Three Stages of Distress

Three Stages of Distress

Act Early. Your Company’s Future May Depend on It

(February 2019)  For many small to mid-sized companies, there is a growing storm led by dramatically changing consumer behaviors, rising interest rates, domestic and international political turmoil and trade disputes, disruptive technologies and a slowing global economy. 

If your business is (or might be) negatively affected by these influences, it’s critical to acknowledge that your company is at risk and create a plan to deal with it. 

Companies that act early, preferably with the help of an outside professional, are much more likely to successfully navigate through troubled times and benefit from the encouragement and support of key stakeholders (investors, lenders, landlords, etc.). 

Those that do not act, or fail to act soon enough, will find themselves falling further and further behind while slowly, but surely, losing the support of their key stakeholders. The time-adjusted risk profile for underperforming companies is not linear  – it worsens geometrically the longer the situation remains unresolved.    

So when is the right time to do act?  And what do you risk by not acting soon enough?

In January 2018 I published an article (“Point A to Point B”)* about distressed companies.  In that article, I defined the “Runway” as the period of time that begins when a company first experiences performance issues and, without an intervention, could ultimately end in a business failure.

This follow-up article breaks the Runway into three easily recognizable stages to help owners and senior executives of underperforming companies gauge where they are on the Runway and the implications that has for the company’s long-term financial health. 

Stage 1: Early Warning Signs.  Here are the most common indicators of early trouble:

  • Coming up short on the Business Plan
  • Losing Availability on a Line of Credit
  • Extending supplier/vendor payables
  • Discounting invoices to accelerate cash receipts
  • Deteriorating fill rates; Loss of a Key Customer
  • Declining selling and operating margins
  • Increasing pressure from competitors; grapevine whispers about the company’s viability
  • Increasing employee turnover

While any one of these might be overlooked as insignificant or temporary, identifying and addressing these early warning signs allows management to head off more severe consequences that usually follow during a time when there is still full control over the business and support from key constituents.   Culturally, this is also a good time to reassess the company’s business strategy and consider options for more fundamental transformational changes.  Failing to act early can easily lead to Stage 2.

Stage 2: Liquidity Crisis

Stage 2 is a dangerous tipping point.  In this stage companies begin to default on bank covenants.  Lenders reduce availability to mitigate their exposure, often demanding the company bring in outside advisors or give the company a deadline to refinance with another lender.  Vendors begin requiring deposits with purchase orders (or worse, cash in advance).  Loss of availability leads to inventory imbalances and an inability to ship in full and on time. Companies that in better times mastered just-in-time inventory management will be the worst hit as replenishment comes to a halt virtually overnight.

This is typically the time when ownership and management shift their focus away from running the business to conserving cash, which counter-intuitively puts the company at even greater risk with their customers.  They contemplate changing lenders and/or raising more capital, but that is often a fool’s errand since lenders and/or investors willing to jump into a liquidity crisis will take their pound of flesh in the form of outsized fees, interest costs and dilution. At best, it’s a short-term fix.  At worst, it’s the last nail in the coffin.

Board members may begin to doubt the capabilities of current management to bring the company through the crisis.

All of these Stage 2 issues contribute to a more severe and accelerating downward spiral towards Stage 3, where the very survival of the business is at stake.

Stage 3: Disruption, Intervention and Loss of Control

Companies that reach Stage 3 are most likely to emerge as a significantly restructured company, if they emerge at all.  At this point, the company is in a full-blown liquidity crisis with concerns about meeting payroll.  It might begin deferring executive pay and cannibalizing inventory to generate desperately needed cash.  The wave of departing employees and key executives is growing.  Customers now worry about deposits and warranty coverage. Competitors are openly and aggressively pursuing your customers.  Lenders, who are already watching cash on a weekly basis, may trade their debt as a stop-loss, bring new, unfriendly parties to the table.

Legal counsel is brought in as decisions must be made to go down the path of a fire sale, out-of-court reorganization or formal bankruptcy, all of which will inflict significant pain on all stakeholders.  Key constituents retain their own legal counsel, adding to the cost and confrontational nature of the process.  Company and management reputations are tarnished.  The cost of this process is enormous.  Many companies in Stage 3 do not have the resources to achieve a restructuring and end up in an orderly liquidation.

With economic headwinds building, now is the time to assess and prepare.  To explore your options click the link below to schedule a confidential, no-cost consultation:

Schedule a Call

About Gary Nacht and Synergy Enterprises, LLC

As the principal of Synergy Enterprises, LLC, I’ve been acquiring, advising and turning around distressed and underperforming companies for over 25 years, from start-ups to over $1b in revenue across a diversity of industries and channels, including retail, wholesale, manufacturing and distribution.  Specialties include holistic strategic business planning, sophisticated financial modeling for management, lenders and investors, operational execution, key executive and vendor negotiations, incentive planning, product development, sourcing, supply chain, debt financing and equity capital sourcing with pitch books and private placement memorandums. I am also active as an executive coach, board member, educator, public speaker and more.

For more information, please contact:

Gary Nacht, Principal
gnacht@synergyllc.net
O: (561) 264-2570
M:  (732) 406-0377

*(“Point A to Point B”) – The Most Critical Phase of an Underperforming or Distressed Company)