Time To Exit - When it's time to say goodbye...
Why do some companies make a sharp exit, while others suffer a lingering demise? And once the writing’s on the wall, can time to exit be controlled by managers?
As the global economy recovers, most businesses are at last looking forward and planning for growth. But what lessons might have been learned from recession? In particular, while it’s easy to blame business failures solely on external factors generated by the economic downturn, are there aspects of the way certain companies were managed that might have accelerated their demise? Why did some firms – operating in the same sectors, with comparable client portfolios and similar sizes of workforces – experience such different fortunes, with some collapsing much sooner than others? And looking back, what actions could company owners have taken to stave off bankruptcy or voluntary liquidation?
A study by Ghent University and Vlerick Business School indicates that certain factors can determine the time that passes between the first sign of a business in distress and the point at which it is wound up (either voluntarily or by court order), most notably, slack resources and stakeholder dependence. The study, although confined to Belgium, has important implications for businesses in most EU economies. The study covered nearly 6,000 companies that exited over the period 1998-2000 – all operating within the private sector and chasing profits. Start-ups (those firms less than five years old) were excluded, due to the contrasting nature of theirmodus operandi. Companies in the study also shared signs of economic distress before exiting, so that researchers could examine how those signs impacted on the behaviour of company owners, and subsequently on the time to exit.
What Makes Companies Go Bust
Researchers had a number of objectives. If there are plentiful resources when distress first manifests itself, what difference might that make to the ultimate arbiters of exit? Why might courts look more favourably on healthy resources, allowing more time for the business to take steps for recovery? Furthermore, how much of an impact does the availability of actual and potential resources have on the time it takes an underperforming company to make its exit? And if higher levels of those resources help to delay bankruptcy, is that necessarily a good thing for owners and creditors, if exit is inevitable?
The age of a firm, as well as its investments and payroll, can play a major role in influencing time to exit. The older the firm and the greater its investments (including its inventory and cash holdings), then the greater its ‘slack’, ie its capacity to continue operating on a business-as-usual basis while simultaneously seeking to identify ways in which it can alleviate its distress and get back on keel – or at least minimise the cost or pain of an ultimate exit. And the greater that slack, the longer it will typically take to go bankrupt. For instance, faced with a diverse range of creditors – such as banks and suppliers – as well as others with a stake in the business (who might include minor but vocal and warring shareholders), the situation might well appear overwhelming to the business owners. After all, demanding suppliers – who themselves might feel in danger – and banks less inclined or able to be generous – loom large. But a complex mix of stakeholders with varying degrees of dependence can in reality allow for buying crucial time before the courts step in.
Bowing out of Their Own Accord
Voluntary liquidation is another story altogether, although for some similar reasons. Long-term relationships (for instance, with banks, shareholders, employees and suppliers) play important roles; owners will wish to exit with minimal disruption or cost, thus mitigating any loss to reputation. In any case, stakeholders themselves have a strong incentive to take action to mitigate their own losses. For instance, workers – who may have ‘insider knowledge’ (not always accurate) that informs their actions – may attempt to use legal means to prevent voluntary liquidation, at least until they are fully paid up-to-date. Increasingly, it might seem that workers – who are often the more high-profile ‘victims’ of business failure, generating public sympathy especially if local or national press has been following the potential bankruptcy – can exert influence over the proceedings. But the reality is typically the reverse, which is good news for those faced with winding up their business in the glare of the media.
However, other stakeholders – notably creditors – are unlikely to back down without a fight. These competing interests provide for a complex web of demands on the time and attention of the company’s owners – and, probably, their advisers too, as many stakeholders will resort to legal means. With this in mind, ‘stakeholder dependence’ has a positive effect on the length of the time period from economic distress to voluntary liquidation.
Well-resourced, Buying Time
Higher levels of available and potential slack resources (reflected by large cash holdings and a low current leverage) increase the length of time to exit, creating an incentive for management to be prudent, in many ways ‘mending the roof while the sun shines’. Conversely, higher available slack resources can speed up voluntary liquidation, especially if company owners want to cut their losses and realise their assets while the going is good (or at least, as good as can be hoped for). Other factors might include the age of the firm, management competence, profitability and levels of investments, as well as asset tangibility (successfully divesting tangible assets can prove a fruitful short-term measure to buy time) and high volumes of trade receivables.
And let’s not forget employees. Where significant numbers of redundancies are likely to attract attention outside a company’s relatively controllable business sphere – for instance, in local communities or in the media – company owners may wish to adopt a less obviously ruthless approach to voluntary liquidation. In an era characterised by an increasing emphasis on corporate social responsibility, the workforce factor cannot be ignored. And in the smallest firms, where owner-managers work alongside their employees (or family members), there may well be emotional factors at play too, with owners as likely to feel paternal about their workers as they are to feel desperate for their business to survive – and therefore perhaps more resourceful or imaginative in finding ways to avoid voluntary liquidation.
Time to Change Tactics?
The findings have implications for managers. Voluntary liquidation may be held at bay by maintaining high levels of available cash (rather than tying it up in working capital) and low levels of debt, while operating within a flexible, agile management hierarchy. If voluntary liquidation becomes unavoidable, though, the company’s owners may yet avoid bankruptcy if they have the business skill and commercial acumen to identify the gravity of their situation and take the necessary steps at an early stage. This is especially the case within the SME space, although the characteristics and nature of entrepreneurs may mean they’re less likely to want to be seen ‘admitting defeat’, and instead plough on, delaying the inevitable and costing themselves dearly in the long run. But overall, regardless of the size of the organisation, the first signs of distress need not spelling impending disaster – provided management is alert to those signs at an early stage, and have the conviction and know-how to do what’s required.
Looking ahead, a few questions remain. For instance, how might the most recent recession have generated different results than the study of exiting companies over 1998-2000? The suddenness and severity of the global meltdown in many ways presented a unique set of circumstances, and certainly many management teams had no practical hands-on experience of dealing with crisis after crisis. With banks being leaned on heavily by governments in virtually every major economy to cut some slack to struggling businesses, it may be some time before we can see whether the contributory factors revealed by Vlerick’s study have resonance in the current climate.
Balcaen S. Ooghe H. Manigart S. 2011. From distress to exit: Determinants of the time to exit. Journal of Evolutionary Economics. 21 (3) : 407 - 446.