Why does a company really fall into distress? While the problems are visible on the financials, the true causes go deeper than the numbers and into the operations of the business. By the time the financials reflect trouble, the one or two root issues of a company’s distress have manifested as a core — but broken — part of the business. Like cancer, they metastasize to other parts of the organization.  Root cause issues can be easy to resolve in isolation if properly identified. However, a comprehensive solution to save a broken company in its entirety is more complex. It requires knowledge of how the parts of the business work and in what sequence did they actually begin to fail. Not all failures are equal, and understanding the elements of operational failures are the greatest indicator of the company’s ability to repay debt.

As discussed in Indispensable Secrets for a Small Business Turnaround, there are ten key business factors beneath the numbers. In this blog, we examine four external factors that influence success or failure: markets, environment, risk management and legal issues.

Market

The external market is segmented into five components: size, growth, number of direct competitors, aggressiveness, and recent changes.

• How big is the market this company plays in? In other words, is it an open market with ample opportunity or is it a self-contained market that is so niche it lacks growth capability?
• Is the market growing faster than GDP, less than GDP, or is it even shrinking?
• Are there a number of direct competitors diluting the market, or are there a few or none direct competitors thus allowing for a unique and strong market offering?
• Does the company have the capability to sell with a good gross margin or is it dealing with a pure commodity/trading mentality where price often feels like a race to the bottom?
• How much is the market changing? Relatively little movement versus one, two, or three dramatic occurrences.

Environment/Stakeholder Management

The immediate surrounding stakeholder groups that can either help or hurt a business include lenders, vendors, customers, board of directors, and owners/family engagement. In a turnaround scenario, the relationship between one or all of these groups and the company has been damaged. Each will have a grievance with the company.

Risk Management

Risk management encompasses macro-economic issues. While the company may avoid direct impact, there’s a trend in the market changing the dynamic in which the company operates. The adage, “you can turn around a company but you can’t turn around an industry” applies here. Risk management may not apply in all cases, but it does define factors to be wary of, which can be broken into three categories:

Customers

• Sales channels: encompasses the ways the company goes to market, who the company sells to directly, and the ways in which they reach those customers
• Competitors: relates to direct competition, including a particular competitor who has changed or is consolidating markets
• Demographics: often relates to consumer behavior, but also affects B2B companies. Demographics change by generation and while slow in motion, its momentum is irreversible
• Loyalty: the cost for customers to switch between alternatives

Technology

• Innovation/substitutions: substitutions of product or services in the marketplace
• Technology/process: process-driven improvements for the production of products or services
• Product life cycle: the ever-accelerating availability of technology and innovation accelerates change in an industry.

Secondary stakeholder

• Regulations: laws credited by a governing body that can either hurt or help a company
• Special interest groups: people who are trying to create barriers or regulations
• Stakeholders not part of the industry (e.g.; people who are affected by the company’s actions who are not directly involved in the company)
• Globalization: new markets and/or new competitors from other markets
• Outsourcing/offshoring: shifting non-core activities to people who deliver with a better outcome or a lower cost

Legal

Legal conditions can provide protection or contribute to a slow death. Four scenarios in particular contribute to operational success or failure:

• Assets owned and protected: the business produces widgets that are interesting and unique. Are they protected?
• Legal liabilities: the business lost a lawsuit.
• Legal concerns, notices, actions, and lawsuits: how many fires is the company managing at once?
• Recent external changes: the industry pattern of litigation has changed for the worse. In the last one to five years, lawsuits have become more significant and frequent.
• Recent internal changes: the pattern of litigation has changed for the worse. In the last one to five years, lawsuits have become more significant. There seems to be uncertainty on the company’s legal stance on matters. It could be HR issues, product liability issues, or a struggle with compliance restraints; overall, there’s greater concern about legal standing.

External factors in the market, environment, risk management, and legal go beyond the financials to influence a company’s success or failure. In the next installment of our series, we will examine the power of internal factors.