Highly Leveraged Companies Face Financing Risk … Is your Company Highly Leveraged?


In our last email on banking we discussed the need for a reasonable debt to equity ratio when looking for a loan.

While we focused on small to mid-sized companies, companies of all sizes run risks when they become too highly leveraged.

A recent Moody’s publication expressed concern that some leading retail companies have developed an unsustainable capital structure.

The companies, however, contend that any problems are at least two-to-three years down the road. The report further states that highly leveraged retailers are facing increased refinancing risk when their debt begins to mature.


The Most Interesting Statistic …

This is a result of high leverage and weak operating performance. Moody’s did not focus on small to mid-sized companies, but larger companies such as, J. Crew, Payless Shoes and Sears Holdings, among others.

The most interesting statistic is that of all the companies referenced, only two were public companies, the rest owned by private equity firms.

While this article is focused on companies in the retail business the same case can be made for highly leverage companies in any industry. It might be appropriate at this point to look at one business definition of “Highly Leveraged.

” A company or other institution with a high level of debt in proportion to its equity. A highly leveraged company carries a great deal of risk and may increase the likelihood of default or insolvency. A highly leveraged company may have to pay higher interest rates on its debt.”


So What Changed?

Many companies have historically had respectable debt to equity ratios and may not have relied on high levels of debt to finance their business.

So what changed?

There are a number of reasons companies take on more debt to finance their business. For example: companies take on more debt to finance an expansion of their business; to finance a new building expansion or an office or warehouse in a new market; to finance an acquisition; as a result of a leveraged buyout by a private equity firm; or sadly, to finance poor performance and financial losses.


In Most Cases …

In most cases, with the exception of financing losses, debt is taken on to finance projects that will result, at least in the mind of management, in future increases in profitability that will more than cover repayment of the loans.

This mindset creates a situation where the company is highly leveraged for a short period of time, and when the projected profits appear as a result of the investment, debt to equity ratios will return to normal!

Let’s go back to the statement that “companies contend that any problems relating to high levels of debt, are at least two-to-three years down the road“.


Dangerous Assumptions …

In many cases, the type of debt these companies have incurred, has deferred principal payment, interest only periods and balloon payments at the end of the loan.

What companies are assuming is that they will achieve their operating plans, the credit markets will be willing to refinance the loans and interest rates will not be substantially higher.

These assumptions are often misguided and dangerous.

We have written several articles on the impact of higher interest rates and the continued impact of regulation in decreasing the availability of credit. All companies go through unpredictable ups and downs. With the recent concerns about the prospect of a “manufacturing recession” in the next one to two years, an assumption of continued profit expansion is a dangerous one to make.


What To Do Now?

What should highly leveraged companies be doing now? Most of the troubled companies we work with became highly leveraged as a result of consistent multi- year losses that resulted in a declining equity base.

This string of losses reduced the company’s equity and made a once reasonable debt level, highly leveraged.

In other situations, companies incur a high level of debt to finance inventory and accounts receivable.

They may have high inventory levels as a result of unsold obsolete inventory. They may have extended customers’ accounts receivable terms beyond their ability to finance the longer payment period.


We Focus On …

In our engagements with highly leveraged troubled companies, we focus on improving operating performance, as well as monetizing assets to reduce debt.

These steps are important to improve equity in a manner that will reduce leverage over a reasonable period of time.

What our experience has shown is if the company does not take action, or obtain outside help to assist with this process, the company’s continued poor debt to equity ratio will jeopardize its future financing capabilities.

This in turn, creates difficulty in continuing operations or a worst case risk of bankruptcy and/or liquidation.

Remember the definition of Highly Leveraged noted earlier? It is imperative that every business owner, CEO or board member understand if their company is “Highly Leveraged” and have a plan to deal with it.

And if need be, ask for help to ensure the plan and execution are achievable. There is absolutely NO room for error when a company is highly leveraged!

Why Banks are Saying No to Small and Mid-Sized Business


Despite an economic recovery that is well underway, many recovering businesses are still getting turned down for new business loans and loan renewals.

Despite the fact that the company shows signs of bouncing back from any recession based problems and management believing that their projections make a clear case for the future, often a regulated banking entity declines to make the loan.

Why doesn’t the bank see the situation the same way that management does? There are many factors that go into making that creditworthiness decision. We look at some of them here, beginning with the banking system.

Size Does Matter ...

In the end, anyone who says size doesn’t matter is lying – at least when it comes to business lending.

Size matters a lot and perhaps more than any other factor determines which bank will and won’t provide a credit facility. Borrowers that need loans between $2 million and $10 million are finding that they have the fewest choices and pay the most for their money.

All banks have legal lending limits that they cannot exceed when making loans. A bank legal lending limit is the maximum amount that any particular bank can lend to a single borrower or related group of borrowers.

Also, banking regulators want banks to spread their risk by having a diversified portfolio and don’t want them making a lot of loans at or near their legal lending limit. As a result, for most banks the effective in-house lending limit is considerably less than its legal lending limit.


As A General Rule …

As a general rule, borrowers that need loans with balances consistently larger than $2 million are too big for about 80% of the banks in the U.S. Surprisingly, only about 6% of the banks in the U.S. are larger than $1 billion in size and have the capital base to concentrate on middle- and lower-middle-market businesses.

After a generation of bank consolidation, the U.S. banking industry has been hollowed out from the middle. While big banks deliver diversified, professional and cost-effective products and services, they just don’t do it for small – and lower-middle-market businesses.

On the other hand, small banks lack balance sheet size, geographic reach, back office infrastructure and product mix to satisfy the needs of most middle- and lower-middle-market businesses.

Regulators that are rightfully concerned about future loan losses and credit quality are further restricting small bank credit in an effort to prevent today’s new loans from becoming tomorrow’s mistakes.


The Effect Of Dodd-Frank …

Bankers who say that the rules really changed after the 2008/2009 banking crisis are only partially correct. The rules for small business and lower-middle-market lending are essentially unchanged. What has been added is the effect of Dodd-Frank legislation on the regulators, recently causing them to play a greater role in enforcing their rules rather than trusting bank executives to self-regulate.

As an example, the rules for providing business loans secured by accounts receivable and inventory have been around since March 2000. And, the rules concerning floor plan lending to retailers haven’t materially changed since May 1998. These rules are set forth in easy to understand and very detailed “how to” manuals published by the Office of the Comptroller of the Currency and can be easily found on the Internet.

Unfortunately, only a few banks under $1 billion in size comply with the lending rules, and as result only a few banks can participate in the collateral-dependent secured commercial loan market without being criticized by their regulator.


Banks Turning Backs On Community?

That doesn’t mean that banks that don’t make an effort to comply with the rules and therefore don’t lend are bad banks or are turning their back on the business community. The problem that small banks have is that it is expensive to comply with the lending rules. Unless banks are going to make a large number of accounts receivable and inventory-secured loans or inventory-dependent floor plan loans, it just doesn’t make economic sense to spend the money required to comply with the rules.

Small banks in all but the most densely populated and largest metropolitan markets can’t make money providing collateral-dependent loans and still comply with decades-old regulations. Since regulators are now enforcing these regulations, many small banks have pulled out of collateral-dependent business lending and business borrowers are finding that their financing options have been restricted.

Many times when banks say no, it’s because they’ve looked at what the company is requesting in light of historical performance or its balance sheet, and we see that it really needs equity in addition to debt.

Obviously it’s more appealing for a business owner to pay a low percentage to the bank than to give away a portion of the company, but unfortunately, equity investments are the reality most entrepreneurs face once they’re past the bootstrap stage. Most companies can’t grow just with debt.


A Good Rule Of Thumb …

A good rule of thumb is that for every $1,000,000 in debt you’re seeking, you should have $300,000 in equity. If you are asking for a loan that will put your company at a debt-to-equity ratio of more than three or four to one, a bank will think you are over-leveraged.

Banks look at an application like this: if we gave them that money today, could they make the payments based on their cash flow from last year? Companies often want a lender to make a loan based on their projections. If you can demonstrate why the profit is going to be greater and have a very convincing story built around facts, often a well put together projection will get a successful hearing.

If you’re asking for a loan based on projections, nail down the proof. “The market’s great and we think we can grow 20 percent” probably is not going to be assurance enough for a bank.


The Curse Of QuickBooks…

Part of this problem is the curse of QuickBooks. Many companies think that because someone on their team can use QuickBooks, they barely need an accountant, much less a CFO.

People who start businesses are usually smart, capable and talented, so they believe they can manage the loan process themselves. But you need to understand the correct data and ratios that the banks want to see before you can finalize a presentation to the bankers.

One of our major services at RP is assisting our clients to get new loans. And we see these problems constantly, not just with companies that have in the low millions or so in sales, but sometimes with companies that have tens of millions in sales.

We’ll start analyzing their financials and see that something doesn’t make sense and something else doesn’t balance. We’ll see projections that don’t tie in with accounts receivable levels or current payables.

And that makes any lender looking at the data think the company has poor financial controls.

This is a problem you can fix (or ideally, prevent) by making sure that you have the talent that knows how to present your situation in the best light to the lender and that makes certain that your data and projections are accurate and tie together.

The Political Process in the Workplace


The effect of what has become a particularly nasty political season is beginning to trickle down to the workplace.

Comments of the type that we have seen in our political campaigns are being made to employees in the workplace, and the majority of them have been labeled as mere “stray remarks” by courts, resulting in the dismissal of each employee’s resulting discrimination or harassment lawsuit.

The “Stray Remarks” Doctrine …

Because the courts held that these comments were ambiguous and unrelated to any adverse employment action, the comments could not be used as evidence that the employee worked in a discriminatory environment. This is part of an ongoing trend of courts using the so-called “stray remarks” doctrine to keep employment discrimination claims away from a jury, and in so doing, possibly minimizing and disregarding legitimate evidence of bias.


A Cultural Backlash …

It should come as no surprise that some courts are routinely brushing aside comments like these; we are in the midst of a cultural backlash against anything “politically correct” or deemed overly sensitive to the feelings of women, racial and ethnic minorities, and LGBTQ individuals. The mantra of “people are too sensitive” is repeated often and loudly, especially now that the political campaigns show no signs of changing rhetoric.


The PC Police …

Every day there are new articles lamenting the state of our discourse and complaining that the “PC police” are violating individuals First Amendment rights to say whatever they want. Dismissing these kinds of comments as mere jokes or passing remarks, lionizing those who have the audacity to utter them unapologetically, and classifying those who were harmed by them as overly sensitive, does real damage.


Words and Actions …

This trend is particularly important to highlight now through the lens of what has become a political anti-PC campaign. Some candidates are praised by supporters for being unapologetically offensive to women and minorities.

And as Kareem Abdul Jabbar so aptly pointed out recently, political correctness is not policing. It’s an awareness campaign with the goal of sensitizing people to the fact that their words and actions may be harmful and insulting to others.


The Discrimination That Remains …

Now that the American workplace has generally made progress in eliminating much of the overt racism and sexism that once barred women and minorities from fully participating, the implicit discrimination that remains is too often ignored or pushed under the rug. If a person’s workplace experience is anything less than enduring constant racial slurs or sexual propositions, the dominant feeling is that it’s not discrimination.


Studies Have Shown …

Yet studies have shown that when women and minorities who experience “soft discrimination” in the workplace – in the form of micro-aggressions, micro-invalidations, or passing comments based on stereotypes – can experience negative mental health consequences that can adversely affect job performance. Thus, passing comments that exhibit implicit discrimination can result in lost job opportunities, lost promotions, and ultimately, lost earnings.


Recognized For What They Really Are …

In short, these comments, and more importantly, the freedom to utter them without consequence, say a lot about a workplace and who it values.

Ignoring their impact serves to further silence those who already do not have an equal say. It is even more important that we recognize “stray remarks” for what they really are: evidence of a discriminatory workplace.

But until courts and employers realize that these comments can cause real damage, this trend of invalidation and ignorance will continue, and the consequences of pushing this behavior under the rug will endure.

And what is the ultimate result of allowing this behavior that we see thriving in the political arena to move into the workplace? A breakdown of workplace cohesiveness and the risk of disruption to productivity of the enterprise.


Disruptive Politics …

Disruptive politics in the workplace can involve employees’ differing opinions about issues of public policy as related to issues like discrimination and race. Not to mention the politics of the workplace itself. While some employees may be distracting one another over the details of the latest Presidential campaign, others may be busy undermining each other’s’ office reputations as they compete for a promotion.


Incompatible Political Views …

Whether the politics originate in the public sphere or between individuals within the office, they can result in a lack of harmony and cooperation in the workplace.

Ideally, individuals can separate their political opinions from their work lives, but in the real world some people are unable to do this and they let differing opinions get in the way of effective workplace behavior.

The result can be employees who don’t work well together simply because they hold incompatible political viewpoints.


Compromised Productivity …

Passionate discussion of political issues has its place but can distract workers from the tasks that they should be focusing on. Whether people are agreeing or disagreeing about politics, they aren’t likely to be doing their work when they are discussing politics.

In a worst-case scenario, political discussions grow into ongoing differences of opinion between two groups, something that can result in disruptive feuds that split a workplace into opposing camps.

If ongoing feuds are allowed to develop over a long period of time, the result can be compromised productivity in the workplace, hurting everyone equally, no matter what their political positions.


Easiest Way To Avoid Complex Troubles …

Negative effects for someone who disruptively discusses politics at work can include warnings by management and, in extreme cases, termination.

Political issues can grow into a complex series of accusations and counter-accusations as employees make claims of free speech and managers respond with charges of poor performance and lack of conscientious work. It may appear that a worker is being persecuted for his political opinions, when in fact the discipline is because he was simply not doing his job.

The easiest way to avoid these complex troubles is to save political discussions for outside of the workplace.

The Problem of Being “Poorly Educated”


While political candidates bemoan low minimum wages and one candidate for President states: “I love poorly educated people“; there are currently over three million jobs that are going begging in the US.

And despite all of the rhetoric about bringing back the old jobs requiring less education, those jobs that have either left the US or been replaced by technology are simply not coming back.


Can’t Find Qualified Workers …

Every month since January 2009, over 20 million Americans have been unemployed or underemployed because they can’t meet the qualifications of those open positions.
In the manufacturing sector alone, over 500,000 jobs are going unfilled because employers can’t find the qualified workers that they need.


The “Skills Gap” …

At a time with so many people out of work, especially those over 40, how could this be? It’s called the Skills Gap.
And according to a number of economists, “it’s definitely a concern and it should be a concern to anyone who cares about the future of US workers.”
There are a number of factors preventing these jobs from getting filled. Experts state that job training programs in the US pale beside programs in Europe and Asia.

Easily Automated Tasks …

Just as the shift from an agrarian society to an industrial society changed the education requirements for employment, the shift to an Information Age has affected the workforce in several ways.
It has created a situation in which workers who perform tasks that are easily automated are being forced to find work which involves tasks that are not easily automated. Workers are also being forced to compete in a global job market.
Lastly, workers are being replaced by computers that can do their jobs faster and more effectively. This poses problems for classic industrial workers.

Traditional Middle-Class Jobs …

Jobs traditionally associated with the middle class (assembly line workers, data processors, foremen and supervisors) are beginning to disappear, either through outsourcing or automation.
Individuals who lose their jobs must either move up, joining a group of “knowledge workers” (engineers, doctors, attorneys, teachers, scientists, professors, executives, journalists, consultants), or settle for low-skill, low-wage service jobs.
More than 5 years after the official end of the Great Recession, millions of Americans remain unemployed, underemployed, or continue to face uncertainty over how long they can hold on to their jobs in a volatile labor market.

Older Job Seekers …

The labor market has been especially difficult for older job seekers who often experienced long term unemployment, underemployment, age discrimination, and diminished retirement assets.

These individuals, across a wide span of educational levels, job skills, and occupations experienced tremendous economic upheaval during and since the Great Recession.

Many older workers hope that education and skills training programs will help them remain in their jobs or return to work.

However, adults with less formal education after high school or less job-relevant skills were hit especially hard. Older job seekers who have limited basic skills and literacy are likely to need further education and training in order to return to work, in part because employers are demanding more education and skills from workers than they did in the past. Employers’ demand for workers with more advanced computer and technology skills may also be a significant barrier to older job seeker.


Adults Seeking Education Must …

Adults seeking education and training must choose from thousands of degree and certificate programs offered by colleges or universities, technical or vocational schools, community organizations, or employer associations. Not surprisingly, these options vary widely in character, quality, and cost.

So what is the answer? Education across all levels of our society that matches the needs of our employers. And while there are many programs to help our older workers, serving on the Board of Advisors of one of them, Western Governors University of Washington has been an eye opener.

This fully accredited on-line university specifically designed for working adults uses a competency based educational model that allows students to not have to relearn subjects in which they can demonstrate deep competency, thus shortening their time to complete their education.

The following statistics are for the total University operating in 20 states.

  • Students: 65,000
  • Graduates: 50,000
  • Average time to a Bachelor’s degree: 2.5 years
  • Average Cost of a Bachelor’s degree: $15,000
  • Average Increase in Wages following degree completion: $10,000 per year.

It is important to note that this is only one way for an employed or unemployed adult to complete an education. But it is representative of the type of program that will both address the skills gap problem, solve the growing needs of employers for educated workers and do it in an affordable way for the employee.


Why Are “We” Writing About This?

Why, you may ask, is a Corporate Restructuring and Reengineering firm writing about adult education.

Because any successful restructuring begins and ends with the people in the organization.

From management to professionals to support staff, the quality of the people determines the success of any company and the better employee education, the greater the chance for success.

While some politicians may talk about loving poorly educated people, it would be more productive to focus on programs for education, enabling them to fully participate in our rapidly changing society.

A Culture of Personal Accountability

There is an interesting and telling TV commercial currently being broadcast. The commercial shows a middle aged man walking off of a sporting field holding the hand of a child.

The child is holding a trophy that proudly displays the title “Participant”. The man shakes his head and states: “Participant! They won every game.” He then pulls off the title and writes in “Champion”.

The microcosm of this commercial demonstrates the major shift in attitudes occurring in our workforce. And as those shifts occur, we often find that our organizations suffer from a crisis of personal accountability, which makes the effort of either changing or bolstering a culture of accountability difficult and more prolonged.

To deal with this crisis, current leaders and managers often revert to old fashioned command and control structures and methodologies in order to drive accountability within an organization. They simply expect and demand accountability, but do not engage in it.


We Are Not Just “Participants” …

Let’s be honest. In business and in much of life, we are not just participants. There are winners and those who do not win. There are those who succeed in business and those who fail. There are attorneys who “win” in court and those who do not.

It is important to note that we are not talking about winners and losers, but achievement and failure. it is precisely that difference, and the individual need to personally be accountable, that often drives someone who fails, to ultimate success.

What really defines and creates a culture of accountability in a business? It is a type of culture where people demonstrate high levels of ownership to think and act in the manner necessary to achieve organizational results. The defining characteristic of this type of culture is that people voluntarily assume their own accountability.


A Culture Of Accountability …

In this culture, employees at every level of the organization are personally committed to achieving key results targeted by the team or organization; reporting proactively and following up constantly, diligently measuring their own progress because they have internalized their commitment to achieving results.

Their mantra: “What else can I do to achieve the desired results“; leads them to continually find answers, overcome obstacles, and succeed in the face of problems that occur. And, as you might expect, everyone holds everyone accountable for results.

Authors Roger Connors and Tom Smith have written and studied about accountability for years. One of the stories they use as an example is The Wizard of Oz.

The “participants” think of themselves as victims of circumstances, skipping down the yellow brick road, where the all-powerful Wizard will grant them courage, heart, wisdom and the means to succeed.

Even Dorothy believes she must travel the yellow brick road just to go home.


A Very Thin Line …

Successful managers recognize that the difference between success and failure; between great companies and ordinary, is a very thin line.

And whether or not the organization operates above or below that line is highly determinate of success or failure.

People and organizations operating below the line consciously or unconsciously avoid accountability for results.

Falling into a victimized cycle, ignoring accountability, ducking responsibility, blaming others for their errors, asking others to tell them what to do, developing their story for why they are not at fault, and waiting for some hoped for miracle to be dispensed by the Wizard.


It’s Easy To Criticize …

While it’s easy to criticize those who play to participate rather than those who play to win, it is important to examine the culture that managers and business owners create.

The role of the Wizard is often played by those that have a high need for personal verification at the expense of others, creating this culture of fear and eventually apathy.

A culture of accountability begins at the top and is driven deeply into the organization both by educating everyone on what is acceptable behavior and what is not, but mostly by the most senior management in the company living, every day, the culture they espouse. In our practice we see the results when words and actions are in conflict.


Who Really Failed? …

In a letter to a small group of private investors by a company CEO, he discusses the reasons for the poor performance of the company.

In discussing the failures, he cites an “unreliable website and lack of experienced and dedicated management”. In another part of the business, he blames the failure on “gross mismanagement of sales.” While he was the senior manager responsible for all of these activities, his role is never mentioned.

In another case, the CEO of a company constantly micromanages his employees, blaming them for every real or imagined error, many his own, while, insisting that his company difficulties are the result of not being able to hire “A” employees.


When Andy Grove Was CEO At Intel …

In the 1980’s I had the privilege of working at Intel when Andy Grove was CEO. While there have been books written both by and about Andy and the Intel culture; at the bottom line, Grove is the poster child for demonstrating how it is possible to be a tough and effective leader without being an ass.

In part, because he was one of the most honest executives around, about both his own errors and those made by others. Very few executives were as honest about their own mistakes and worked to correct them so rapidly.


How To Build A Culture Of Accountability …

How does one establish and reside in a culture of accountability?

Look to the Wizard of Oz.

  • Don’t get stuck on the yellow brick road
  • Don’t blame others for your own circumstances
  • Don’t wait for wizards to wave their magic wands
  • And never expect for your problems to disappear.

And by practicing and managing with personal accountability, the label on your particular “trophy” will say a lot more than participant.