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 is 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 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 to 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 as 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 is 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 will 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 round 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 would 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.’

A turnaround expert’s view

Andy Pear, a director at professional services firm Tenon Recovery, takes a look at the common mistakes he sees at companies which are struggling

It’s fairly obvious that the sooner an owner-manager acknowledges their business is in trouble, the higher the chances of turning around its fortunes. Strange then, that so many owner-managers and boardroom execs prefer to keep their head in the sand.

While the wider economic circumstances may be exceptional, the problems facing embattled companies are often the same. Frequently, the financial information they are reporting is woefully below par.

Inadequate accounting and cash control are inexcusable. Every business should be producing a rolling forecast that is updated every month. It should incorporate a profit and loss forecast, a balance sheet forecast and cash flow forecast.

All businesses have their value tied up in the sales ledger. Cash may be waiting to be released in stock or work-in-progress, or there may simply be debts that stretch back for six months or more. The longer those balances are on the ledger, the far greater the risk of them going bad.

The trick is to be proactive. There are plenty of options available when it comes to settling outstanding balances.

If a sale has been made to a customer, there is evidently an employee who has a relationship with that customer who can apply pressure to get the money in.

Sometimes it makes sense to offer a discount for early payment, or to use invoice finance, which in certain industries like recruitment, can be ideal.

The capital structure of the business will also need to be examined. You have to make sure the funding is appropriate for the business model and its particular requirements.

For instance, it’s not unusual to find a company funding itself from an overdraft facility when a ‘term loan’ would make more sense. It’s a cheaper form of borrowing and easy to manage – after all, most overdrafts are repayable on demand if the bank decides it wants its money back.

Even though we are clearly in the midst of exceptionally tough times, where sectors such as retail, construction and property are being decimated, there will always be a number of options to rescue a company. Just don’t act too late.

Andy Pear, a director at professional services firm Tenon Recovery, is happy to answer questions or queries about turnarounds. He can be contacted at andy.pear@tenongroup.com

Business Recovery Terms

DIY turnarounds

Cutting costs, accepting low profitability and focusing on retention of customers may work in the short term, but often you’ll need to look further ahead and consider more radical changes to your business, writes Malcolm Prowle, a professor at Nottingham Business School.

Restructuring

Think big, like a revision of product specification, a change of location or a different distribution method. Or withdraw from your current line of business entirely and invest in an alternative more suited to the times.

Working partnerships

Economies of scale can be achieved as businesses pool resources such as buildings, equipment, specialist staff and back office functions. New products can be developed on the back of the companies’ combined expertise.

Mergers

A business may not constitute a viable independent entity in the long term. If other companies are in the same position, a merger may be the most feasible option, minimising competition and increasing market share.

Related: Turnarounds and restructuring – Reach for a lifeline