Risk Management
Chief Restructuring Officers: The Lender’s Secret Weapon
Auteur : Stanley Frieze
Du : 01/02/2006
Chief Restructuring Officers are turnaround managers: professionals experienced in determining a company’s longterm viability and options. As the number of bankruptcies continues to rise, lenders are helping their borrowers gain managerial expertise in the early stages of crisis by employing the services of such professionals.
Bad Times Call for Better Attitudes
These are scary times for lenders, and not just because every month
seems to bring a new headline-grabbing, record-setting Chapter 11 filing, from Enron to WorldCom to UAL Corporation to Conseco, Inc. The absolute number of bankruptcies also continues to swell. According to the American Bankruptcy Institute, bankruptcy filings by businesses and individuals are up 12% in the third quarter of 2002 over third quarter 2001, to 400,000, and 30% since third quarter 2000. The twelve months ended September 30, 2002 set the unenviable all-time record of 1,550,000 filings. And given
the ongoing flight of manufacturing, the wrenching cuts that still await troubled industries such as telecommunications and energy trading, the continuing negative economic effects of the September 11 terrorist attacks, and the ripple effects exerted by all these factors, things are certain to get much worse before they get better.
It’s true that these days, bankruptcy does not have to be a company’s
death sentence. Chapter 11 can be a much-needed time out for reflection, assessment and renewal — from the debtor’s point of view. Lenders, however, would prefer to salvage all the value they can from debtors on the way to a Chapter 11 filing. In fact, as opposed to flusher times when they were quick to pull the plug, smart lenders would much rather stave off bankruptcy for as long as possible. They understand that under current conditions it is far better to keep the debtor company alive and effect a successful reorganization. Therefore, lenders have grown much more flexible
in trying to restructure troubled loans rather than liquidating them — even, in some cases, to the extreme of taking equity in the debtor.
Good Managers for Bad Times
The most sophisticated lenders, though, are those that recognize that
a company can be saved long before it approaches the precipice. They
know that even in a business world of turbulent forces outside any company’s control, problems don’t just happen. Operational failures are the result of a history of poor management, of a pattern of poor decisions causing gradually deteriorating performance. The September 11 terrorist attacks devastated the entire airline industry, but the bankruptcy of United may have been avoided had it not been for a string of managerial miscues. The consequence of one disastrous managerial decision, the acquisition of Green Tree Financial Corporation, was enough to sink Conseco.
Lenders who are watchful for the warning signs of bad management
can intervene in time to turn things around. Increasingly, worried lenders are helping their borrowers gain objective managerial expertise in the early stages of crisis by unleashing a secret weapon: an objective, outside professional whose operational, strategic and interpersonal skills can set the company on the path to recovery — a chief restructuring officer, or CRO.
CROs are turnaround managers: professionals experienced in determining a company’s long-term viability and its options for maximizing value for shareholders. The CRO’s first order of business is operational: to get the company’s financial house in order the old-fashioned way. This means hands-on management of the working capital at every stage. CROs will slow down the outflow of payables and speed up the collection of receivables to get their hands around the cash flow. They will take control of the company’s physical capital, squeezing pockets of cash out of inventory and carefully
reviewing the state of equipment and physical plant. To be a CRO, a turnaround manager must indeed be an expert at restructuring debt. This operational expertise is ideally suited to calming the jittery creditor, who can gain some assurance that the company is being run with an eye to maintaining value. Since lenders recover more when a CRO is put in place to effect turnaround, it’s little wonder that they are demanding that troubled debtor companies take on a CRO — quite often, particularly those involving private and family-run businesses, against the will of company leadership.
Increasing Lenders’ Comfort Level
Along with operational excellence, the turnaround specialist’s paramount characteristic is complete objectivity and integrity. He must also bring superior analytical skills to bear. But the most important operational factor is the human component. CROs are parachuted into a chaotic and demoralizing situation and must win the confidence of employees and outside stakeholders.
CROs must calm their people and win their respect to motivate
top performance and teamwork.
The very same communication skills that CROs use to inspire confidence internally are even more vital in regaining the confidence of the outside world. In order to achieve their operational goals, CROs must maintain open lines of communication with stakeholders including vendors, suppliers and customers, keeping everyone on the same page. They must take particular care to cultivate excellent relationships with lenders of every kind.
Secured lenders, if alienated, can walk away with the company’s equipment. But unsecured lenders are no less important even though they lack such leverage. Trade creditors, for example, are unsecured lenders, and they are the company’s main suppliers as it tries to continue operations.
Thus, not only does the CRO have the interest of all classes of lenders uppermost in his mind, he is at pains to keep them aware of this fact.
When Should Lenders Call in a CRO?
What are the early warning signs of trouble? The classic scenario,
played out thousands of times in down conditions, looks something like this. A company does well for a period of time but, sooner or later it begins to show deteriorating trends. Cash flow tightens while inventory control loosens; the company begins to miss its targets consistently. Management will offer inconsistent explanations for sub-par performance, raising the suspicion that the current leadership does not fully understand business economics. As the company lags industry performance, worker morale plummets.
The analysts chime in, and suddenly there’s blood in the water.
Against this background, it’s a foolhardy lender who fails, these days, to take a searching look at its borrowers and ask:
• Are they late in producing their financial statements?
• Are their strategic plans (a) nonexistent? (b) based on faulty assumptions? (c) incapable of execution?
• Are they late in collecting money owed by customers?
• Is overhead too high and out of line in relation to operating profits?
• Is there too much inventory to finance? How slow moving or obsolete
is it?
• Are controls and procedures not in place or not being followed?
• Are their fill rates of customer orders low?
• Are their planning and production schedules poor?
If a borrower doesn’t measure up on these business fundamentals,
there may be trouble. But lenders need to tread lightly, at least in the early stages of the progression. The harder outsiders press, the greater the chance that management will get belligerent and defensive. Further, as with a medical diagnosis, one or more of these warning signs may be harmless — red signals, true, but with trivial underlying causes that can be quickly identified and addressed. But the more those red signals proliferate and
the more insistently they flash, the more likely it is that they signify serious managerial failings that lenders need to address for their own protection.
If there are problems with a borrower’s cash flow, strategy or reporting, lenders should begin thinking about suggesting the services of a turnaround manager. Late financial statements, in particular, are signals to the entire financial community that trouble may be afoot. And in particular, if a borrower should default on a loan covenant, the affected lender should insist on the
appointment of a CRO immediately, no if’s, and’s or but’s.
The CRO’s Relations with Existing Management
With a CRO on board, the CEO and other senior executives are free to oversee day-to-day business operations without the disruptive distraction of having to deal with the restructuring. Kmart, although it is in Chapter 11, provides an excellent recent example of the appropriate division of labor. Kmart’s new chairman, James Adamson, recruited restructuring executive Ronald Hutchison as CRO; Hutchison handles the bankruptcy dealings while Adamson oversees the big picture. Both executives help shore up relationships with anxious creditors and suppliers, staying in front of key constituencies by executing a bankruptcy communications plan and
keeping customers, employees, shareholders, vendors, suppliers, analysts and the media apprised of their progress.
How the CRO Deals with Obstinate Management
Unfortunately, existing management is not always as proactive and cooperative as Adamson. In fact, it is likely to provide the CRO with his biggest challenge. If the CRO has been imposed on a company by creditors or other outsiders, current managers are, naturally, likely to resist. When they are not in full-blown denial, they are likely to blame the company’s troubles on anybody but themselves. In the worst-case scenario, the company’s problems are, in fact, due to questionable or even illegal behavior on the part of the CEO, who may be feeding the CRO misinformation from the start.
Often, CROs will have to live with the recalcitrant CEO, persuading
him to sing from the same page. The key is to earn his respect, and the most reliable way to do this is through the calm demonstration of expertise. The CEO knows the industry; he doesn’t know the art of turnaround management. Seasoned CROs, who have been through dozens of turnarounds, will know the ropes, and their every action will reflect their experience. When the CEO sees competence, he is in a position to understand that the CRO is acting in the best interests of his company — and should respond accordingly.
The Special Case of Family-owned Businesses
In the small and family-owned companies most likely to have a CRO
imposed from outside, the CEO is a particular potential obstacle. He may well picture himself as the omnipotent godfather of the company, and will naturally be inclined to regard the CRO as a competitor, not just an interloper. With such an investment of self-image in the company, the godfather CEO is especially prone to denial and to reminiscing about long-departed good times. That’s all the more true when, as in the movies, the capo plans to keep the business succession in the family — a strategic plan usually
best confined to the movies.
In this situation the CRO’s “people skills” are tested to their fullest. He must show the CEO that he understands his situation. This requires experience. A freshly minted MBA just won’t cut it. He won’t be able to display the well-placed show of empathy needed to seal the CEO’s allegiance to unpleasant but necessary measures.
Conclusion
The turnaround expert is not a miracle worker. However, even with
the economy lurching ahead, most prior mismanagement is not quite that egregious, most situations are not quite that hopeless. By applying commonsense managerial principles (keep the cash flow positive; keep the company working together), the CRO can be a lender’s most effective recourse for salvaging value from today’s troubled companies.
Stanley B. Frieze is a founding partner of the Carl Marks Consulting
Group LLC. Frieze has 35 years experience in stabilizing and revitalizing under-performing and distressed companies with special emphasis on the following: leadership and organizational restructuring, efficiency improvement planning and implementation, debt restructuring and rationalization of scope of operations, facilities and product lines.
He served as interim CEO of 10 companies ranging in size from $10
million to over $1 billion and as consultant to owners, debt holders, financial institutions, trade creditors in over 50 different industries. Examples include the following: textiles & apparel, footwear, consumer products, telecom, electronics,
health and beauty aids, home furnishings, trucking, plastics, hardware, and security.
Frieze received both his BA and MBA from New York University. He is a Certified Management Consultant, and a member of the turnaround management Association and the American Bankruptcy Institute.
Related Articles
[15/05/2008] USB shuffles investment bank, beefs up risk management
[31/05/2007] Bally Total Fitness Reaches Agreement in Principle on Proposed Terms of a Consensual Restructuring With Holders of Senior Subordinated Notes
[08/05/2006] Changes at ISM, IGDA, THQ, ELSPA & More
Bad Times Call for Better Attitudes
These are scary times for lenders, and not just because every month
seems to bring a new headline-grabbing, record-setting Chapter 11 filing, from Enron to WorldCom to UAL Corporation to Conseco, Inc. The absolute number of bankruptcies also continues to swell. According to the American Bankruptcy Institute, bankruptcy filings by businesses and individuals are up 12% in the third quarter of 2002 over third quarter 2001, to 400,000, and 30% since third quarter 2000. The twelve months ended September 30, 2002 set the unenviable all-time record of 1,550,000 filings. And given
the ongoing flight of manufacturing, the wrenching cuts that still await troubled industries such as telecommunications and energy trading, the continuing negative economic effects of the September 11 terrorist attacks, and the ripple effects exerted by all these factors, things are certain to get much worse before they get better.
It’s true that these days, bankruptcy does not have to be a company’s
death sentence. Chapter 11 can be a much-needed time out for reflection, assessment and renewal — from the debtor’s point of view. Lenders, however, would prefer to salvage all the value they can from debtors on the way to a Chapter 11 filing. In fact, as opposed to flusher times when they were quick to pull the plug, smart lenders would much rather stave off bankruptcy for as long as possible. They understand that under current conditions it is far better to keep the debtor company alive and effect a successful reorganization. Therefore, lenders have grown much more flexible
in trying to restructure troubled loans rather than liquidating them — even, in some cases, to the extreme of taking equity in the debtor.
Good Managers for Bad Times
The most sophisticated lenders, though, are those that recognize that
a company can be saved long before it approaches the precipice. They
know that even in a business world of turbulent forces outside any company’s control, problems don’t just happen. Operational failures are the result of a history of poor management, of a pattern of poor decisions causing gradually deteriorating performance. The September 11 terrorist attacks devastated the entire airline industry, but the bankruptcy of United may have been avoided had it not been for a string of managerial miscues. The consequence of one disastrous managerial decision, the acquisition of Green Tree Financial Corporation, was enough to sink Conseco.
Lenders who are watchful for the warning signs of bad management
can intervene in time to turn things around. Increasingly, worried lenders are helping their borrowers gain objective managerial expertise in the early stages of crisis by unleashing a secret weapon: an objective, outside professional whose operational, strategic and interpersonal skills can set the company on the path to recovery — a chief restructuring officer, or CRO.
CROs are turnaround managers: professionals experienced in determining a company’s long-term viability and its options for maximizing value for shareholders. The CRO’s first order of business is operational: to get the company’s financial house in order the old-fashioned way. This means hands-on management of the working capital at every stage. CROs will slow down the outflow of payables and speed up the collection of receivables to get their hands around the cash flow. They will take control of the company’s physical capital, squeezing pockets of cash out of inventory and carefully
reviewing the state of equipment and physical plant. To be a CRO, a turnaround manager must indeed be an expert at restructuring debt. This operational expertise is ideally suited to calming the jittery creditor, who can gain some assurance that the company is being run with an eye to maintaining value. Since lenders recover more when a CRO is put in place to effect turnaround, it’s little wonder that they are demanding that troubled debtor companies take on a CRO — quite often, particularly those involving private and family-run businesses, against the will of company leadership.
Increasing Lenders’ Comfort Level
Along with operational excellence, the turnaround specialist’s paramount characteristic is complete objectivity and integrity. He must also bring superior analytical skills to bear. But the most important operational factor is the human component. CROs are parachuted into a chaotic and demoralizing situation and must win the confidence of employees and outside stakeholders.
CROs must calm their people and win their respect to motivate
top performance and teamwork.
The very same communication skills that CROs use to inspire confidence internally are even more vital in regaining the confidence of the outside world. In order to achieve their operational goals, CROs must maintain open lines of communication with stakeholders including vendors, suppliers and customers, keeping everyone on the same page. They must take particular care to cultivate excellent relationships with lenders of every kind.
Secured lenders, if alienated, can walk away with the company’s equipment. But unsecured lenders are no less important even though they lack such leverage. Trade creditors, for example, are unsecured lenders, and they are the company’s main suppliers as it tries to continue operations.
Thus, not only does the CRO have the interest of all classes of lenders uppermost in his mind, he is at pains to keep them aware of this fact.
When Should Lenders Call in a CRO?
What are the early warning signs of trouble? The classic scenario,
played out thousands of times in down conditions, looks something like this. A company does well for a period of time but, sooner or later it begins to show deteriorating trends. Cash flow tightens while inventory control loosens; the company begins to miss its targets consistently. Management will offer inconsistent explanations for sub-par performance, raising the suspicion that the current leadership does not fully understand business economics. As the company lags industry performance, worker morale plummets.
The analysts chime in, and suddenly there’s blood in the water.
Against this background, it’s a foolhardy lender who fails, these days, to take a searching look at its borrowers and ask:
• Are they late in producing their financial statements?
• Are their strategic plans (a) nonexistent? (b) based on faulty assumptions? (c) incapable of execution?
• Are they late in collecting money owed by customers?
• Is overhead too high and out of line in relation to operating profits?
• Is there too much inventory to finance? How slow moving or obsolete
is it?
• Are controls and procedures not in place or not being followed?
• Are their fill rates of customer orders low?
• Are their planning and production schedules poor?
If a borrower doesn’t measure up on these business fundamentals,
there may be trouble. But lenders need to tread lightly, at least in the early stages of the progression. The harder outsiders press, the greater the chance that management will get belligerent and defensive. Further, as with a medical diagnosis, one or more of these warning signs may be harmless — red signals, true, but with trivial underlying causes that can be quickly identified and addressed. But the more those red signals proliferate and
the more insistently they flash, the more likely it is that they signify serious managerial failings that lenders need to address for their own protection.
If there are problems with a borrower’s cash flow, strategy or reporting, lenders should begin thinking about suggesting the services of a turnaround manager. Late financial statements, in particular, are signals to the entire financial community that trouble may be afoot. And in particular, if a borrower should default on a loan covenant, the affected lender should insist on the
appointment of a CRO immediately, no if’s, and’s or but’s.
The CRO’s Relations with Existing Management
With a CRO on board, the CEO and other senior executives are free to oversee day-to-day business operations without the disruptive distraction of having to deal with the restructuring. Kmart, although it is in Chapter 11, provides an excellent recent example of the appropriate division of labor. Kmart’s new chairman, James Adamson, recruited restructuring executive Ronald Hutchison as CRO; Hutchison handles the bankruptcy dealings while Adamson oversees the big picture. Both executives help shore up relationships with anxious creditors and suppliers, staying in front of key constituencies by executing a bankruptcy communications plan and
keeping customers, employees, shareholders, vendors, suppliers, analysts and the media apprised of their progress.
How the CRO Deals with Obstinate Management
Unfortunately, existing management is not always as proactive and cooperative as Adamson. In fact, it is likely to provide the CRO with his biggest challenge. If the CRO has been imposed on a company by creditors or other outsiders, current managers are, naturally, likely to resist. When they are not in full-blown denial, they are likely to blame the company’s troubles on anybody but themselves. In the worst-case scenario, the company’s problems are, in fact, due to questionable or even illegal behavior on the part of the CEO, who may be feeding the CRO misinformation from the start.
Often, CROs will have to live with the recalcitrant CEO, persuading
him to sing from the same page. The key is to earn his respect, and the most reliable way to do this is through the calm demonstration of expertise. The CEO knows the industry; he doesn’t know the art of turnaround management. Seasoned CROs, who have been through dozens of turnarounds, will know the ropes, and their every action will reflect their experience. When the CEO sees competence, he is in a position to understand that the CRO is acting in the best interests of his company — and should respond accordingly.
The Special Case of Family-owned Businesses
In the small and family-owned companies most likely to have a CRO
imposed from outside, the CEO is a particular potential obstacle. He may well picture himself as the omnipotent godfather of the company, and will naturally be inclined to regard the CRO as a competitor, not just an interloper. With such an investment of self-image in the company, the godfather CEO is especially prone to denial and to reminiscing about long-departed good times. That’s all the more true when, as in the movies, the capo plans to keep the business succession in the family — a strategic plan usually
best confined to the movies.
In this situation the CRO’s “people skills” are tested to their fullest. He must show the CEO that he understands his situation. This requires experience. A freshly minted MBA just won’t cut it. He won’t be able to display the well-placed show of empathy needed to seal the CEO’s allegiance to unpleasant but necessary measures.
Conclusion
The turnaround expert is not a miracle worker. However, even with
the economy lurching ahead, most prior mismanagement is not quite that egregious, most situations are not quite that hopeless. By applying commonsense managerial principles (keep the cash flow positive; keep the company working together), the CRO can be a lender’s most effective recourse for salvaging value from today’s troubled companies.
Stanley B. Frieze is a founding partner of the Carl Marks Consulting
Group LLC. Frieze has 35 years experience in stabilizing and revitalizing under-performing and distressed companies with special emphasis on the following: leadership and organizational restructuring, efficiency improvement planning and implementation, debt restructuring and rationalization of scope of operations, facilities and product lines.
He served as interim CEO of 10 companies ranging in size from $10
million to over $1 billion and as consultant to owners, debt holders, financial institutions, trade creditors in over 50 different industries. Examples include the following: textiles & apparel, footwear, consumer products, telecom, electronics,
health and beauty aids, home furnishings, trucking, plastics, hardware, and security.
Frieze received both his BA and MBA from New York University. He is a Certified Management Consultant, and a member of the turnaround management Association and the American Bankruptcy Institute.
Related Articles
[15/05/2008] USB shuffles investment bank, beefs up risk management
[31/05/2007] Bally Total Fitness Reaches Agreement in Principle on Proposed Terms of a Consensual Restructuring With Holders of Senior Subordinated Notes
[08/05/2006] Changes at ISM, IGDA, THQ, ELSPA & More