Archive for July 20th, 2011

 A Guest Blog by Bobby Guy, Author, “Distress to Success: A Survival Handbook for Struggling Businesses and Buyers of Distressed Opportunities” (www.distresstosuccessbook.com; www.distresstosuccessblog.com)

When it comes to business, we all know the easy signals that indicate a company is in financial distress: a loan default, a business plan that just isn’t working, failed FDA trials at a one-product company, and the like.  For business owners though, the harder issue is to spot the more subtle internal warning signs of financial distress — and then to take corrective action while the best options are still available.

What are important warning signs that business owners should watch for at their companies? Here are ten examples:

  • When the company is having to float taxes or trust funds to pay other expenses (vendor obligations are one thing, but unpaid taxes and trust funds can result in personal liability for officers and directors)
  • When the company is bumping up against covenant requirements on its loans (even if it hasn’t blown a covenant yet, and even if the lender and preferred equity don’t know it yet)
  • When the company can’t meet the conditions to sign the draw request on its working capital line (and remember, the  reason lenders require representations and draw request certificates is because officers have potential personal liability for signing a materially false request)
  • When the company cannot come up with a cash flow forecast, or its forecast is negative after considering all available cash and credit sources — said another way, when the burn rate is higher than projected cash and there is no reasonable expectation of change prior to exhaustion of all available capital (many companies fail not because of a bad business idea, but because they have a cash crunch, or lack the financial controls to do accurate cash forecasting)
  • When the company’s team cannot tell senior managers the company’s current financial position within about four business hours (you might be surprised, but I’ve seen companies with hundreds of millions in loans and assets that were unable to calculate their current financial position at all — is it $0? Is it positive? Is it negative?)
  • When there is any doubt about the company being able to make the next FOUR payrolls (that’s right, not one, but four – missing a payroll is often the death of a company, and if the next payroll is the problem, the financial distress process is acute and early warning signs are no longer the issue)
  • When the company and affiliates are using restricted acquisition capital to pay working expenses (as an example, when the company’s  source of cash to pay expenses on current assets is money borrowed on new deals which has restricted use; more than an early warning sign, this may also have certain legal implications, but for our purposes here, the importance is that the company is having to tap restricted sources to stay afloat)
  • When viability of the company is based on a single definable event, and there is a reasonable likelihood the event won’t take place (realize this is the definition of when a company begins undergoing a “restructuring,” and often companies do not recognize they are in a restructuring until long after it has begun)
  • When the company is having explosive growth, but has limited working capital to fund it (the definition of working capital is the amount of money it takes to stay alive in Monopoly until your property begins generating income or you pass go to collect $200; just like in business, working capital needs increase in Monopoly as the gameboard builds up with more expensive rent;  also, if you draw the “Chance” card requiring you pay for repairs, the expense is a fee multiplied by the number of properties/hotels you own — so your capital needs increase based on the growth of the business)
  • When the company’s lender asks the company to hire a financial advisor, or transfers the company’s loan into  special assets (realize there is no requirement that the company be in default before the bank brings in the special assets department; banks look for early warning signs, and often recognize the signs that their borrowers are in trouble before management teams are ready to acknowledge it)

How should a company’s management respond if it begins to see these signs?  If a company takes quick action, its probability of success, and ability to avoid failure, increases dramatically.  Management also has the opportunity to present itself as part of the solution.  Early intervention is key, and when a company sees the signs, it needs to begin contingency planning — preparing multiple potential exit strategies and solutions, instead of relying simply on the original plan of uninterrupted success.

Bobby Guy

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