Turnaround Case Study - Professional Service Firm

The Background:

Owned and operated by its founder for over 35 years, this professional service firm primarily provided assistance to municipalities and governmentally funded projects. The client mix was 85% and 15% - governmental vs. for-profit, respectively.

Unfortunately, there was no genuine lower level appreciation as to the level of work performed by the founder. The founder was the “rain maker,” the “face of the firm” and, more importantly, the leader. The founder would not only bring in the work, but made the tough decisions and controlled the strategic financing.

The founder had sold the firm to its five managers, who headed the various business areas within the firm. With this change of ownership, each manager became a stockholder and collectively became the firm’s executive management team. Together, the shareholders selected one of the managers to become the majority stockholder in order to ensure the firm could qualify with a minority firm designation — the theory was that with this designation, the firm would have a better chance of securing engagements with municipalities and government agencies.

The Problem:

The new owners had no experience in running a business. Although individually they were good professionals within their specific disciplines, the new management team’s combined talent had zero business acumen. The crux of the problem was that the new shareholders did exactly what they had been doing for years, without one of them “stepping up to the plate” and actually running the firm. Everything was by “committee” or consensus. The adage “a camel looks like a horse that was planned by a committee” was most apposite for this specific situation.

The professional service firm provided four lines of services to their clients. Each of the services was “managed” by a shareholder. It was as if each line of business was managed, executed and marketed as private dominions. Despite the firm’s relatively limited size (+50 employees), more than one accounting system existed for the revenue and cash flow cycle; that fact alone was reflective of the degree of autonomy. There was virtually no common marketing, cross-selling, or standard brand within the firm, and absolutely nobody took accountability for the firm’s total overhead. Given its dysfunctional departmental organizational structure, the firm’s overhead expense was not considered “their expense.” After properly allocating the overhead to each department, three of the four lines of business were operating at a loss.

In addition, there was no doubt that the new shareholders overpaid for the firm. And to complicate the matter more, the main office building was sold to an unrelated third party who had a different agenda.

Even before the buyout, the firm was highly leveraged. The buyout price included 60% of the acquisition price being placed on the books of the firm, with the remaining 40% accounted for with stock directly purchased by the individual shareholders. This debt from the acquisition of the equity, coupled with the liberal line of credit was an unrealistic debt burden from day 1. The line of credit was 20% of the prior gross revenue with an average gross profit margin for the past three years of only 7%. Of course, the new entity virtually maxed out their line of credit within a few months of the sale. These funds, generated from the line of credit, were literally wasted on engagements that were lost financial leaders without supervision – several of the engagements had a negative gross profit margin. None of the new projects had a gross profit margin greater than 6%. The executives were the first ones to utilize the finances while the line of credit existed.

In the first year of operation under new management, year-over-year gross revenue decreased over 30% while fixed expenditures decreased less than half that percentage. Add in that earned gross profit margins were at an all-time low – this was a recipe for both short- and long-term failure.

Finally, the cash flow cycle was curtailed by the fact that the firm did not bill on a timely basis, nor was there any urgency to collect on their accounts receivable. Management did not aggressively pursue collection of these outstanding receivables due to the nature of dealing with municipalities and government funded clients. To put it in perspective, of their accounts receivable, 15% were more than 90 days old. 

For some reason(s), the bank financed this team and this firm. It may have been because of the great story of the firm’s +35 years of success, its business reputation or the fact that the same people would be moving forward, ad infinitum. But now within this six-month time frame, the bank and the prior shareholders realized this firm was not equipped to solve the elementary business challenges.

That’s when Lakelet Advisory Group (“LAG”) was called in.

The Solution:

LAG thoroughly analyzed the firm and its situation to develop an effective solution. Within two weeks, LAG had a plan acceptable to all stakeholders. Even Henry Kissinger would have had a challenge addressing the necessary diplomacy given the personalities involved. It had literally been months since all the shareholders met, each blaming the other’s line of business for the firm’s overall problems.

 In an attempt to eliminate that silo effect, we set up weekly meetings for all parties to actively participate. Unfortunately, this barrier was never fully eliminated. The complicity was the different lines of business, different offices and, to make matters worse, family nepotism involved amongst shareholders.                                                  

Weekly reports were shared throughout the organization so that all parties could recognize, on a timely basis, the results of the prior week and month vs. where they needed to be.

We took a very aggressive role in regard to accounts receivable collection. A customized process was set forth for all overdue transactions – there were “no sacred cows.” Over a period of approximately three weeks, collected funds produced a reduction in the line of credit of 61.5% (not a typo).

Besides improving the cash flow from a collection perspective, we also restructured the firm’s existing contracts and aggressively achieved relief through reduction of the lease obligations. As a result, we were able to reduce the monthly rent by 27% between the two locations. 

By the third month after hiring LAG, the firm (a) was for the first time in over a year, profitable on a monthly basis, (b) had reduced the bank debt by over 60%, (c) had restructured the debt with prior shareholders by 55% from that of the prior year’s end, (d) decreased the backlog 23% and (d) reduced expenses over 27%. One would consider this a success. In this case – Lakelet had won the battle but lost the war.

The Results:

These changes were above and beyond what the shareholders could accept. The realization that the firm could not exist as it had for the past 35 years was too much for the stakeholders to handle. Our prompt changes and procedures – although tangibly beneficial – were too adversarial. “If you do not change direction, you may end up where you are heading.” [Lao Tzu] It is a difficult trade-off. A turnaround organization is literally addressing the cash flow for the next 12 weeks – not 12 months or years. Yet, the management team was not accustomed to strategic transactions, accountability, responsibilities and business development.

The required CI (Continuous Improvement,) accountability and responsibilities were beyond what they could accept and we could implement. LAG’s changes and recommendations had the firm poised for turnaround, but it was time to turn the reigns back over to the firm.

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