Show Me The Money

 

 

There has been much written recently about companies handing out year-end bonuses after the recent tax cut legislation was signed prior to Christmas.

Many mega companies such as ATT, Walmart, Alaska Airlines, American Airlines, Comcast and others, proudly announced that they were giving employees an unexpected year- end bonus.

Some of the same companies also announced an increase in hourly wages as well.

While this has been viewed as positive for those receiving this unexpected gift, it is estimated only 1% of companies in the US gave out year-end bonuses.

Many pundits and economists are asking the question, why are more companies not sharing the potential upside of the upcoming tax breaks.

They are also asking why more companies are not giving wage increases in lieu of one-time bonuses. “As a worker, it’s great to get a one-off bonus, but that doesn’t guarantee anything for the next year,” said Stephen Stanley, chief economist at Amherst Pierpont. “You’d rather have the raise, because next year you’re working off the higher base.”

While one-time bonuses are nice, they are just that, one-time bonuses, with no commitment to employees that companies will share any future upside with their rank and file workers.

This makes it more difficult for individuals to plan for family finances. It also makes if difficult to help them deal with the current and looming impact of inflation.

Korn Ferry, an international recruiting and human resource firm, predicted that wages in the US will not change from 2017, where average pay increased 1% adjusted for inflation.

The issue of giving permanent wage increases is more pronounced for middle market companies, as they have higher risk of regional cycles and downturns than larger national or international companies that have significant financial resources.

Middle market and particularly lower middle market companies have more vulnerability to market fluctuations when they lock in permanent wage increases year over year.

This is especially true in highly cyclical industries where they are required to hire additional employees to keep up with demand and to conduct a significant layoff when business turns down.

This hire and fire cycle in fact creates more uncertainty within the ranks, particularly during the layoff cycle. When this happens, productive or highly skilled workers are likely to leave regardless to find a position in a more stable company.

In our practice we find that our client companies are constantly struggling with keeping the right balance of staffing levels. They usually over react by hiring more workers in an up cycle than is required, and in a down turn, are not focused on improving productivity first and then downsizing to the appropriate level.

Given the challenge that lower middle-market companies face with balancing the demand of retaining workers and continuing to operate a profitable business, there is an approach we have implemented successfully with our clients that mitigates this challenge.

First of all, it is important to develop a compensation plan that works for the long term. We believe that a long-term incentive plan should be developed that is focused on accomplishing the company’s profit objectives.

Establishing an incentive plan that is focused on achieving or exceeding quarterly profit targets typically is a significant motivating factor.

A certain % increase in base pay for the quarter can be established for achieving the stated objective. If the company exceeds the quarterly target, an accelerating % increase can be established that rewards everyone for an increase in performance.

The accelerator can be fashioned in several different ways depending on the long-term compensation strategy, using different tiers based on the increase over targeted performance.

Obviously, if the quarter target is not achieved, there can be a graduated reduction in the targeted incentive percentage and at some point, no one receives an increase.

The key factor is to establish frequent evaluation points to provide more frequent motivation.

There are many elements that must be factored into developing an incentive compensation plan, however this concept has many advantages.

The main advantage is that everyone is working together to achieve the company’s profit objective and understands that if objectives are exceeded there is an upside.

The most important element is including all employees, including executives, and communicating the program at the beginning of the year.

Laying out the plan in clear understandable terms is important to ensure everyone is on the same page.

It’s also important to frequently update everyone on where the company stands in achieving its goals and to pay the incentive quarterly for each quarter it is achieved.

Using the plan as a motivator to improve performance is key.

Establishing a variable incentive plan to mitigate the up and down cycles of a business is important for the long-term health of a company and its employees.

Not only does it turn pay increases into a variable cost, it can be a huge motivator for the entire staff having everyone working together to accomplish the company’s goals.

 

Revitalization Partners is a Northwest business advisory and restructuring management firm with a demonstrated track record of achieving the best possible outcomes for our clients. And now, we’ve written a book to help our readers understand the issues facing their businesses. You can find this compilation of our business thoughts at:
http://revitalizationpartners.com/we-could-write-a-book/ or on Amazon.

We specialize in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations.

Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Success?

 

 

Welcome to 2018, This year Revitalization Partners celebrates its 15th year in business.

We began writing our blogs about 6 years ago and this is the first one of the New Year.

These blogs are generally based on our experience or on the experience we read or hear about that we believe will be valuable to share.

This Holiday Season, I received a drone for the Holidays. It is not a toy, but a sophisticated aerial photography platform. OK, it’s an adult toy.

And after spending three days following instructions, sending messages to technical support and looking at every you tube video I could find, nothing.

Some of the software said it should be working, but the drone didn’t sync-up with the software.

The company, located in China has 70% of the world-wide drone market and about 80% of the higher end consumer market. It has revenues of $1.5 billion in a market that is growing about 30% a year.

Some of their products work perfectly fine and others, well, the comments on the forums and comment boards are tough. “Two-thousand-dollar piece of crap.” Is one of the milder ones.

That led us to thinking, how many market leading companies that we knew have had great success and then lost the market. Some based on their performance; others so enamored with their success that they missed changes in the industry and others that just stopped listening to their customers.

Digital Equipment Corporation was founded in 1957 making digital cards for the controller industry. At its peak, the company had $14 billion in sales and employed 130,000 people worldwide. It was recognized as the second largest computer company in the world.

Yet, by 1998, it was sold to Compaq Computer after sustaining over $200 million in losses that year.  So, what happened? As DEC invented the minicomputer model when computers meant “mainframes”, it became so attached to the success of that business model, it failed to recognize the impact of the microprocessor and the impact it would have on the computer business.

In fact, Ken Olsen, the founder and CEO of DEC is famously quoted as stating: “Why would anyone want a computer in their home?” And with that, the company’s fate was sealed.

IBM, a larger company with a longer business history, recognized the potential of the market and was able to break free of its traditional business model, sending a small group off to Florida where they figured out how to make a microcomputer for under $2000 with 20% margins.

The PC created an industry. DEC no longer exists.

These lessons don’t only apply to the fast-moving technology industry. Sears, founded in 1898, was the major retailer in America from its founding. By 1895, the famous Sears catalog was 532 pages and contained everything from dolls to houses. In the early 1900’s you could order a complete house package including appliances and have it delivered to your door.

And yet, by 2017, all Sears had left was basically a few stores and real estate. It had sold off its premium product lines such as Whirlpool and Craftsman, as well as most other assets. The company has gone from 3500 physical stores to a projected total of 680 in 2018. Sales peaked in 1992 at $59 billion and by 2016, sales were down to $22 billion and dropping. In contrast, Amazon, which was founded in 1994 achieved $136 billion in sales in 2016.

What are the lessons to be learned for the rapidly growing drone company and others with major market positions?

1. Watch out for disruptive innovations. These are not just technical innovations, but business model and customer service disruptions.   In technology, the technical disruption was the microprocessor which so simplified the design of a computer that they could be developed and sold by almost any company.

2. Business disruptions did more to sink DEC than technical disruptions. DEC had microprocessors, but their business model could not bring the technology to the market in a rapid and cost-effective way.  In the case of Sears, the problem was not technology, but a changing business model based on consumer tastes and on-line shopping.  Like DEC, they could not accommodate the paradigm shift of the market.

Edger Schein, professor emeritus at the MIT Sloan School argues that a corporation’s founding values, if they lead to success, tend to ossify as a set of tacit assumptions about successful strategy. 

When the business environment shifts, the organization may not be able to adapt, rejecting plans or ideas that don’t fit its preconceived notions. The illusion that organizations can control their own fate stems from the failure to understand how technology and culture limit what is possible.

You don’t have to be a market leader to take Schein’s words to heart. Companies with any degree of success develop those assumptions.

If you are a founder or manager of a successful company, continuing that success is dependent on your ability to see the change coming and act on it.

By the way, the drone is now working.

 

Revitalization Partners is a Northwest business advisory and restructuring management firm with a demonstrated track record of achieving the best possible outcomes for our clients. And now, we’ve written a book to help our readers understand the issues facing their businesses. You can find this compilation of our business thoughts at:
http://revitalizationpartners.com/we-could-write-a-book/ or on Amazon.

We specialize in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations.

Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Thank You

 

 

To all of our readers, those who have commented on our writing, have reproduced our blogs in your businesses and become our valued clients, a sincere “Thank You” for your participation. We hope that, in some way, we have been helpful in 2017.

As we enter 2018, all of us at Revitalization Partners want to wish all of you the best of holiday’s and a very successful New Year. We look forward to picking up our blog posting after the first of the year.

All of the very best,
Al, Bill and all of our RP Associates

 

Revitalization Partners is a Northwest business advisory and restructuring management firm with a demonstrated track record of achieving the best possible outcomes for our clients. And now, we’ve written a book to help our readers understand the issues facing their businesses. You can find this compilation of our business thoughts at:
http://revitalizationpartners.com/we-could-write-a-book/ or on Amazon.

We specialize in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations.

Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Examining the Next Credit Cycle

 

 

It is generally incorrectly assumed that business cycles arise out of the free market system.

But rather they are the consequence of the expansion and contraction of using unsound money and credit.

Since 2013, an average of 37 private credit funds has raised $22 billion of capital every quarter and this trend shows little sign of slowing.

By the start of Q3, there were more than 300 private debt funds actively raising in excess of $130 billion in capital; 60% targeting North America.

 

Middle Market Credit Expansion …

No segment of the debt capital markets has grown or evolved more than middle market credit.

The dramatic increase in the number of lenders and the capital allocated to middle market direct lending, has increased the competition for loans. 

This increased competition for loans has led to compressed yields and very borrower-friendly structures with minimum or no covenants and relaxed due diligence.

 

Boom and Bust Cycles …

However, the credit cycle is a repetitive boom and bust phenomenon. The bust is the market’s way of eliminating unsustainable debt created through credit expansion. 

If the bust does not occur, trouble accumulates for the next business and credit cycle.

Traditional lenders (banks) have also benefited from the current market expansion.  Competition for new loans, increased liquidity at traditional lenders, and an increased appetite for middle-market loans has moderated problems within traditional bank portfolios; a trend that is likely to continue.

Risk has shifted from banks to private lenders as challenged loans that no longer have a home within banks are often able to find financing from private lenders.

 

A Story To Tell …

Private lenders are often more selective than traditional banks. 

These lenders are often industry and geographic specific, and these challenged loans are very often storied credits. 

Long before attempting to broadly “shop” a loan such as this, it is critical to make certain that the underlying company has a story to tell that will be received by the lender.

Knowing the characteristics of the lender is critical lest the loan becomes “shopworn”.

 

Next Crisis Trigger?

Today, economic distortion from the past economic crisis have accumulated to the point where only a small rise in interest rates will be enough to trigger the next crisis.

When the next restructuring cycle arrives, whenever that may be, it will be met by a lending ecosystem that is significantly different than during the last financial crisis.

This means that the majority of the issues are likely to be concentrated with the private lenders.

At first blush, the result seems to be a market share shift in favor of traditional banks owing to a shift in the underlying liquidity of traditional banks as compared to private lenders.

 

Who Absorbs Troubled Credits?

As banks look to resolve challenged credits within their portfolio, the refinancing or secondary sale of a debt position to an private lender is likely to be more challenging given that the alternative lender sphere will be dealing with problem credits of their own, and will be less interested in absorbing more troubled credits.

Without the private lender relief valves, banks will resort to traditional approaches to work out – rehabilitation or monetization through a sale of the company.

In the event of a sale of the company, the post-sale financing will be more likely to be provided by a traditional bank lender, again owing to the relative liquidity position of bank lenders.

 

A Change In Control …

Credit resolution situations in alternative-lender portfolios will also be more likely to result in a change of control and (for the same reasons cited above) the post-sale financing will be increasingly likely to be provided by traditional bank lenders rather than private lenders.

A deeper analysis of the impact of the next cycle casts some doubt, however, that bank lenders are set to regain market share. 

In recent years, another interesting trend has emerged, which could serve to couple the fate of credit funds and banks.  Banks have made loans to alternative lenders at the portfolio level.

If the next credit cycle is significant, these loans may serve as a conduit for distress for private lenders looking to their way into the traditional bank market as well.

The result will be an across-the-board reduction in liquidity, akin in many ways to the last financial crisis.

 

Must Have A Plan …

What does this mean for middle-market companies?  If you have a solid banking relationship, have a discussion as to how your relationship may change during a business downturn.

Before having that discussion, it is critical to have a plan for how you will, under those circumstances, meet your credit obligations.

If you have a “storied credit” and are seeking new credit relationships, make certain that you work with an advisor that both understands your situation and has relationships with both banks and alternative lenders to maximize your loan opportunities.

The next credit downturn is coming, despite the current credit boom. Enjoying the boom while being prepared for the bust may make the difference between success and failure of your company.

 

Revitalization Partners is a Northwest business advisory and restructuring management firm with a demonstrated track record of achieving the best possible outcomes for our clients. And now, we’ve written a book to help our readers understand the issues facing their businesses. You can find this compilation of our business thoughts at:

http://revitalizationpartners.com/we-could-write-a-book/ or on Amazon.  We specialize in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations.

Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Happy Thanksgiving

 

Today would be the day for another blog from Revitalization Partners.

But, since we and many of our readers are beginning the Thanksgiving holiday, we wanted to take this opportunity to thank all of you for reading and commenting on our blog.

We wish you the Happiest of Thanksgiving holidays to you, your families, clients, customers and business associates.

All of us at Revitalization Partners are very appreciative for our continuing relationship with all of you.

Thank You,
Al & Bill

 

Revitalization Partners is a Northwest business advisory and restructuring management firm with a demonstrated track record of achieving the best possible outcomes for our clients. And now, we’ve written a book to help our readers understand the issues facing their businesses. You can find this compilation of our business thoughts at:  http://revitalizationpartners.com/we-could-write-a-book/ or on Amazon.

We specialize in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations.

Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.

Equity vs. Debt … There is a difference

 

Over the past year, Revitalization Partners has been asked by several our clients to assist them in raising additional debt for their companies.

In most of these cases they have either outgrown their current debt facilities or the company has hit a roadblock and needs funds for restructuring.

In any case, the current lender has declined to lend additional funds.

 

Borrow or Dilute Equity?
As some of these companies are owned by or have large investments from private equity funds and these funds have often added to their original investment through bridge loans or additional equity, they would like to see the company borrow the additional money needed.

In other cases, the board of directors prefers debt to equity as they do not want to see their equity positions in the company diluted.

 

A Failure To Understand …

What equity holders often fail to understand is how differently they see the company and its prospects from that of a banker.

Equity holders invested in a company to benefit from that company’s long-term growth.

They believe in the future of the company and even in the case of a downturn or hiccup, they believe that they can make the changes that will, in the end, bring a benefit that will increase the value of their investment.

 

Same Situation … Seen Differently

Lenders view a company very differently.

Their return consists of getting their money back along with the agreed upon interest payment.

Unlike investors, they only look at the historical performance of the company to determine if, based on that history, the company will be able to pay back the loan in the future.

No matter how well the company does in the future or how much the value of the equity becomes, unlike equity investors, a lender is only entitled to repayment of principal and interest.

 

When Something Goes Wrong …

In many cases, the company may have a senior secured lender already in place.

A senior secured lender has a lien on the assets of the company; in most cases it is receivables and inventory.

In some, it is equipment and real estate.

But should something go wrong and the company is unable to make the agreed-on loan payments, the senior lender can seize the collateral and sell it to recoup its loan.

 

Dependent On Cash Flow …

In other cases, the company needs funds in addition to those supported by the assets or collateral.

This is where we hear the term subordinated or mezzanine debt.

These are lenders that will loan a company money that is only secured by any assets of the company beyond those that the senior lender might have to sell to recoup its loan.

In many cases, there are not assets to cover the loan, so the lender is totally dependent on the cash flow of the company that is above its operating expenses and existing debt.

These loans are more expensive than secured debt and the due diligence of the lender is greater.

 

Upside vs. Risk …

The problem often arises when the investor believes it has dealt with the problems of the company and now needs to borrow the money to execute the company’s plan.

The company puts together a plan, the investor believes in that plan, but the execution of the plan hasn’t happened yet.

The lender looks at the performance of the company, the amount of secured debt the company has and the historical and current cash flow.

The investor sees the upside, the lender sees the risk.

The investor wants to have the lender view the future the way that it does, while the lender would like the investor to see the risk that it sees.

 

Do You Speak “Bankanese?

What is needed here is the ability to speak, as the title of a webinar we did a few months ago, “Bankanese”.

The role of the third party such as Revitalization Partners is to make sure that investors and the company are understanding the lender’s issues and that the prospective lender understands why the investor believes in the future as strongly as it does.

 

Are We A Good Match?

Matching lenders, companies and investors is also critical.

Lenders, especially Mezzanine or subordinated lenders often have industries that they understand better than others.

Some have both lower and upper limits as to the amount of a single loan.

It does no good to focus on a presentation to a lender whose interest starts at 5 million dollars, if you can only support a two-million-dollar loan.

 

Successful Relationships Matter!

The exception to the above is where the party approaching the lender has relationship with the lender and has brought them successful loans.

Like any other part of business, successful relationships count.

Whether you’re an investor looking for a loan or a lender looking at a loan, being willing to listen to and understand the other parties thinking is critical to success.

And speaking “Bankanese” doesn’t hurt.

 

 

Revitalization Partners is a Northwest business advisory and restructuring management firm with a demonstrated track record of achieving the best possible outcomes for our clients. And now, we’ve written a book to help our readers understand the issues facing their businesses. You can find this compilation of our business thoughts at:
http://revitalizationpartners.com/we-could-write-a-book/ or on Amazon.

We specialize in improving the operational and financial results of companies and providing hands-on expertise in virtually every circumstance, with a focus on small and mid-market organizations.

Whether your requirement is Interim Management, a Business Assessment, Revitalization and Reengineering or Receivership/Bankruptcy Support, we focus on giving you the best resolution in the fastest time with the highest possible return.