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Business Failures…Top 10 Warning Signs

  

Authors: Mirella Pisciuneri and Carl Adjami

Top 10 Warning Signs

To the outsider looking in, the failure of a business is precipitated by a few major events that precede the obvious signs of recurring unprofitability.  Waiting until a few days before coming to the decision that there is insufficient cash to make payroll is too late.  But when caught in time, a creative restructuring solution can help a company get refocused and steer clear of bankruptcy. 

The top 10 warning signs which should trigger a red flag that things are heading seriously downhill are summarized as follows:

Weak upper management

• The most common reason for business failures is weak upper management.
• Change is inevitable, and those organizations which do not keep up with change put
• their long-term viability in peril.  Change happens and therefore, management needs to anticipate, monitor and adapt quickly.
• upper management needs to keep a constant close eye on environmental changes such as technological advances, new competitors entering the market and changes in fiscal laws and regulations that could affect the organization’s profitability. 

Chronically late production of financial statements

• This is often a tactic to delay reporting poor results. 

 High turnover in top Management

• When executives see the writing on the wall, they often leave for greener pastures.  These executives are often replaced with unqualified employees who have been with the company for many years but unfortunately do not have the expertise to weather the storm.

 Excess Leverage

• When EBITDA is not sufficient to service capital and interest debt charges...it usually means there is trouble.

Absentee Management

• A business cannot be run by remote control without the proper infrastructure and shrewd managers at the helm. When the cat is away…the mouse will play! 

Unexplained increases in receivables, inventory and major reductions in R&D and CAPEX

• Increases in accounts receivable, not accompanied by a proportionate increase in sales, is usually a strong indication that Management is having collection issues often related to customer liquidity or disputes arising from quality issues.
• Unplanned increases in inventory can be a strong indicator of decreased demand in the product.
• Reduction in R&D and CAPEX budgets are a quick band-aid cash problem solution. Recurring reductions in R&D and CAPEX threaten the long term viability of a Company.

Economic dependence

• Dependence on a key supplier, customer or upon a single key product is often a recipe for disaster up ahead. 

Declining Cash Balances and Increasing Trade Payables

• Companies that are failing or are about to fail usually report sharp declines in cash balances or increases in their line of credit.  The decrease in cash is usually accompanied by an increase in trade payables and/or the age of the payables. 

Lack of succession planning and “One Man Shows”

• “One man shows” and ageing top Management with no succession plan are very dangerous because they can bring about an abrupt end.

Abrupt Replacement of Auditors

• When a company changes accounting firm for no apparent reason, it is usually a sign that there is some sort of disagreement with Management over how to book “creative” revenues or disclose/report liabilities. 

The above is not an exhaustive list. The stakeholders (employees, shareholders and their advisors) have the responsibility of having foresight regarding these warning signs and reacting in a timely manner before it is too late. 

Missing the Warning Signs…Your Busted Blockbuster : What Happened to Blockbuster?

•  In 2002, Blockbuster was the king of the movie rental industry with a market capitalization of $6 billion.
• Just eight years later, in September 2010, Blockbuster US filed for bankruptcy and the Canadian company, saddled with the US Company’s guarantees, filed for receivership eight months later.
• Netflix and I-Tunes have revolutionized the movie entertainment industry and given Blockbuster a knockout punch. 

 

Insolvency Landscape in Canada

Business Insolvency Rates

The volume of business insolvency rates in Canada decreased by approximately 50% in the last decade.  The following table summarizes the bankruptcies and proposals per 1000 businesses in Canada for the last decade: 

As can be seen by the table below, the bank’s prime rate remained under 8% in the last decade, decreasing from a high of 7.2 in 2000 to 2.4 in 2009.  Inflation was insignificant during the last decade remaining below 2% and as low as 0.3% in 2009.  The low interest rates and nominal inflation have given companies more manoeuverability and room for error which in part explains the decrease in business insolvency rates.

 

Fortunately (or unfortunately if you are an insolvency practionner), economists predict that interest rates will remain low until 2013, however, as Jim Flaherty said, “We are cautioning people not to assume too much long-term debt on the assumption that interest rates will stay as low as they are -- because they won't…interest rates have nowhere to go but up".

Keys to maximizing the value of your business

Author: Mathieu Gauvin

Some things bear repeating. For instance, the sale of a business requires that its owner or owners do some serious planning and implement measures that will not only speed up the sale process and make it more effective, but also maximize the value of the business.

An overview of the 10 items that we believe to be crucial in attaining this objective is provided below:

1. A vision and strategy to ensure buy-in from all of the company’s stakeholders

• Investors, lenders and other financial partners.

2. A solid and diverse management team

• Avoid one-man shows (dependence on a single individual)

3. Structured and effective corporate governance

• Makes it possible to align the seller’s organizational culture with that of a potential buyer that has a more highly-structured organizational model.

4. A solid business plan

• The buyer must be made to understand how it can continue to generate upside value.
• Financial projections must be based on realistic and credible assumptions.

5. Position the business to make it attractive to more than one strategic buyer

• Impact on the premium that such buyers will be willing to pay.

6. Understand and maximize value drivers:

• Intangible assets (technology, trademarks, distribution network, etc.).
• Focusing business efforts on the primary value drivers to develop their full potential.

7. Manage the balance sheet efficiently

• Eliminate all non-operating assets (e.g. marketable securities, rental properties, unused intangible assets) and intercompany/shareholder loans.
• Sale and leaseback of the company’s operating facilities.
• Accelerate collection of receivables.
• Reduce working capital.

8. Record actual earnings and maximize the profitability of the business

• Eliminate inventory reserves and value them appropriately so that they will reflect the true profitability of the firm.
• Record all income (eliminate unrecorded cash sales).
• Eliminate all expenses that are unrelated to the operations of the firm.

9. Resolve all outstanding tax-related problems or legal actions

10. Minimize concentration (clients, suppliers, technology)

• Avoid centering sales on a single client, purchasing from a single supplier, and developing and marketing a single technology.

Before entering into any process to sell a business, the owner or owners must first identify their needs and objectives, develop the best strategy for bringing the transaction to fruition, identify the potential buyers/investors that will be approached and prepare a full disclosure document identifying and highlighting the major value drivers of the business. Accordingly, the choice of the right advisor is a key factor that all entrepreneurs should consider as soon as they decide to launch the process of selling their business.

Entrepreneurs and the succession issue

 


Author: David Pelletier

Disturbing statistics…

For several years now, much has been made of the challenges facing entrepreneurs in Quebec and elsewhere in North America who want to ensure the succession of their business. Who among us is unaware of the following statistics, which are alarming to say the least?

• 40% of all Quebec entrepreneurs are contemplating retirement within five years, and 70% of them will retire within 10 years;
• 65% of all owners of small and medium enterprises (SMEs) have no succession plan;
• 70% of family businesses fail to survive beyond the first generation, only 30% succeed in passing on the business to a second generatinon, and a mere 10% reach the third generation.

Fortunately, there are options!

Transferring the ownership of SMEs and ensuring succession are major challenges. For many business owners, lack of planning unfortunately jeopardizes their personal wealth, as well as the future of the business, in terms of both jobs and collective assets.

Where an intergenerational transfer of a family business is not feasible, the remaining options are as follows:

• The sale of the business to interests in Quebec, Canada or abroad;
• The buyout of the business by its managers and/or workers (management buyout) or by borrowing (leveraged buyout), or through a combination of the two.

In certain cases, the sale of the business to foreign interests may be a satisfactory solution for the entrepreneur and his or her employees. In other cases, however, this involves major risks relating to the continuity of the business and to the retention of jobs in Quebec. This is where the option of a management buyout becomes attractive. Even so, the entrepreneur and his or her advisors have to convince a financial institution or syndicate to invest in such a project, and this will require a substantial planning effort.

When examining a management buyout proposal, the financial institution or syndicate that is funding the project will often require the implementation of new structures and initiatives to ensure the growth of the business, thus validating its investment. For instance, it may recommend the creation of a board of directors and the preparation of a strategic plan. Should this option be retained, the entrepreneur must keep in mind that the offering price may be lower than that of a competing business, especially if more than one competitor shows a serious interest (strategic buyer premium). The owner of the business could then be faced with an agonizing choice between the two options.

Worker shareholder cooperatives: an increasingly popular solution

Although they may have been around for several years in Quebec, worker shareholder cooperatives (WSCs) may emerge, in the near and medium term, as a model solution for transferring business ownership.

A WSC is a legal entity comprised of workers that acquires a block of shares in their business, making it a shareholder. It provides workers with several interesting advantages:

• Employees share in the profits of the business and are represented on its board of directors;
• At the provincial level, they may deduct, from their taxable income, 125% of their investment in the cooperative’s eligible shares, up to a maximum of 30% of their total income, through the Government of Quebec’s Cooperative Investment Plan («CIP»);
• Any shares acquired by workers in the cooperative are eligible investments for an RRSP, and any unused portion of their deduction may be deferred over a 5 year period.

A WSC enables workers to share in the risks related to the operations of the business and, in return, to share in its financial returns, which represents an excellent means to increase their loyalty to the business. For the owner, this makes it possible to sell part of the business’ share capital, to ensure that jobs are maintained in the area and to involve workers in strategic choices designed to ensure that the business continues to operate as a going concern.

A number of Quebec financial institutions are committed to promoting the use of WSCs as part of their funding of management buyouts. Because of its fundamentally cooperative character, Desjardins is naturally pledged to assuming a leadership role in this regard. Fondaction CSN and Investissement-Québec are also championing this model.

A few examples of recent transactions

Capital régional et coopératif Desjardins (CRCD), a tax-advantaged fund managed by Desjardins Venture Capital, has already carried out a number of buyouts over the last few years using the WSC model:

• In 2008, CRCD invested $22.5 million in Fempro, a manufacturer of sanitation products located in Drummondville with sales of approximately $180 million, making it possible for Fempro’s owners to sell their shares. A WSC was set up in 2009 so that employees could acquire 9.5% of the company;
• In February 2011, CRCD announced that it was investing $30 million in A&D Prévost, a designer and manufacturer of aluminum architectural products (doors, windows, skylights and curtain walls) located in Richelieu, in the Montérégie area. Through this investment, CRCD became the firm’s majority shareholder, and two of its executives became minority shareholders. Desjardins intends to promote the creation of a WSC that will enable workers to acquire a portion of the firm’s share capital, enabling the CRCD to gradually reduce its interest in the company.

Over the past two years, several other management buyouts have been announced, including the following:

• IPL, one of the largest manufacturers of molded plastic products in North America (with sales of nearly $170 million) located in St‑Damien, in the Bellechasse area (near Québec), was acquired by Novacap Industries and the Fonds de solidarité FTQ in 2010. This transaction enabled the company to go private after being listed on the exchange since 1985;
• Saladexpress, an agro-firm located in St‑Rémi, in the Montérégie area, was acquired by the Fonds de solidarité FTQ in 2010. The Fonds became the company’s majority shareholder after buying out the owner’s shares;
• TeraXion, a business based in the city of Québec specializing in optical components for high‑speed fibre‑optic networks with about 150 employees, was acquired in 2010 by a syndicate of investors comprised of the Fonds de solidarité FTQ, the Caisse de dépôt et placement (CDP) and Fondaction CSN. A total investment of $11.5 million allowed the company’s management to buy out the owner;

Fortunately, concrete solutions exist for entrepreneurs who are unable to carry out an intergenerational transfer. At the same time, it is imperative that such entrepreneurs adequately delineate their objectives and retain the services of advisors who will guide them through a solid planning process to complete the most significant transaction of their lives.

A portrait of retail in Canada

Author: Marie-Claude Frigon 

The interest expressed by foreign retailers to set up stores in Canada has been examined for several years, in particular since Target’s announced expansion into this country.

The ministère du Développement économique, innovation et exportation (MDEIE) asked the Altus Group to provide the most comprehensive description possible of foreign retail interests operating in Canada as a whole, as well as in Québec. The study provided several interesting observations:

• International retailers operating in Canada had estimated sales totalling approximately $64 billion in 2010, equivalent to 15% of all sales in Canada (estimated at $436 billion in 2010);
• Of this amount, U.S. retailers had sales totalling $62.6 billion, which is close to 98% of total sales by foreign corporations;
• 60% of these sales by U.S. retailers related to four corporations: Walmart (24.7%), Costco (16.2%), The Home Depot (12%) and Best Buy (8.1%);
• Excluding retail sales in the grocery, gasoline and pharmacy product sectors, as well as vehicle sales, where international retailers do not have much of a presence, foreign retailers have a market share of close to 41%. Moreover, just over 96% of these sales were made by U.S. retailers;
• Only 17% of the total space occupied by international retailers is in Quebec, although Quebec represents 23% of the total Canadian population. Quebec therefore seems to be under-represented;
• Several players are already operating in Canada, although not yet in Quebec. They include: Abercrombie & Fitch, Hollister, Victoria’s Secret, Williams Sonoma, Pottery Barn, Bed Bath & Beyond, Michaels, Lowe’s, Crate & Barrel, etc.;
• The following players will or may penetrate the Canadian market in the near future: JC Penney, Dollar Tree, Nordstrom, J. Crew, Kohl’s, etc.

The spring 2011 edition of the retail report of Colliers International also addressed the reasons why the Canadian Economy lures American retail interests; the main conclusions are as follows:

• The stronger dollar makes it increasingly worthwhile for U.S. retailers to establish Canadian stores rather than to sell only to those Canadian customers who shop online or on cross-borders trips;
• Canada is the largest, closest, and/or similar market to the U.S.;
• In Canada, total retail spending increased by 5% from 2009 to 2010;
• Retail spending per capita for Canada and the U.S. expressed in U.S. dollars are now equal;
• The U.S. has more than 23 square feet of shopping centre floor area per capita compared to only 14 square feet per person in Canada;
• Shopping centre sales averages $580 per square foot in Canada compared to $309 in the U.S.;
• American retailers may consider entering the Canadian market through acquisition for the following reasons:
  • Timeliness;
  • Tried and tested retail locations;
  • Acquiring existing leases with lower base rates than new ones.

Michael Baker, a retail and property analyst, did a review of highly effective retailers and noticed the following common traits:

• Adapt store formats and merchandise assortment to the local environment;
• Invest in e-commerce and in stores, but more strategically and selectively;
• Integrate online and offline sales channels to present customers a seamless shopping experience;
• Leverage social media for direct sales;
• Maintain and increase the proportion of private label sales;
• Expand in international territories by direct store, licensing or franchising;
• Deliver an exciting in-store experience;
• Employ people who believe in what they sell;
• Understand that hiring more people does not mean better service;
• They deliver what they promise or make themselves accountable for not doing so.

As can be seen, international retailers are already an important part of the Canadian landscape and this will likely continue. Canadian retailers will therefore face increased competition, not only from international retailers, but also from internet sales, from wholesalers becoming retailers as well from existing retailers expanding their productions to non-traditional activities such as a pharmacy selling food or renovation retailers selling appliances.

This will definitely be a challenge for Canadian retailers, but challenging periods also stimulate many to outperform. Canadian retailers will need to take stock of the environment, assess their competitive advantage, develop the highly effective retailers’ traits and become top of their class.

Ten Practical Risk Management Tips for SMEs

               
Authors: Massimo Cecere        Yves Nadeau

A global economic crisis, new competitors invading local markets, new regulations, fluctuating raw material prices, demographic changes, major weather events and new technology are all elements of risk that are now a part of our daily reality but that are difficult to anticipate and whose impacts are difficult to predict. Many such risks seem to be theoretical, worldwide phenomena, and therefore more of a concern to large enterprises. However, it is important to keep an eye on these risks since they will eventually have an impact on SMEs.

Anticipate risks to take timely action

Some of the risks that have more of an impact on SMEs include the inability to obtain financing, difficulties in recruiting and, especially, retaining specialized personnel, being evicted from leased premises or a drastic increase in rent following the arrival of a major retailer, family disputes, business successions, the loss of a major client, a rigged bidding process, inventory theft, and the retention of imported goods resulting from a port facility strike that is jeopardizing production or retail sales. Even one of these risks can pose a serious threat to the financial stability of an enterprise and can even cause its demise. These risks are very difficult to manage once the event has occurred or is on the verge of occurring. In such cases, mechanisms must be put into place to deal with the situation. Nonetheless, the best way to address these risks is to anticipate them so as to be able to take timely action. By investing in a risk management program, you give yourself a chance to prepare for these situations, to minimize their impacts and even to turn them into opportunities.

For the past several years, enterprise risk management practices have become much more structured, developed and formalized. A number of recognized organizations, in particular the Committee of Sponsoring Organisations of the Treadway Commission (COSO) and the International Standards Organisation (ISO), have proposed master plans to help businesses to develop risk management programs. These approaches are based on some very simple principles that include the following steps:

This approach obviously requires time and a certain control structure as well as strict adherence to rules. However, several practical solutions exist to allow SMEs to develop their risk management program.

The following tips will enable you to see the main benefits resulting from risk management with a minimum amount of investment:

Risk management is a very practical vehicle that acts as a watchdog for your company. It is an exercise that allows everyone to take some time and question all internal business processes in addition to the external environment. When risk management is well developed, it goes beyond a simple list of risks and mitigation mechanisms, leaving room to develop a risk culture that will make employees more aware of the threats that companies may face, and the ability to plan for them.