At crisis point

The turnaround industry is booming as more companies face financial problems. Nick Britton talks to entrepreneurs and advisers on how it can take more than cash to get a business back on track

The turnaround industry is booming as more companies face financial problems. Nick Britton talks to entrepreneurs and advisers on how it can take more than cash to get a business back on track

The turnaround industry is booming as more companies face financial problems. Nick Britton talks to entrepreneurs and advisers on how it can take more than cash to get a business back on track

The JCB Tough Phone made headlines last year as gadget reviewers lined up to put its “indestructible” tag to the test. In the name of science, the phones were dropped, pummelled, battered and crushed – and emerged still working. What many people reading those reviews didn’t realise was that the Silicon Valley-based company behind the phones, Sonim, had been through a similar ordeal.

“We became the pariah of the industry,” says Bob Plaschke, Sonim’s CEO. “We spent millions of dollars [of investors’ money] chasing a grand vision that wasn’t grounded in solving real people’s problems.”

The vision was internet telephony (VoIP) over mobile phones – a prospect that excited Sonim’s venture capital (VC) investors so much that they invested $47 million (£34 million) before the company had made a sale. Sonim won awards and contracts but, critically, failed to deliver working software on time to the mobile operators it had signed up. The hype quickly turned to derision, and with a burn rate of $1.8 million a month it was only a matter of time before Sonim ran out of cash with “no chance of any viable funding after that”.

It’s a position many entrepreneurs will be familiar with, though Sonim’s journey from stardom to near-bankruptcy will be faster than most. Jamie Constable, CEO of turnaround investment firm RCapital (which now owns Little Chef) says there’s “a very steady flow of companies getting themselves into serious financial trouble”. Survival in this environment depends “not on how well run you are, but on how you’re structured financially”.

Limited options
The Art Group, which supplies touch-screen kiosks enabling visitors at art galleries to print off their favourite works, is a case in point. RCapital got involved with the business last year after its VC backer decided not to invest further. There was an added irony because the backer had already replaced the old management team and agreed in principle to a fresh injection of funds.

“The company’s only choice was to go to the bank for the money and, of course, if the VCs won’t do it, the bank won’t do it,” says Constable. “The business had already put in place the operational changes it needed to return to profitability – it was just a case of [repairing] the balance sheet.” RCapital bought the company for £2.5 million and made the changes needed to get it back on track.

Deeper cuts
For investors like Constable, it’s essential to distinguish between good businesses that are simply running out of cash, such as The Art Group, and those with more fundamental issues. When Rob Woodward took over Scotland’s ITV franchise STV in 2007, he knew it was in serious financial difficulties: its market cap had shrunk from £2.1 billion in 2001 to less than £200 million that year, partly the result of an unsuccessful expansion strategy. Now he admits that he underestimated the scale of the problem.

“We informed the City upfront of the reality of the situation and it was far worse than anyone had expected,” says the CEO. “All the good news had been drained from the company: the plans were far too optimistic. So the starting point was very different to what we had anticipated, though the endgame remained the same.”

When Woodward took over, STV’s board resigned en masse, leaving him free to pursue his threefold strategy of rectifying the “challenged” balance sheet, reducing costs by refocusing on STV’s core business, and investing in new areas he believes have growth potential.

Though the company’s share price is still in the doldrums, Woodward has transformed losses of £23 million in 2007 to pre-tax profits of £14 million, reduced net debt from £47 million to £36 million, and returned £30 million to shareholders (after a rights issue raising £92 million in December 2007).

The most difficult aspect of the process, he says, was “delivering the message of huge cost reductions and at the same time investment in future growth opportunities”. Some 120 staff were made redundant, while a “new team” was brought in to grow STV’s online presence.

Strategic thinking
Woodward’s point is instructive. Few turnarounds can be achieved without an injection of cash, and cutting costs is another common theme. But simply paring a business down and pumping it with money could be flogging a dead horse unless there is a fresh approach to go with it.

For Plaschke, whose role at Sonim changed from CFO to CEO after the company went into crisis mode, the first priority was survival. By cutting the company’s head count from 180 to 15, its monthly burn rate was reduced from $1.8 million to $500,000. But Sonim still had no way of making money.

Plaschke began in-depth research into potential markets, leading him away from the idea of selling generic software to mobile operators towards producing a “ruggedised cell phone” aimed at blue-collar workers. It’s a fascinating story with its own ups and downs: Plaschke secured another $10 million from his investors but battled long and hard to find a distribution channel for the phones – eventually striking lucky in Sweden. But the essential point is that Plaschke had completely changed tack.

“The board found a presentation I’d given to them before, and there was one slide that listed ‘12 reasons we’ll never become a cell phone company’,” Plaschke relates. “Well, I still believe in six of the 12 but I’ve disproved the other six. It was a choice between shutting the company down and firing all the employees or selling more phones.”

The decision to sell more phones resulted in sales of $31 million last year (which Plaschke expects to increase to more than $40 million this year). With just three salespeople, Sonim distributes its phones in 42 countries and is now at break-even.

Out with the old
Sometimes, turnarounds are more about a fresh approach than a complete change of direction. Richard Brighton, MD of electronics manufacturer Exception EMS, was hired to turn around a company that was “going through a degree of stagnation, always making around £17 million, always chasing sales to make up for the customers it had lost, always at a break-even level”.

When Brighton first walked into the company, he saw a sea of green printed circuit boards covering every available surface. Looking into how it was run, he found it “chaotic and disorganised”: the manufacturing process was “a collection
of fiefdoms” and there was “a lot of work in progress” with no one taking responsibility for it. Underlying these problems was the autocratic management style of the previous MD, who had been “asked to leave”.

“One of the first meetings I had with management, I asked people for their thoughts and it was like tumbleweed. It was so obvious they had never been asked that kind of question before,” Brighton reveals.

The changes were radical but they were operational rather than strategic. Brighton created five “mini-MDs”, each of whom was given responsibility for a number of customers. Work for each customer was to be managed in a separate, U-shaped area, so that progress was clearly visible. There were management changes too, and a reduction in head count ­– from 250 to 210, achieved mainly without redundancies.

The result was that turnover increased from £17.5 million in 2007 to £20 million in 2008, with an operating loss of £500,000 transformed to a profit of £1.1 million. Most notably, that was achieved by gaining only one major new customer and simply serving the others better so the company won more work and, in some cases, could justify raising prices which had not been adjusted in years.

In a similar vein, RCapital’s Constable states that Little Chef’s problems boiled down to the fact that outlet managers had no sense of accountability, and staff were demoralised.
“It was about giving ownership back to the people running the restaurants. We improved the food but kept prices the same, and told managers that if they made excess profits they’d be rewarded.”

Deep breath
Viewed with hindsight, the solutions to a company’s problems may look obvious. But when you’re at your lowest ebb, those troubles can seem insurmountable. Plaschke, an ex-employee of consultancy firm McKinsey, says that if he had applied the principles he learned there to Sonim, there would have been no option but to liquidate the company as quickly as possible.

“There are lots of folks who told me to shut [Sonim] down and get another job,” he recalls. “And if you looked at the business in any rational way, I should have done just that.“But entrepreneurs defy logic. At times like these you’ve got to trust your gut conviction and follow it, even if it leads to failure.” 

Marc Barber

Marc Barber

Marc was editor of GrowthBusiness from 2006 to 2010. He specialised in writing about entrepreneurs, private equity and venture capital, mid-market M&A, small caps and high-growth businesses.