards that govern them that a company need not even manu-
facture the changing technology in order to falter, as did Wang
Computer in its failed attempt to hang onto the “ midframe ” com-
puter market in the 1980s.
For example, Electronic Data Systems found itself lagging
signi?cantly behind more nimble competitors like Razor?sh,
Scient, and even IBM Global Services in the late 1990s, as its his-
torical expertise in legacy mainframe systems created a strategic
mismatch with the rapid adoption of the client/server model.
The wide - scale introduction of personal computers into the
workplace drove adoption of the client/server architecture,
leaving EDS with increasingly obsolete mainframe expertise.
Though EDS only provided outsourced IT services, its expertise
in the disappearing mainframe model (and corresponding inex-
perience with the client/server model) made it no less a victim
of technological change than the manufacturers of such main-
frame products. (See Chapter One for more information on the
challenges faced by EDS.)
Kodak and Xerox came close to collapse with their belated
realization that customers preferred digital cameras and copiers
over analog devices. Similarly, it was the Internet as a technical
pipeline of information that affected newspapers at the turn of
this century, even more than the technical advance in television
advertising did in the 1950s.
Introduction: Conditions and Causes of Distress xxiii
Government Regulation
Government regulation can send shocks to an otherwise stable
industry, most often through deregulation such as that brought
about by the Telecom Act of 1996, which sent telecommunica-
tions providers scrambling to adjust to the new economic realities
of increased competition in the form of competitive local
exchange carriers, or CLECs. Bans or restrictions can also shrink
market sizes (such as the increase in the legal drinking age to
twenty - one from eighteen in many states in 1984) or cut off mar-
keting channels (such as the ban on advertising cigarettes on
television and radio enacted by the Public Health Cigarette
Smoking Act in 1970). However, regulation need not be so dra-
matic or sweeping to affect an industry. For example, the push to
produce more environmentally friendly fuel prompted the 2007
passage of the Energy Independence and Security Act, which
speci?ed levels of ethanol production well above current market
demand. This arti?cially increased demand for the corn used to
make ethanol, in turn increasing the price of corn and compress-
ing margins across the livestock and dairy industries, which rely
on corn as a primary component of cattle feed.
6
Furthermore,
local minimum wage increases can signi?cantly increase operat-
ing costs for labor - intensive industries such as retail, as San
Francisco ’ s 26 percent minimum wage increase in 2004 drove
many Bay Area restaurants out of business.
7
Changing Interest Rates
Changing interest rates can change the cost of a company ’ s debt,
thereby leading to ?uctuations in cash out?ows. Although the
most common example is an unexpected spike in interest rates
for a company that has issued ?oating - rate debt, many ?nancial
institutions ranging from investment banks such as Goldman
Sachs to credit card issuers such as GE Commercial Finance
have complicated balance sheets full of interest rate derivatives,
with pro?tability often predicated on a steady “ spread ” between
?oating - and ?xed - rate debt. Such institutions can suffer merely
from increases in interest rate volatility, even in the absence of a
sustained directional move in interest rates. Even non?nancial
companies seemingly without interest rate exposure can suddenly
xxiv Introduction: Conditions and Causes of Distress
?nd themselves hamstrung by interest rate spikes when custom-
ers or suppliers with ?oating - rate debt ?nd themselves cash -
constrained, and begin stretching out payables or demanding
stricter cash collection policies, respectively.
Changes in Business Model
Changes in business model can also hamper historically sound
businesses. Newspapers are currently facing a drastic shift from
their old monopoly - based business models in response to the
popularity of reading news on the Internet and their strategic
misstep in giving away content for free online. In order to survive,
they will have to adapt to these new realities while preserving their
historical mission: discovering and presenting the news. As dis-
cussed later, they need to rely on their core competencies as
“ trusted infomediaries. ”
Internal Causes
Though managers are naturally eager to point to external causes
so as to de?ect blame, a study suggested that causes of distress
coming from within the company are six times more likely to
cause a ?rm ’ s failure. Although there are many examples of such
internal causes, the most common — and most deadly — is unques-
tionably ineffective management, which plagues everything from
small, family - led concerns to multinational conglomerates.
Just as Roman writer Publilius Syrus wrote that “ anyone can
hold the helm when the sea is calm, ” many management teams
can coast along smoothly during periods of stability and economic
prosperity. However, executives often fail in the face of adversity
simply because they lack the skills to deal with the challenges
posed by any of the external causes of distress just discussed.
Steven Rogers at the Kellogg School of Management extends this
naval metaphor, comparing the revelation of management teams ’
weakness in times of crisis to a boat that has cruised through a
passageway time and again at high tide. When the water level falls,
though, dangerous rocks appear suddenly, making navigation
unexpectedly treacherous. Always present, the rocks — or manage-
ment incompetence and organizational problems — lurked inno-
cently below the surface until falling tides or plunging economies
Introduction: Conditions and Causes of Distress xxv
reveal the danger that had been there all along. While ineffective
management is by far the most common internal cause of distress
for faltering companies, it is not the only one. But even when
there is another internal problem, like those listed next, manage-
ment failure usually plays a role, making a bad situation worse.
Blind Pursuit of Growth
Blind pursuit of growth can cause an organization to lose sight of
what made it successful in the ?rst place. CEO John H. Bryan took
Sara Lee through a reckless strategy of acquisitions for most of
the 1980s and 1990s, as the company purchased more than 200
companies, many well outside of Sara Lee ’ s core foods business.
This overly aggressive acquisition binge increased revenues from
just over $2 billion when Bryan took the helm in 1975 to nearly
$20 billion in 2004, a massive growth that hid several underlying
problems in the company ’ s management, who fundamentally
failed to understand their core customers. Sara Lee had become
a complex, decentralized organization with inef?cient cost con-
trols, causing Sara Lee to have the highest sales and administrative
expenses among its competitors (see Figure I.2 )
8
and poor cus-
tomer relationships.
9
Blind devotion to “ the deal ” had many side effects common
to poorly managed companies. First, the overriding inclination to
buy competitors rather than innovate from within led to insuf?-
cient investment in research and development, thus frequently
leaving Sara Lee a step behind other competitors and forcing it
to play catch - up with “ me - too ” offerings. Like many companies
who overexpand during times of prosperity, Sara Lee ’ s unrelent-
ing pursuit of growth led to inadequate postmerger integration
efforts, with management seemingly uninterested in ensuring that
new pieces ?t together before becoming distracted by the pros-
pect of the next big deal. For example, Sara Lee soon owned nine
meat companies, each with a different sales team approaching
large grocery chains, an approach that annoyed those chains ’
buyers who preferred to deal with only one contact. As they so
often do, these distractions prevented management from seeing
coming changes in the industry, with disastrous results. A host of
problems, including slowed growth following the 2001 recession,
rising input costs, and pricing pressure from consolidated retail
xxvi Introduction: Conditions and Causes of Distress
customers, led to the replacement of CEO Steven McMillan in
2004, just four years after he had succeeded Bryan.
Organizations that grow too fast often demonstrate a second
example of ineffective management that frequently leads compa-
nies further into decline: an excessive reliance on cost - cutting, to
the exclusion of more effective alternatives. In the absence of a
comprehensive turnaround strategy that pairs a genuine strategic
change with downsizing to create a leaner, more focused organiza-
tion, simply reducing costs by cutting headcount or selling off
divisions will invariably fail. In their efforts to turn Sara Lee
around, McMillan and his successor, Brenda Barnes, relied heavily
on cost - cutting and downsizing. After ?ve years of trying, Barnes
still hadn ’ t fully turned Sara Lee around. Sara Lee ’ s turnaround
efforts have faltered at least in part due to its reticence in reach-
ing out for help, either from turnaround specialists or from newer,
more talented hires lower in the organizational structure. Despite
Figure I.2. Cost Inef?ciency at Sara Lee in 2007
Sara Lee
Procter & Gamble
Campbell Soup
Heinz
Kraft Canagra
General Mills
15.9%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
S
G
&
A
E
x
p
e
n
s
e
a
s
a
P
e
r
c
e
n
t
a
g
e
o
f
S
a
l
e
s
30.0%
35.0%
40.0%
19.2%
21.0%
21.6%
24.5%
31.8%
32.8%
Introduction: Conditions and Causes of Distress xxvii
a decade of underperformance, change at the top came slowly,
typi?ed by McMillan ’ s moving to the chairmanship from CEO and
staying there throughout several failed turnarounds.
In the early 1980s, Frank Lorenzo grew Continental Airlines
through the acquisition of four airlines, following a standard
protocol of ruthlessly cutting costs at each subsequent target in
order to help fund the next deal. Passengers on Continental
?ights saw a mismatched assortment of seats: some red, some grey,
some tall, some short, based on whatever had become available
from different planes being stripped for parts. Duct tape secured
ancient overhead bins, and on - time performance plummeted.
Gordon Bethune, the CEO later credited with the turnaround at
Continental, compared this cost - cutting strategy to saving money
by taking toppings off a pizza to cut costs; sooner or later, no one
will buy it at any price. The key elements to Bethune ’ s successful
turnaround are chronicled in Chapter Five .
As noted earlier, Krispy Kreme management blamed the low -
carb diet craze for the company ’ s plummeting pro?ts. In reality,
many of their problems resulted from excessive growth. As the
company ?rst expanded across the country from its home in the
southeastern United States, a mystique surrounded their hard -
to - ?nd hot donuts, a real treat for many. Soon, however, they
appeared in thousands of gas stations and retail outlets, a situa-
tion that made them a ubiquitous commodity. The resultant turn-
around involved closing some outlets and retrenching, as discussed
in Chapter Five .
Overextension of Credit
Overextension of credit in overly indulgent credit markets can
sink companies who become too optimistic about their own
growth prospects. In boom times, ?rms often ?nance acquisitions
with debt, naively using “ best case ” scenarios as base cases for the
purposes of ?nancial forecasting. Excessive liquidity can hide
severe underlying critical problems at a company the way a fresh
coat of paint may conceal dry rot in a building ’ s timbers.
Management grows complacent, knowing that they can ?nd an
accommodating lender who will let them simply throw money at
the problem instead of attacking it head - on. In the face of a
downturn, these companies ?nd themselves swamped with debt.
xxviii Introduction: Conditions and Causes of Distress
Box 1: Typical Covenants Tripped by Downturns
Although the frothy capital markets of 2004 – 2007 led to the preva-
lence of so - called “ covenant - lite ” loans featuring very few, very lax
restrictive covenants, bank loans have historically contained fea-
tures requiring certain levels of ?nancial performance in order to
protect lenders with warning signals. If a company fails to meet
one of the covenants at an agreed upon date — typically the end
of each ?nancial quarter — the lenders may enforce certain rights,
such as a higher interest rate, an additional equity contribution,
the divestiture of a subsidiary, the retention of a turnaround pro-
fessional, or even seizure of the assets. The following covenants
have returned to popularity in the wake of the 2007 credit crisis,
and are likely to remain so for the foreseeable future.
Fixed Charge Coverage Ratio (FCCR) = Cash Flow / Fixed Charges
The ?xed charge coverage ratio measures a company ’ s ability to pay
its ?xed expenses, typically comprising interest expense, the
current portion of long - term debt, capitalized leases, and rents.
Lenders often insist on a minimum FCCR of, for example, 2.0x,
indicating that cash ?ow divided by agreed - upon ?xed charges
must equal or exceed 2.0, with cash ?ow measured quarterly on
a rolling four - quarter basis and adjusted for any unusual or one -
time items. The rolling calculation means that one down quarter
could throw a company previously above the 2.0x threshold below
it. The company below, for example, remains healthily above the
threshold before a sudden downturn brings it into violation in
Q1 2007.
Funded Debt to EBITDA = Funded Debt / EBITDA
Like many such measures, this ratio uses earnings before interest,
taxes, depreciation, and amortization (EBITDA) as a proxy for cash
Just one or two bad quarters can lead to depressed pro?tability
and result in tripped covenants, thus forcing these companies to
negotiate often expensive forbearance and waiver agreements
with their lenders. See Box 1 for examples of frequent covenants
that can require such forbearance agreements.
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Brief description pertaining to reversing the slide a strategic guide to turnarounds and corporate renewal.
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Reversing
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A Strategic Guide to
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James B. Shein
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Shein, James B., 1942-
Reversing the slide : a strategic guide to turnarounds and corporate renewal / James B. Shein. —
1st ed.
p. cm.
Includes index.
ISBN 978-0-470-93324-4 (hardback), 978-1-118-00845-4 (ebk), 978-1-118-00846-1 (ebk),
978-1-118-00847-8 (ebk)
1. Corporate turnarounds—United States–Management. 2. Corporate turnarounds—
United States—Case studies. 3. Working capital—United States. 4. Strategic planning–
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Introduction: Conditions and Causes of Distress ix
Box 1: Typical Covenants Tripped by Downturns xxviii
1 The Phases of Decline and Early Warning Signs 1
Box 2: The Effects of Financial Shenanigans 17
2 The Turnaround Tripod 29
3 Leadership in a Crisis 58
Box 3: Governance and Leadership Issues
in Family-Owned Businesses 80
4 Cash Not GAAP 93
5 Downsizing Is a Tool, Not a Goal 121
Box 4: Other Legal Issues in Announcing Layoffs 130
6 The Bankruptcy Process as Sword and Shield 152
Box 5: State Laws 156
Box 6: DIP Financing 159
Box 7: Committee Formation 162
Box 8: Plan Con?rmation 181
7 Managing International Turnarounds 203
8 Turnarounds at (Intentionally)
Nonpro?t Organizations 231
Box 9: Chapter 9 Bankruptcy 257
9 Turning Duds into Dreams 259
Box 10: Additional Issues in Valuing
Distressed Companies 278
Contents
v
vi Contents
Box 11: Fiduciary Duties of Directors in
M&A Transactions 300
10 A Different Fresh Start 306
Notes 313
Acknowledgments 325
About the Author 327
Index 329
Dedicated to my wonderful sons, Justin and Jered, for their
encouragement, their senses of humor, and for teaching me
what’s important in life
ix
Employees at Rhodes Plastics in Linden, New Jersey, trudged
through another dreary March day. The plant received its raw
materials and supplies at one end of the building, converted them
into sterile packaging for the food and drug industry, and shipped
them out the other end. The of?ce workers were the ?rst to reg-
ister shock and confusion when armed sheriff deputies stormed
in and ordered everyone out of the building.
“ You will take nothing, not even the family pictures on your
desks! ” one of?cer shouted. “ Not until the bank ?gures out who
owns what. ”
While locksmiths arrived to change all the locks, the plant
workers were ordered out and told to leave even their own tools
behind. Unbeknownst to everyone there, the company ’ s top of?-
cers had failed to convince the company ’ s lenders that they could
turn the company around. Unpaid suppliers and customers with
un?lled orders would soon share in the employees ’ shock.
Although your problems may not be as dramatic, chances are,
at some point in your career, you will participate in a turnaround.
No matter how pro?table you have made your business, or how
recession - proof you consider your industry, you will ?nd yourself
dealing with a troubled company. Perhaps your own company will
need to reinvent itself to deal with new competitive realities, or
perhaps a valued customer will begin paying you later and later
due to its own internal distress. You may even serve on the board
of a nonpro?t organization that requires its own strategic, opera-
tional, and ?nancial initiatives to remain viable. Whatever the case
may be, you will — with near 100 percent certainty — be party to a
turnaround at some point in your professional career.
Introduction: Conditions
and Causes of Distress
x Introduction: Conditions and Causes of Distress
A turnaround is any effort to revitalize and make a clear change
in the direction of a struggling business of any size. It also applies
to improving a business that has simply underperformed its com-
petition. Understandably, many executives are reluctant to admit
that their ?rm needs a turnaround, so I began using the term
corporate renewal almost a decade ago; they seem to ?nd it a bit less
threatening. These terms can apply to an entire company, a sub-
sidiary, or just a division.
The turnaround ?eld relates to companies and nonpro?ts
with clear problems, but also to those who should question
whether their employers, customers, or suppliers are on the wrong
track. Years ago, I met with the CEO of Siemens Corp., a $100
billion company based in Munich, Germany. The CEO has 700
internal consultants, but still pays out tens of millions of Euros
per year on outside consultants, none of whom could prevent the
fact that at any given time, at least one of his business units would
invariably be performing poorly. He asked me very frankly what
“ turnaround consultants ” do differently than the big consulting
?rms. This book will answer that question.
Bob Johnson, the highly successful entrepreneur and founder
of BET (Black Entertainment Television), asked me to speak to
his executives. Although I usually meet with companies in trouble,
I met with his staff while they piloted one of the most successful
and pro?table companies in the country. BET wasn ’ t in trouble —
far from it — but Johnson was smart enough to want to know why
so many similarly successful companies got into trouble, and he
wanted his entire senior staff to recognize the warning signs
and avoid similar pitfalls. The saddest cases are those that fail to
heed the many early warning signals that they are in trouble, or
that a customer or supplier is in trouble, until the damage is
irreparable.
I have told my students at Northwestern University ’ s Kellogg
School of Management as much for the better part of the last
decade in my “ Managing Turnarounds ” class. The course draws
on my three decades of experience helping salvage troubled com-
panies and returning them to pro?tability, and this book codi?es
the lessons I have learned in that time and applies them to a
broader audience that will surely need them in volatile economic
times. I also teach “ New Venture Formation ” at Kellogg, a pairing
Introduction: Conditions and Causes of Distress xi
that strikes some executives and students as unusual. However, as
I explain in the very ?rst class of Managing Turnarounds, turn-
around situations often resemble startups in the demands they
place upon management. Effective turnaround managers must
often become much more entrepreneurial in their approach to
any turnaround, and entrepreneurs also should heed the lessons
here.
Turnarounds as Entrepreneurship
As already mentioned, one need not work in the ?eld of turn-
arounds and restructuring to apply the lessons of this book.
Turnaround CEOs face many of the same challenges faced by
entrepreneurs. In fact, the following ten conditions most fre-
quently encountered by turnaround professionals are also char-
acteristic of entrepreneurial startup situations.
Lack of Cash
Most entrepreneurial ventures fail due to undercapitalization,
which prevents a company from gaining suf?cient working capital
to fund its operations until it can create positive cash ?ow. Even
rapid growth can exacerbate this problem, for as Figure I.1 dem-
onstrates, the gap between cash outlay for salaries and supplies
that occurs later in a company ’ s life (G2) typically exceeds that
same gap earlier (G1).
Such a cash crunch also rears its ugly head during turn-
arounds, for it is precisely the lack of working capital that brings
a company into crisis. In both cases, turnaround managers and
entrepreneurs must carefully scrutinize any expenditure requir-
ing a cash outlay. Both types of managers must quickly and accu-
rately determine which expenditures are absolutely critical to the
company ’ s ongoing operations (payment to key suppliers or
payroll taxes) and which can be delayed (a new machine or
holiday party). Both types of managers must also ?nd short - term
projects that generate cash, such as the sale of nonproductive
assets. The successful execution of such projects not only frees up
incremental liquidity but also restores credibility with suppliers,
customers, and employees. Cash is an issue for large as well as
xii Introduction: Conditions and Causes of Distress
small companies. One of my students, a young entrepreneur
who developed a new energy - bar business, found himself runn-
ing out of cash despite a truly phenomenal growth in new orders.
He wound up on the ABC television show Shark Tank to raise
money from a rather nasty panel of ?nanciers of ventures. He
succeeded in procuring ?nancing for his small business, but most
do not. At the other end of the spectrum, it was a critical cash
shortage that caused Flying J — an $18 billion company — to come
to a screeching halt. Best known for its truck stops, they missed
payroll only days before Christmas, forcing them to ?le bank-
ruptcy on short notice. They failed to monitor true cash avail-
ability, relying instead on “ book ” earnings, a subject discussed in
more detail later.
Analytical Needs
In a crisis, a turnaround manager often must focus on near - term
problems with near - term solutions, typically those related to the
cash issues discussed previously. Similarly, entrepreneurs make
investment decisions based heavily on the timing of cash out?ows
Figure I.1. Cash Flow Timing Across the
Organizational Life Cycle
C
a
s
h
O
u
t
l
a
y
/
R
e
c
e
i
p
t
s
Age of Organization
Cash Expenditures
for Labor and Supplies
Shipping of Goods or
Provision of Services
Cash Received
from Customers
G1
G2
Introduction: Conditions and Causes of Distress xiii
to ensure that the ?edgling enterprise can remain viable long
enough to turn pro?table. As a result, entrepreneurs and turn-
around executives both have little use for widely used Generally
Accepted Accounting Principles (GAAP), as the accrual methods
of accounting that they prescribe are irrelevant if a company
cannot continue as a going concern. One subtle difference is that
turnaround managers frequently must “ shock ” accountants or
chief ?nancial of?cers out of their historical reliance on GAAP
accounting methods, whereas an entrepreneur rarely encounters
such problems, if only because of the realization that every dollar
is their life blood to survival.
Aside from its manipulability, GAAP provides little value to
these managers because it provides an incredibly detailed account
of the company ’ s historical performance at a time when the only
thing that matters is the accurate forecasting of each of the next
thirteen weeks. Both types of executives require up - to - date infor-
mation about how various strategic decisions — increasing a start-
up ’ s advertising reach, perhaps, or selling a division of a troubled
company — will affect the company ’ s cash balance. The accrual
accounting methods of GAAP often mask the cash effects of such
decisions, and its assumption of “ smoothed ” and “ matching ” of
collections and disbursements can project a break - even ?nancial
quarter when in fact the company ’ s cash balance will turn nega-
tive in a matter of weeks. As such, managers in startups and turn-
arounds alike have no use for the historical analysis tools provided
by GAAP — they must take more of a pragmatic forecasting
approach to ?nancial analysis. This concept is discussed in depth
in Chapter Four .
The J.A. Jones Construction Company was a highly successful
contractor based in Charlotte, North Carolina, with billions of
dollars of massive construction projects under way around the
world. Jones appeared pro?table, because income and expenses
were booked according to GAAP. Their projects, including eight
new U.S. embassies, hotels, airports, hospitals, and of?ce build-
ings throughout the world, all came to a halt when the company
ran out of cash and declared bankruptcy.
One should not confuse executives ’ manipulation of earnings
reports allowed under GAAP with fraud. When CEO Garth
Dabinski changed the depreciation and other schedules at
xiv Introduction: Conditions and Causes of Distress
Cineplex Odeon to make earnings look deceptively strong, those
moves were technically permissible under GAAP. While the
accounting changes allowed him to show a $40 million pro?t, in
reality the movie theater chain bled over $50 million in cash that
year, because he focused on ?nancial engineering instead of on
the turnaround tripod discussed in Chapter Three . Dabinski later
fraudulently changed accounting records at LiveEnt Company,
for which he is now serving a seven - year sentence.
Hiring Dif?culties
Entrepreneurs and turnaround managers also constantly face the
problem of recruiting and retaining quality employees. Employees
naturally gravitate toward stability, something neither a startup
nor a distressed company can offer. The entrepreneur must
recruit new employees without any guarantee that the company
will thrive suf?ciently to pay their salaries, while the turnaround
manager often ?nds a staff whose most quali?ed members have
already departed, leaving only those employees unable to ?nd
employment elsewhere, often an indication of their productivity.
In both cases, the use of equity incentives proves very useful in
overcoming this incentivization problem, as employees can typi-
cally receive restricted stock or stock options at a low valuation,
indicating signi?cant ?nancial upside if the new venture takes off
or the distressed company returns to pro?tability and increased
equity value.
In addition to the dif?culty of attracting full - time staff, entre-
preneurs and turnaround managers also have trouble paying for
legal, information technology, marketing, and advertising ser-
vices. Just when such services can prove immensely valuable, man-
agers in both situations can least afford them. As a result,
turnaround executives and entrepreneurs often have no choice
but to perform those crucial tasks either themselves or with
minimal support.
Disbelieving Customers
Customers also crave stability, not wanting to jeopardize their
company or their career if a supplier fails to deliver an order on
Introduction: Conditions and Causes of Distress xv
time, reliably, and of the promised quality. Without a track record,
entrepreneurs struggle to convince potential customers that they
can deliver, whereas a turnaround manager must overcome a
recent negative track record caused by the distressed company ’ s
failure to meet customer expectations. One venture capitalist has
opined that a successful high - growth startup must offer a tenfold
improvement in quality or other important product features over
existing alternatives to convince prospective customers to risk
relying on an unproven venture. A troubled ?rm ’ s competitors ’
salespeople often try to add to potential customers ’ fears with
implicit threats to purchasing executives along the lines of “ we ’ ll
only supply those who buy from us now ” and “ you ’ ll look foolish
when they don ’ t deliver. ”
As a result, both entrepreneurs and turnaround professionals
?nd that they can only earn business from less creditworthy cus-
tomers and those who shop exclusively based on price, thus exac-
erbating the company ’ s problems with low - or no - margin buyers.
Less price - sensitive, more creditworthy buyers can simply wait
until the struggling company stabilizes itself by using the advice
found in this book. Chrysler faced such problems in 1980
and again in 2009, when consumers and large ?eet buyers post-
poned Chrysler purchases until they could feel comfortable that
the company would survive long enough to honor its warranty
obligations.
Time Sensitivity
Both startups and troubled companies face a rapidly shrinking
time span during which a new opportunity can be exploited or
disaster can be averted. With employees working long hours,
managers must run meetings focused on speci?c, detailed “ to do ”
lists rather than as a chance to discuss the company ’ s problems
in general. Lacking the luxury of time to conduct detailed analy-
ses, managers must make decisions quickly, often relying on a
“ Ready — Fire — Aim! ” decision - making philosophy. This frenzied
pace forces managers to walk a delicate tightrope; they must at
once create the sense of urgency necessary to spur an often com-
placent workforce into rapid, aggressive action, but they must
do so in a manner that assuages employee anxiety rather than
xvi Introduction: Conditions and Causes of Distress
exacerbates it. Such a balancing act requires a unique blend of
charisma, competence, and credibility on the part of the entre-
preneur and the turnaround practitioner, shown primarily
through how one makes and implements those timely decisions.
This concept is discussed in greater detail in Chapter Three .
Steve Miller, author of The Turnaround Kid and professional
turnaround CEO of six companies, uses this approach.
1
He warns
his employees of “ paralysis by analysis, ” whereby they keep study-
ing an issue rather than making much - needed decisions.
Centralized Decision Making
Startups lack organizational structure, thus making it dif?cult for
the entrepreneur to turn to resources inside the company for
consultation or delegation. Conversely, such organizational struc-
tures may be in place for the turnaround manager, but those same
structures ’ complicity in causing the company ’ s distress makes
them an unattractive source of such support. As a result, both situ-
ations require a strong, centralized leadership structure rather
than a democratic process of decision making until the organiza-
tion is on an upward course. One need not go to the extreme of
“ Chainsaw ” Al Dunlap, who belittled everyone around him when
he took charge of Scott Paper, or “ Queen of Mean ” Leona
Helmsley. Helmsley frequently shouted obscenities at employees
just before ?ring them, and made them beg on their knees for
their jobs even for the slightest mistakes, while Dunlap told long -
term Scott employees that they were “ stupid ” for staying so long;
both approaches are foolish and short - sighted. Strong manage-
ment requires at least a short - term focus on centralization which
eases as the organization changes course, but leaders must boost
morale in the process. Better role models include Jamie Dimon
at Bank One, Selim Bassoul at Middleby, or Michael Jordan at
EDS, each of whom is discussed elsewhere in this book.
Scarcity of Knowledge and Risk
Both startups and troubled companies operate in an environment
of bounded rationality, with limited information and a great deal
of uncertainty. Startups lack an organizational history to guide
them, while troubled companies are typically troubled precisely
Introduction: Conditions and Causes of Distress xvii
because the lessons of their own histories have limited value (see
under the heading “ Causes of Distress ” ). Both types of companies
lack the institutional knowledge necessary to deal with the problem
appropriately, thus making planning and forecasting dif?cult
while increasing the risk of failure. Relying on poor institutional
knowledge has caused the downfall of many executives, such as
Rick Wagner, the CEO of General Motors, who relied on GM ’ s “ If
we build it they will buy it ” mentality, even in the face of plum-
meting market share. It wasn ’ t until the U.S. government forced
him out that the board faced up to the fact that change was
needed. It didn ’ t help much when a longtime GM executive, Fritz
Henderson, was named as the replacement, but he only lasted
eight months on the job.
At a company that made appliance parts, the CEO ?nally
agreed to a detailed list of steps to return the company to pro?t-
ability. Months later, when the board of directors confronted him
as to why he had not yet implemented any of the steps, he
responded that he had split the list in two. They assumed he had
created short - and long - term goals, but he took a more practical
view of the two lists, declaring that the lists were “ those things I
don ’ t know how to do and those that I can ’ t bring myself to do. ”
He chose early retirement, and his replacement turned the
company cash ?ow positive once again.
Supplier Problems
Competitors ’ sales and marketing personnel will invariably extol
the weaknesses of a new venture or distressed company, telling
potential or existing suppliers that they would be “ foolish ” to
supply such ?rms given the likelihood that they will not survive
long enough to pay for the goods or services provided. Suppliers
often feel disinclined to alienate their established customers by
selling to the startup or distressed company, requiring an entre-
preneur or turnaround manager to exercise almost mystical forces
of persuasion to overcome their objections without leverage in
terms of price, delivery, or quality. In particular, both the entre-
preneur and turnaround practitioner must try to avoid the
dreaded “ cash in advance ” demand from suppliers.
This is a particular problem when there are critical, key sup-
pliers. Fannie May Candies faced this when Bloomers Chocolate
xviii Introduction: Conditions and Causes of Distress
Company demanded cash in advance on all orders. Only Bloomers
could produce the exact chocolate mix Fannie May needed to
make its well - known Mint Melt - a - Way ’ s ™ . Unable to pay Bloomers
in advance, Fannie May had no choice but to declare bankruptcy
when it couldn ’ t come up with the cash.
Lack of Credibility with Lenders
Lenders generally will not extend credit to startups, for they lack
the assets necessary to collateralize a revolving or term loan.
Similarly, distressed companies have already stretched their
lenders to the limit, going so far as to exceed their loan advance
rates on accounts receivable, inventory, and other collateral,
thereby forcing lenders to enter into an “ over - advance. ” Such a
situation allows the debtor access to working capital in excess of
the company ’ s collateral in order to ?nance its turnaround, but
it implies that a lender has taken on equity - like risk without equity -
like returns, for it stands to lose the entire uncollateralized portion
of its advance. Eventually, a lender will require a forbearance
agreement or waiver of its foreclosure rights, which typically
imposes new restrictions on the company, increases the debtor ’ s
effective interest rate, and may even mandate the hiring of turn-
around professionals to rectify the over - advance situation.
One company that leased railroad boxcars, coal cars, and
containers received multiple waivers on debt defaults from its
lenders. When cash ?ow problems persisted, the lenders, suppli-
ers, and lawyers met to reach an agreement. The meeting started
poorly when an argument between the lawyers for the two largest
lenders escalated into a full - on ?st ?ght, as both began grappling
on the ?oor over who got to talk ?rst. Each wanted to show every-
one how tough they planned to negotiate with each other and
with the borrower. It became clear that the company executives
probably wouldn ’ t get any additional relief from their creditors.
Great Chance for Equity Gains
When companies start up, it ’ s clear that the equity values are very
low, with great opportunity for capital gains. The risk of failure is
high, but so are the potential rewards.
Introduction: Conditions and Causes of Distress xix
Similarly, the stock of troubled companies is valued very
cheaply. The difference, of course, is that the stock of a poorly
performing company is low because the company is in ?nancial
and operating distress. A successful turnaround can thus bring
substantial rewards to those who acquire equity even when risk
is high.
In the case of the railcar leasing company mentioned above,
all the employees who helped with the turnaround received shares
valued at ?fty cents each. Four years later, the company was sold
for fourteen dollars a share: not bad, but there are many stories
of investors in troubled companies doing even better, which are
discussed in more detail in Chapter Nine . It is interesting to note
that one of the lenders represented by the battling lawyers became
more cooperative, and was paid in full plus a premium, while the
other remained contentious and had his client sell its loan for ten
cents on the dollar after months of ?ghting, thinking he had
outsmarted everyone.
In summary, both turnaround managers and entrepreneurs
face crisis situations that require the skillful management of mul-
tiple, often con?icting constituencies. This requires incredible
persuasion and salesmanship in order to overcome their objec-
tions and get all of the company ’ s stakeholders working toward a
common goal. Ultimately, the two primary challenges are the
same: conserving and raising cash, and establishing trust both
inside and outside of the organization. Doing so requires a very
different skill set than that required of a traditional manager, for
mere competence and con?dence will not suf?ce. Startups and
turnaround crises demand a certain charismatic zeal
2
in the face
of overwhelming adversity to inspire the con?dence necessary
to invigorate cautious employees and build the trust necessary to
assuage nervous suppliers. Therefore, this book is every bit as
much about entrepreneurship and innovation as it is about reor-
ganization and corporate recovery.
Causes of Distress
It is important to diagnose the causes of organizational distress,
both to help avoid it as well as to repair it. Companies may ?nd
xx Introduction: Conditions and Causes of Distress
themselves in distress from a variety of sources, which can be
broken down into the two main categories — internal and external
causes.
External Causes
As the name suggests, external causes represent exogenous shocks
to all or a signi?cant part of the company, sending management
into a tailspin. Here are some common external causes of com-
panies ’ declines:
Economic Downturns
Economic downturns such as the one recently plaguing world
markets can undermine even the soundest businesses. For
example, Saks Fifth Avenue ’ s pristine brand equity and strong
retail presence in critical markets has historically afforded it sig-
ni?cant bargaining power against vendors.
3
Combined with its
effective use of technology to streamline its inventory manage-
ment, this put Saks in an enviable competitive position against
other high - end luxury retailers. But even Saks began to struggle
in the face of a nationwide collapse in discretionary consumer
spending following the macroeconomic crisis of 2008; it watched
its gross margin fall an unprecedented sixteen percentage points
from the fourth quarter of 2007 to the same period in late 2008.
Such downturns could also come in the form of troughs fol-
lowing waves of ?nancial liquidity. That same macroeconomic
crisis of 2008 came on the heels of a tightening in credit markets
that kept even healthy companies from ?nancing that could have
carried them through. Companies with suf?cient foresight, luck,
or both to raise funding while credit markets remained loose
could ride out the storm, while companies who came too late to
the party found themselves unable to close ?nancing.
When Flying J failed to make payroll, they could not raise
additional capital on short notice in the face of falling oil prices
and frozen credit markets. Similarly, when Circuit City could at
last borrow no more to cover the problems it never ?xed, it too
?led for bankruptcy.
Not all downturns are as far - reaching as the crisis of 2008 and
2009, but regional, or even local, downturns can have a negative
Introduction: Conditions and Causes of Distress xxi
impact on businesses. For example, the closing of the Fore River
Shipyard in Quincy, Massachusetts, represented a devastating
external cause of distress for the nearby restaurants and bars that
catered to the shipyard ’ s employees coming off shift from build-
ing submarines and tankers.
Industrywide Issues
Industrywide issues, particularly structural ones rather than cycli-
cal ones, may affect not an entire national or regional economy,
but instead focus on one industry or vertical. Such changes could
come in the form of industry consolidation — such as how the
explosive growth of Wal - Mart gave it disproportionate bargaining
power against its vendors of clothing, cosmetics, and children ’ s
toys, thus crippling supplier margins — or the emergence of new
competitive products, such as the eventual devastating effects
margarine had on butter producers, or the growing competition
steel producers faced from plastic in products ranging from con-
tainers to automobiles. Weather can represent another industry
issue, as it did when a severe drought devastated coffee manufac-
turers throughout Brazil in 1999, wiping out some 40 percent of
the crop. Changes in commodity prices can also affect entire
industries on both the top and bottom lines. For example, sugar
processors such as Imperial Sugar faltered in the wake of increased
sugar prices in the 2001 – 2002 timeframe, as they struggled to pass
along such cost increases to customers.
4
Similarly, tumbling oil
prices in late 2008 slashed revenues at major oil companies, which
subsequently rippled through the drilling and exploration indus-
try because it had become less pro?table to drill for new reserves.
Finally, litigation — particularly class action toxic tort litigation
such as that which prompted dozens of bankruptcies among man-
ufacturers with asbestos in their products from the 1980s through
today — can represent a widespread external cause of distress to
an entire industry.
Shifts in Consumer Demand
Shifts in consumer demand can unexpectedly erode a company ’ s
revenue growth. For example, the explosion in popularity of low -
carbohydrate diets such as the Atkins, South Beach, and Zone
diets weakened many fast - food restaurant chains, notably donut
xxii Introduction: Conditions and Causes of Distress
maker Krispy Kreme, which cited the diets ’ popularity in explain-
ing its expected lower pro?ts to Wall Street in 2004.
5
Similarly,
Chapter Nine will demonstrate how Schwinn ’ s failure to recog-
nize the growing popularity of lighter, more agile mountain bikes
over its traditionally heavier cruising bicycles presaged its dwin-
dling sales and eventual bankruptcy ?ling.
Changes in Technology
Changes in technology have disrupted many industries, from the
iconic business school example of the buggy whip industry falling
in the face of the automobile to signi?cantly more subtle, com-
plicated technological shifts in computing architectures. Today ’ s
information technology products and networks have grown so
interdependent between software and hardware products and the
standards that govern them that a company need not even manu-
facture the changing technology in order to falter, as did Wang
Computer in its failed attempt to hang onto the “ midframe ” com-
puter market in the 1980s.
For example, Electronic Data Systems found itself lagging
signi?cantly behind more nimble competitors like Razor?sh,
Scient, and even IBM Global Services in the late 1990s, as its his-
torical expertise in legacy mainframe systems created a strategic
mismatch with the rapid adoption of the client/server model.
The wide - scale introduction of personal computers into the
workplace drove adoption of the client/server architecture,
leaving EDS with increasingly obsolete mainframe expertise.
Though EDS only provided outsourced IT services, its expertise
in the disappearing mainframe model (and corresponding inex-
perience with the client/server model) made it no less a victim
of technological change than the manufacturers of such main-
frame products. (See Chapter One for more information on the
challenges faced by EDS.)
Kodak and Xerox came close to collapse with their belated
realization that customers preferred digital cameras and copiers
over analog devices. Similarly, it was the Internet as a technical
pipeline of information that affected newspapers at the turn of
this century, even more than the technical advance in television
advertising did in the 1950s.
Introduction: Conditions and Causes of Distress xxiii
Government Regulation
Government regulation can send shocks to an otherwise stable
industry, most often through deregulation such as that brought
about by the Telecom Act of 1996, which sent telecommunica-
tions providers scrambling to adjust to the new economic realities
of increased competition in the form of competitive local
exchange carriers, or CLECs. Bans or restrictions can also shrink
market sizes (such as the increase in the legal drinking age to
twenty - one from eighteen in many states in 1984) or cut off mar-
keting channels (such as the ban on advertising cigarettes on
television and radio enacted by the Public Health Cigarette
Smoking Act in 1970). However, regulation need not be so dra-
matic or sweeping to affect an industry. For example, the push to
produce more environmentally friendly fuel prompted the 2007
passage of the Energy Independence and Security Act, which
speci?ed levels of ethanol production well above current market
demand. This arti?cially increased demand for the corn used to
make ethanol, in turn increasing the price of corn and compress-
ing margins across the livestock and dairy industries, which rely
on corn as a primary component of cattle feed.
6
Furthermore,
local minimum wage increases can signi?cantly increase operat-
ing costs for labor - intensive industries such as retail, as San
Francisco ’ s 26 percent minimum wage increase in 2004 drove
many Bay Area restaurants out of business.
7
Changing Interest Rates
Changing interest rates can change the cost of a company ’ s debt,
thereby leading to ?uctuations in cash out?ows. Although the
most common example is an unexpected spike in interest rates
for a company that has issued ?oating - rate debt, many ?nancial
institutions ranging from investment banks such as Goldman
Sachs to credit card issuers such as GE Commercial Finance
have complicated balance sheets full of interest rate derivatives,
with pro?tability often predicated on a steady “ spread ” between
?oating - and ?xed - rate debt. Such institutions can suffer merely
from increases in interest rate volatility, even in the absence of a
sustained directional move in interest rates. Even non?nancial
companies seemingly without interest rate exposure can suddenly
xxiv Introduction: Conditions and Causes of Distress
?nd themselves hamstrung by interest rate spikes when custom-
ers or suppliers with ?oating - rate debt ?nd themselves cash -
constrained, and begin stretching out payables or demanding
stricter cash collection policies, respectively.
Changes in Business Model
Changes in business model can also hamper historically sound
businesses. Newspapers are currently facing a drastic shift from
their old monopoly - based business models in response to the
popularity of reading news on the Internet and their strategic
misstep in giving away content for free online. In order to survive,
they will have to adapt to these new realities while preserving their
historical mission: discovering and presenting the news. As dis-
cussed later, they need to rely on their core competencies as
“ trusted infomediaries. ”
Internal Causes
Though managers are naturally eager to point to external causes
so as to de?ect blame, a study suggested that causes of distress
coming from within the company are six times more likely to
cause a ?rm ’ s failure. Although there are many examples of such
internal causes, the most common — and most deadly — is unques-
tionably ineffective management, which plagues everything from
small, family - led concerns to multinational conglomerates.
Just as Roman writer Publilius Syrus wrote that “ anyone can
hold the helm when the sea is calm, ” many management teams
can coast along smoothly during periods of stability and economic
prosperity. However, executives often fail in the face of adversity
simply because they lack the skills to deal with the challenges
posed by any of the external causes of distress just discussed.
Steven Rogers at the Kellogg School of Management extends this
naval metaphor, comparing the revelation of management teams ’
weakness in times of crisis to a boat that has cruised through a
passageway time and again at high tide. When the water level falls,
though, dangerous rocks appear suddenly, making navigation
unexpectedly treacherous. Always present, the rocks — or manage-
ment incompetence and organizational problems — lurked inno-
cently below the surface until falling tides or plunging economies
Introduction: Conditions and Causes of Distress xxv
reveal the danger that had been there all along. While ineffective
management is by far the most common internal cause of distress
for faltering companies, it is not the only one. But even when
there is another internal problem, like those listed next, manage-
ment failure usually plays a role, making a bad situation worse.
Blind Pursuit of Growth
Blind pursuit of growth can cause an organization to lose sight of
what made it successful in the ?rst place. CEO John H. Bryan took
Sara Lee through a reckless strategy of acquisitions for most of
the 1980s and 1990s, as the company purchased more than 200
companies, many well outside of Sara Lee ’ s core foods business.
This overly aggressive acquisition binge increased revenues from
just over $2 billion when Bryan took the helm in 1975 to nearly
$20 billion in 2004, a massive growth that hid several underlying
problems in the company ’ s management, who fundamentally
failed to understand their core customers. Sara Lee had become
a complex, decentralized organization with inef?cient cost con-
trols, causing Sara Lee to have the highest sales and administrative
expenses among its competitors (see Figure I.2 )
8
and poor cus-
tomer relationships.
9
Blind devotion to “ the deal ” had many side effects common
to poorly managed companies. First, the overriding inclination to
buy competitors rather than innovate from within led to insuf?-
cient investment in research and development, thus frequently
leaving Sara Lee a step behind other competitors and forcing it
to play catch - up with “ me - too ” offerings. Like many companies
who overexpand during times of prosperity, Sara Lee ’ s unrelent-
ing pursuit of growth led to inadequate postmerger integration
efforts, with management seemingly uninterested in ensuring that
new pieces ?t together before becoming distracted by the pros-
pect of the next big deal. For example, Sara Lee soon owned nine
meat companies, each with a different sales team approaching
large grocery chains, an approach that annoyed those chains ’
buyers who preferred to deal with only one contact. As they so
often do, these distractions prevented management from seeing
coming changes in the industry, with disastrous results. A host of
problems, including slowed growth following the 2001 recession,
rising input costs, and pricing pressure from consolidated retail
xxvi Introduction: Conditions and Causes of Distress
customers, led to the replacement of CEO Steven McMillan in
2004, just four years after he had succeeded Bryan.
Organizations that grow too fast often demonstrate a second
example of ineffective management that frequently leads compa-
nies further into decline: an excessive reliance on cost - cutting, to
the exclusion of more effective alternatives. In the absence of a
comprehensive turnaround strategy that pairs a genuine strategic
change with downsizing to create a leaner, more focused organiza-
tion, simply reducing costs by cutting headcount or selling off
divisions will invariably fail. In their efforts to turn Sara Lee
around, McMillan and his successor, Brenda Barnes, relied heavily
on cost - cutting and downsizing. After ?ve years of trying, Barnes
still hadn ’ t fully turned Sara Lee around. Sara Lee ’ s turnaround
efforts have faltered at least in part due to its reticence in reach-
ing out for help, either from turnaround specialists or from newer,
more talented hires lower in the organizational structure. Despite
Figure I.2. Cost Inef?ciency at Sara Lee in 2007
Sara Lee
Procter & Gamble
Campbell Soup
Heinz
Kraft Canagra
General Mills
15.9%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
S
G
&
A
E
x
p
e
n
s
e
a
s
a
P
e
r
c
e
n
t
a
g
e
o
f
S
a
l
e
s
30.0%
35.0%
40.0%
19.2%
21.0%
21.6%
24.5%
31.8%
32.8%
Introduction: Conditions and Causes of Distress xxvii
a decade of underperformance, change at the top came slowly,
typi?ed by McMillan ’ s moving to the chairmanship from CEO and
staying there throughout several failed turnarounds.
In the early 1980s, Frank Lorenzo grew Continental Airlines
through the acquisition of four airlines, following a standard
protocol of ruthlessly cutting costs at each subsequent target in
order to help fund the next deal. Passengers on Continental
?ights saw a mismatched assortment of seats: some red, some grey,
some tall, some short, based on whatever had become available
from different planes being stripped for parts. Duct tape secured
ancient overhead bins, and on - time performance plummeted.
Gordon Bethune, the CEO later credited with the turnaround at
Continental, compared this cost - cutting strategy to saving money
by taking toppings off a pizza to cut costs; sooner or later, no one
will buy it at any price. The key elements to Bethune ’ s successful
turnaround are chronicled in Chapter Five .
As noted earlier, Krispy Kreme management blamed the low -
carb diet craze for the company ’ s plummeting pro?ts. In reality,
many of their problems resulted from excessive growth. As the
company ?rst expanded across the country from its home in the
southeastern United States, a mystique surrounded their hard -
to - ?nd hot donuts, a real treat for many. Soon, however, they
appeared in thousands of gas stations and retail outlets, a situa-
tion that made them a ubiquitous commodity. The resultant turn-
around involved closing some outlets and retrenching, as discussed
in Chapter Five .
Overextension of Credit
Overextension of credit in overly indulgent credit markets can
sink companies who become too optimistic about their own
growth prospects. In boom times, ?rms often ?nance acquisitions
with debt, naively using “ best case ” scenarios as base cases for the
purposes of ?nancial forecasting. Excessive liquidity can hide
severe underlying critical problems at a company the way a fresh
coat of paint may conceal dry rot in a building ’ s timbers.
Management grows complacent, knowing that they can ?nd an
accommodating lender who will let them simply throw money at
the problem instead of attacking it head - on. In the face of a
downturn, these companies ?nd themselves swamped with debt.
xxviii Introduction: Conditions and Causes of Distress
Box 1: Typical Covenants Tripped by Downturns
Although the frothy capital markets of 2004 – 2007 led to the preva-
lence of so - called “ covenant - lite ” loans featuring very few, very lax
restrictive covenants, bank loans have historically contained fea-
tures requiring certain levels of ?nancial performance in order to
protect lenders with warning signals. If a company fails to meet
one of the covenants at an agreed upon date — typically the end
of each ?nancial quarter — the lenders may enforce certain rights,
such as a higher interest rate, an additional equity contribution,
the divestiture of a subsidiary, the retention of a turnaround pro-
fessional, or even seizure of the assets. The following covenants
have returned to popularity in the wake of the 2007 credit crisis,
and are likely to remain so for the foreseeable future.
Fixed Charge Coverage Ratio (FCCR) = Cash Flow / Fixed Charges
The ?xed charge coverage ratio measures a company ’ s ability to pay
its ?xed expenses, typically comprising interest expense, the
current portion of long - term debt, capitalized leases, and rents.
Lenders often insist on a minimum FCCR of, for example, 2.0x,
indicating that cash ?ow divided by agreed - upon ?xed charges
must equal or exceed 2.0, with cash ?ow measured quarterly on
a rolling four - quarter basis and adjusted for any unusual or one -
time items. The rolling calculation means that one down quarter
could throw a company previously above the 2.0x threshold below
it. The company below, for example, remains healthily above the
threshold before a sudden downturn brings it into violation in
Q1 2007.
Funded Debt to EBITDA = Funded Debt / EBITDA
Like many such measures, this ratio uses earnings before interest,
taxes, depreciation, and amortization (EBITDA) as a proxy for cash
Just one or two bad quarters can lead to depressed pro?tability
and result in tripped covenants, thus forcing these companies to
negotiate often expensive forbearance and waiver agreements
with their lenders. See Box 1 for examples of frequent covenants
that can require such forbearance agreements.
doc_800522598.pdf