Emotional Restructuring: The Sink and Drown Approach

by Florian Meyer

When you finally admit to yourself that your business is in trouble, you also have to admit to yourself that it was probably something you’ve done wrong that has left you in this position. And, you have to admit that fixing it will require you to make some emotionally difficult changes. Dr. Phil says, “If you keep on doing what you’ve been doing, you’ll keep on getting what you got”.

But, it’s not always easy to see what you did wrong. And, when creditors are climbing all over you, it’s even more difficult to rationally identify what you need to change to solve the problem. “When you’re up to your neck in alligators, it’s hard to remember that your original goal was to drain the swamp.”

Outside Help

Admitting that you need unemotional, objective, outside advice from someone with more experience at helping distressed businesses recover is a good first step.

Perhaps you’ve engaged consultants in the past only to end up feeling like you’ve paid them to tell you what you already know. As the joke goes, “When you ask consultants for the time, they’ll grab your wrist and tell you what time your watch says it is”.

The right consultant won’t tell you what you already know nor tell you what you necessarily want to hear. That’s just another version of “doing what you’ve been doing”. You can’t fix a problem you refuse to acknowledge. The solution begins by casting off that sense of failure, those feelings of guilt and self-blame over your inability to repay all your debts, and by committing yourself to taking those hard-to-swallow pills prescribed by your “business doctor”.

Chief Restructuring Officer

That “doctor” is usually referred to as a Chief Restructuring Officer (CRO). CROs specialize in healing distressed businesses. It’s important to remember that yours is not the first business they’ve helped recover from a tough financial dilemma. And, you have to remember that you’re paying them to tell you the unvarnished, painful truth and for recommending proven methods that have helped others in similar financial straits.

Yet, even the most experienced and successful CRO’s can lose the battle when their clients refuse to emotionally accept the forthright, unbiased recommendations that have worked so well for others. The most perplexing and frustrating challenge is the client who pays for a CRO’s well-founded advice and then chooses to ignore it completely. Isn’t that just another version of “doing what you’ve been doing?” You can throw a drowning man a life ring, but he has to choose to reach for it.

Case Study

In one particular case, we were asked to help a client after the bank moved its account to the Special Loans Department (for distressed companies). By the time we were engaged, its future was already looking very bleak.

The business was founded and successfully operated by the same family for over fifty years and distributed its products nationwide. However, the current family members who managed it were in positions that did not really suit their skills and abilities. Ineffective management that went uncorrected for too long progressively eroded the company’s financial health. Some were encouraged to move into positions that better suited their individual talents. Others, who decided to resign, were offered career counselling and financial support. The remaining family members were supported by existing professional managers and further strengthened by promoting other staff from within and hiring other managers from outside.

Creditor Proposal

Even with the improved management restructuring, we knew that the company could not survive unless it could jettison some of the debt from its very weak balance sheet. Rather than being forced into outright bankruptcy, the better approach for the company (and for its creditors) was to submit a Creditor Proposal under the Bankruptcy Act.

Suppliers had provided a lot of product (inventory) on credit. But, that inventory proved to be unsalable. Much of it had to be severely discounted or written off completely. A Creditor Proposal would, in effect, acknowledge that the unsecured creditors would have to share in the losses from the non-marketable inventory by accepting a reduced payment for those items over a number of years. The alternative was to receive nothing at all as the company slid into bankruptcy. Air Canada, among other notable companies, put itself through a Creditor Proposal, and is now reporting record profits.

When we proposed this option to the family members, they would not for an instant consider it nor investigate it as the logical and best approach for all parties involved. We threw them their life ring, and they chose not to reach for it.

Plan B

Instead, they went to one of the larger suppliers and asked for time to pay off their debt in return for an ownership position in the family-owned business. Consultants can only recommend – they can’t ultimately decide for their clients. If the family was adamant about taking this approach, we could only recommend that they offer only a minor ownership percentage that would allow the family members to retain control of the business.

Under the completely legal and frequently utilized Creditor Proposal, a company’s equity position is not compromised in any way. It would have left the family still owning 100% of the business. After the proposal had been fully paid off, the company would be in a much stronger financial position. The bank would most likely have removed its unfavourable Special Loans status, and it would clearly be worth a lot more should the family later decide to sell all or part of their business.

Instead of reaching for the life ring that would pull it to safety, the family, in its panic, grabbed an anchor that would pull the business, and them with it, to the bottom.

Tough Terms

They chose, instead, to offer the supplier a 45% ownership in the business with no additional cash injection or investment. The supplier modified the offer and accepted a 50% interest with immediate voting control over the business. AND, it included an option to take 100% control of the business.

The supplier take-over did nothing to strengthen the company’s financial position. It was still left facing very tough financial and operating decisions. The supplier had effectively used a previously written-off bad debt to acquire another company with no additional expenditure of cash. It then assumed complete control of its operations and moved it to a new location. The one family member that the new owner continued to employ was demoted from his senior position to a minor mid-level management job on a very short leash.

The Outcome

Jumping forward 18 months, we read in the business section of a national newspaper that the business was sold for over $30,000,000, and the original family members did not receive one penny from it. They were scraped away with only partial proceeds from the building they owned, and the last employed family member was asked to leave with a small severance.

Subsequently, the family came back to us and asked, “Why didn’t we listen to you about that Creditor Proposal?”

And, all we could say was, “Yes – why didn’t you?”

Florian Meyer is resourceful and imaginative Chief Restructuring Officer (CRO) who maximizes the benefits of restructuring for the business. As a client recently said, “You never give up until a great solution has been developed and implemented.”

Florian has an MBA and CPA, CA and is a Principal of Newhouse Partners Inc. He has been consulting as interim CFO and CRO to a number of private and public companies since 1996, You can reach Florian at fmeyer@newhousepartners.com or 416-873-868 . You will find more details on www.newhousepartners.com .