Turnaround and Transformation – Catalysts and Costs

fdu’s guest blogger, David Tilston is a Chartered Accountant, a Fellow of The Association of Corporate Treasurers and a member of The Institute for Turnaround. He has held CFO roles in both listed PLC and PE-backed companies and has significant experience of managing turnaround situations.

How easy is it for Boards of Directors to decide they need to execute a turnaround and transformation of their business?

Turnaround is easy!

It sounds simple. The management reporting suggests a trading downturn and the forecasts show no signs of this ameliorating. A strategy review identifies the changing market and competitive landscape. The pros and cons of alternative options are assessed, and the Board takes the rational decision. Implementation milestones are agreed and the executive directors are tasked with delivery.

Perhaps turnaround is not so easy?

Unfortunately life is often not as easy as that, and the path to salvation can be considerably more tortuous – if salvation can, in fact, be reached.

What often gets in the way is that facts are rarely cut and dried, and their interpretation not cut and dried. Opinions and judgements around the boardroom table will be coloured by past experiences and prejudices. Factors which can be relevant in varying situations can include:

  • Long-standing management teams who might not recognise the degree of change required
  • A lack of transparency and rigour in the analysis presented for Board debate, possibly as the parties involved may not have faced similar backdrops or dynamics in the past
  • A failure to recognise new or emerging trends
  • An implicit complacency, or hope that “things will turn out all right in the end if we hold our nerve” as that has been the path followed in the past

Some management teams will grab the challenge and make the necessary changes. Unfortunately some will not, and in the current environment that could spell disaster.

Catalysts for turnaround changes

For those executive teams that do not have the foresight to react early enough, one solution is to have sufficient challenge from the Chairman and the NEDs to stimulate debate which leads to action in time.

“In such cases some external stimulus will kick-start the process of reappraisal.”

There are enough examples however to suggest that such corporate governance disciplines may not always deliver the desired results. In such cases some external stimulus will kick-start the process of reappraisal, and this may often come as a result of one or more of the following:

  • Banks or other lenders raising concerns that the business may breach its financial covenants
  • An impending liquidity crisis where banks or other lenders have indicated they will not provide additional funding
  • Feedback from investors that they are disenchanted by current performance and will not support an equity issue to relieve pressure on the business
  • The prospect of directors potentially facing personal liability due to unlawful trading
  • A radical move by a competitor, or loss of a major contract for unforeseen reasons
  • Pension Fund Trustees (if the company has a defined benefit scheme in deficit) requesting greater security and cash contributions
  • The arrival of a new NED who asks the right questions and catalyses constructive debate
  • Discussions with the auditor regarding going concern qualifications in the audit report
  • Input from an external party or trusted advisor who has experience of turnaround situations

Wherever it comes from, some catalyst to a frank assessment of the current corporate position and the need for action may often be required. In my experience the recognition of the severity of the challenges ahead is more likely to come too late in the process rather than too early.

What are the turnaround costs?

In practice the later corrective action is taken the greater the turnaround costs will be. In the worst cases the only practical approach to rescue some value may be by the business entering into administration or insolvency, in which case shareholders in most cases lose their entire investment. For directors charged with fiduciary duties and corporate governance responsibilities this is unlikely to be a welcome result.

“The later corrective action is taken, the greater the turnaround costs.”

Why can the recovery costs be so high? The cash costs for purely proceeding with a restructuring can include:

  • Professional costs incurred by the business from accountants, lawyers and other consultants in respect of undertaking due diligence around current status and future forecasts of the business concerned so this can be provided to both the Board and other parties to assist them in their decisions
  • Professional costs in providing advice on actions to take to resolve the situation
  • Professional costs incurred by the other party (be they bank, other lender or pension fund) who need their own independent advice to determine whether they can accept any restructuring proposals
  • Costs of advice to Board members regarding their own personal liability
  • Fees for agreement of new banking or lending arrangements (probably with higher interest costs also attached)
  • M&A fees, where the solution involves selling or merging the business with another entity.

“Recent case where the total exceptional costs of the restructuring … exceeded 50% of total equity.”

These costs can be quite high as the work is often completed at speed in an uncertain environment where deadlines are approaching fast. There are also likely to be additional expense as follows:

  • Support costs for implementing short term cash forecasting disciplines (typically 13 week rolling cashflow forecasts) and driving cash improvement initiatives
  • Cash costs associated with implementing any operational improvements
  • Costs associated with closing down or disposing of elements of the business and exiting long term contracts
  • Accounting write downs (such as goodwill or intangible asset impairments).

To provide an illustrative order of magnitude I have seen a recent case where the total exceptional costs of the restructuring on both the continuing and discontinued business segments exceeded 50% of total equity pre-write downs. I have seen a wide range of comparable figures, both higher and lower than 50% in other situations over the last few years.

“Using some external party ………. can provide disproportionate value.”

Two key messages on turnarounds

I would leave you with two key messages to reflect on:

  • Using some external party, such as a trusted adviser, a new NED or someone with turnaround experience as a catalyst for debate at the Board can provide disproportionate value to all stakeholders if introduced early enough
  • It is more likely that restructuring costs can be constrained to lower amounts if a recovery process is instigated early, rather than at the last minute when the crunch point is in sight.