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Warning Signs of a Business in Trouble A business that is becoming troubled gives off early warnings. Astute, creative bankers who learn to recognize these danger signals in time can protect themselves from severe losses and help the client to find effective remedies. Bankers generally do a good job of screening a new business applicant for credit. Experience helps them avoid companies that give any indications of probable default. The typical business, however, goes through a cycle of growth and decline - and the banking relationship parallels this cycle. It may take these same bankers years to discover that an establish- ed client is in an advanced state of decline, unable to repay its loans. Consider the life cycle of a typical business. The entrepreneur begins by developing a product - and some customer relations - while still in school or working for an established company. The new com- pany operates from very modest facilities. As the business grows it needs more space and more operating staff. Although the staff may now include departmental managers, the founder continues to make virtually all decisions. Senior jobs are filled by member of the founder's family. It is unusual for such a business to employ experienced nonfamily members with profit participations or equity interests. Related products are developed, typically with- out any directly related increase in management, financial controls, produc- tion staff, operating sophistication, or capital. Sales and gross income keep on growing for several years. It is not immediately apparent how dependent the company has become on a few customers or suppliers. As the company prospers, bankers compete for its accounts. The founder's personal success leads to changes in life style. A sure sign of this change is frequent absences from daily company operations. The founder is in conflict with senior management and the board of directors. Key personnel who disagree with the founder are forced out. Sales decline in one or more product lines because of a slowdown in the economy in general, in- creased competition, or problems with the quality and production. No internal adjustments, however, are made to the declining sales. Senior operating managers and the financial personnel take jobs with the company's competitors - or the form their own competing businesses. Their positions are left open, or they are replaced with less experienced, less qualified employees. The company lacks clear lines of authority, decision making, reporting, and responsibility. Disappointed suppliers and customers stop dealing with the company. Sales drop more drastically. The industry begins to gossip about serious problems in this company, accelerating the decline. Finally, the founder must face the music with the banker, to insist that an increased loan will bring about the company's full recover. The founder assures the banker that all the personnel and pro- cesses that were to blame have been eliminated. What is not said - but vital for the banker to perceive - is that an increased loan will also maintain the founder's life style. The typical company will be borrowing more money to continue doing things the same unprofes- sional way. The result is likely to be a slower and more expensive liquidation or Chapter 11 business reorganization. The banker who detects these danger signs should require a discussion of their true causes. The company may reorganize slowly and thoughtfully to recover its stable, successful posture. Inreased funding or loan concessions must be accompanied by basic changes in business activities, organization, and management. The founder should be encouraged to seek solutions within the company and to use outside consultants. The quickest, least expensive route is often to obtain sophisticated, unemotional, temporary outside help.
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