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From startup to screw-up and back again

Turnaround financing has been yielding dividends Keystone

Turnaround financing has the attention of the private equity industry these days as investors seek to turn distressed companies into growth businesses, making a tidy return on their investment along the way.

This content was published on March 6, 2002 - 14:48

When Volker Kraft began to research his PhD thesis, entitled "Successful management of private equity turnaround and restructuring investments", four years ago, he interviewed private equity investors in Europe and the US about their experience with turnaround financing.

The investors were puzzled by the young student's interest in this obscure private equity investment strategy. "Why would we want to seek turnaround financing deals? There are much easier ways to make money," the investment managers told Kraft.

It was 1998. Venture capital was in and private equity houses in Europe, even buyout funds were participating in the venture capital business.

It seemed that no one could go wrong. Every technology venture investment seemed to swing a stellar IPO. Management teams with little more than a PowerPoint presentation were receiving a few million in venture capital from early stage investors and within months investment banks too were taking the startups public, without many more assets than that original PowerPoint file.

The stock price climbed into the stratosphere. So-called "old shareholders", or early investors, cashed out with millions of dollars, euros, or francs.

It was a time when the only mistake that could be made was not to invest. Today private equity investors are looking at turnarounds with different eyes.

Opportunity in insolvencies

Some investors come to the turnaround table unwillingly, usually when a portfolio firms start to flounder and struggle financially. Others investors are specifically targeting distressed firms as a way to create value and increase returns on their private equity funds.

In Switzerland, Equatis has just raised a SFr30 million turnaround fund. Zurich-based Swiss Capital Group has also recently established a private equity fund that invests in companies with "strong restructuring potential".

There is plenty of opportunity for financing distressed firms these days says Kraft, who now works for Allianz Capital Partners GmbH in Munich.

As evidence, he displays a chart with a sharp spike at the end - it is the number of insolvencies reported in Germany over the past ten years.

There are a number of reasons why businesses run into financial difficulties. A quick look at the headlines these days will give plenty of examples.

Usually, it is mismanagement. "Sometimes it is a radical change in the market, or a change in technology that the company has failed to keep pace with. Sometimes it is a global event, such as the September 11 attacks," says Erwin Steinmann, of CapCon Ltd, a Swiss management consultancy specializing in turning around struggling mid-sized firms.

Steinmann and Kraft were part of a panel of five turnaround experts who spoke at a Swiss Private Equity and Corporate Finance Association meeting in Zurich recently.

Experience and know-how required

Turnaround financing is one of the more complex forms of private equity investment, a strategy of value creation whose path to profit is strewn with legal minefields, regulatory hurdles, and bad press.

Although the terms are used interchangeably these days, Steinmann says that it is important to distinguish between a turnaround and a restructuring. They are fundamentally different. A turnaround is a short term situation; restructuring, a longer term endeavour.

A restructuring is concerned with profitability, whereas a turnaround is concerned with survival. A restructuring is process oriented, where as a turnaround is cash flow oriented. A restructuring is methodical, a turnaround pragmatic.

Turnaround managers have to be able to make hard decisions quickly, with only little information to work with. They need to have a high tolerance for frustration as they come up against internal politics, corporate fiefdoms or power structures, and de-motivated employees.

An example of an experienced turnaround manager is Mario Corti, a Swiss who has been in the news lately in relation to the Swissair rescue.

"There are going to be setbacks, guaranteed, and you will have to be able to handle it," points out Peter Rutishauser, founder of Equatis AG.

Rutishauser took Sigg AG from a loss-making firm employing 250 people to a profit-making, fast growth enterprise employing 50 people. "It employs fewer people, but their jobs are more secure," says Rutishauser.

Sigg AG whose trendy aluminium sports bottles are a hit at home and abroad, makes less turnover now, but its profits are greater. It was recently identified as one of Switzerland's hottest SMEs by business journalists working for Bilanz magazine.

A measure of humility and healthy self-esteem is also required in the turnaround manager. "Often employees and management will freeze you out and refuse to speak or provide information," explains Steinmann.

Social competence is also required to be able to speak to shareholders, bankers, workers, journalists, and debtors.

Timing is everything

Knowing when to invest in a distressed firm, and when not to, requires a high knowledge quotient. There is usually little time to waste.

Decision-makers have to quickly assess the company's market, its products, its margins, and the level of motivation and quality of the employees who are still working for the firm, usually within 1 to 5 weeks.

The next step is implement a short term survival strategy by stopping cash drain, raising loans and negotiating with current debtors, selling assets when possible and focus on quick sources of income. Turnaround managers take anywhere from 3 to 9 months to complete this step.

The final phase is to secure the long-term viability of the firm. "You've got to find the margins and set up new profit streams. You cannot make a strong company only based on costs savings," points out Steinmann. This phase takes anywhere from 9 to 36 months.

Knowing when to bring in the lawyers is also important. Dr. iur. Urs Schenker, of Baker & McKenzie Zürich, says "the earlier, the better". His firm handed out a 200 page, double-sided "brochure" of the legal and regulatory considerations for turnaround situations.

by Valerie Thompson

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