The five phases of business failure—and three options for survival

Restructuring specialists believe the number of UK insolvencies will soar by 55 percent toward the end of 2009, more than double the number before the credit crunch. At Plimsoll Publishing, we believe that 110 direct mail businesses are among those at a high risk of failure. They can minimise that risk, however, by facing up to the situation and taking at least one of several actions.

The first issue is to understand the extent of the company’s problems. The symptoms of a failing business are sadly, all too familiar.

* Phase 1: Under pressure to increase sales, the company uses all its resources, often resorting to selling at a loss or adding extra costs to service their customers’ demands.

* Phase 2: To finance the sales drive, the company is encouraged to take on extra short-term debts, putting extra pressure on its profit margins through additional interest payments—therefore failing to cut costs, which is what is actually needed.

* Phase 3: After a while, the banks grow nervous and ask that this unsecured finance be swapped to long-term finance.

* Phase 4: Armed with the extra financed capital, the company continues with its failing strategy and allows the overdraft to start to build up again, thus eroding the profits further.

* Phase 5: The company debt grows to an uncontrolled level, and the banks once again grow nervous about the company’s ability to pay it back. It is often now that the banks will demand immediate repayment of the debt, and when the company is unable to do this, administrators are called in.

A critical factor in this cycle is to understand the key measures to monitor in your business in order to pinpoint any decline. The sooner you’re aware of any problems, the more time you have to put a survival plan in place. Once you’ve determined the company’s strengths and weaknesses, you can put a clear set of turnaround targets in place.

Administration should be viewed as a clear last resort. The damage done to the long-term health of the company in terms of the brand and negative publicity are all too difficult to recover from. In essence, the key to avoiding administration is to put in place yourself the measures that they would instigate.

As I see it, the companies currently under severe financial pressure have three options if they want to survive and be well placed to capitalise when the market picks up:

1) Cut costs now. This is not easy. It means the company must accept it will be a smaller enterprise. Internally this will not be well received, as job losses will generally be part of the plan. The company needs to look at a survival plan and adopt the mindset of a receiver, cutting out nonprofitable contracts, reducing overheads, and renegotiating with key suppliers. The objective must be to reduce the level of debt and get the business back on an even keel.

2) Sell the company or look for an investor. Despite the doom and gloom in the market, this option should not be ruled out. We have identified 193 firms in the sector that have cash to spend and could easily afford to finance a purchase out of cash. The flailing companies are very vulnerable to an aggressive takeover, yet my view is there could be a great benefit in selling up. A new owner would give the company time and resource to turn its performance around. Sadly again, this will inevitably involve job losses and reducing the size of the company to rejuvenate the business.

3) Trade its way out. In the current economic climate this is the least likely strategy. Of the 110 companies on our danger list, most have fairly long-term problems, so clearly their current business is not competitive in the market, and simply doing the same will not change anything. Combine this with the inability to raise extra finance, and time is not on the side of this approach. Only a few of the “danger” companies have this as a viable option.

David Pattison is senior business analyst at Plimsoll Publishing.