E4 Slides C (16)

Chapter 16:
Business failure
and turnaround
measures
AIM AND SCOPE OF CHAPTER
Aim
To distinguish the severity of distress in a business venture and how
to act to turn the business around or to pursue formal business
rescue.
Scope
• Failure in perspective.
• Typical goals for entrepreneurial venture.
• Levels of failure in ventures.
• Key issues of business success or failure.
• Signs of distress.
AIM AND SCOPE OF CHAPTER (cont.)
Scope (cont.)
• Causes of distress.
• When growth leads to distress (overtrading).
• The size of the venture and signs or causes of distress.
• Franchising and failure.
• Success signs that oppose failure.
• Conclusions about failure.
• Turnaround.
• Principles of a turnaround process.
• Options other than a turnaround.
• Business rescue.
LEARNING OUTCOMES
1. Distinguish between business in “distress” and levels of failure.
2. Gain insight into the reasons why ventures have difficulties
and fail.
3. Identify the core factors that cause failure of a venture.
4. Understand the interrelationships between elements
responsible for success and failure.
5. Recognise the levels of failure in a venture and how they might
arise.
6. Identify early warning signs of pending distress.
LEARNING OUTCOMES (cont.)
7. Understand the causes of failure.

8. Identify potential management actions available to the
entrepreneur to manage distress situations.
9. Understand the action necessary to turn a venture from a
distressed situation towards a good one.
10. Understand the new business rescue legislation.
FAILURE IN PERSPECTIVE
• Success is defined as the achievement of realistic goals.

• Failure is the opposite of success – the non-achievement of
realistic goals.
• It is possible to be partially successful (for example, achieving
seven out of ten goals).
• Also possible to fail partially (for example, achieving three out
of ten goals).
• Business ventures normally do not have a single goal whereby
success or failure can be measured.
FAILURE IN PERSPECTIVE (cont.)
• Success will be measured on a continuum between success and
failure.
• To evaluate whether entrepreneurial ventures fail or succeed
would therefore require the goals of the venture to be assessed.
• What are realistic goals for a venture?
• Are these goals also the goals of the entrepreneur?

TYPICAL GOALS FOR THE
ENTREPRENEURIAL VENTURE
• Venture goals vary significantly, depending on the type of

business, industry, entrepreneur, life cycle stage, original reason
for establishment, etc.
• Venture goals can be categorised into:
 Personal goals.
 Financial goals.
 Strategic goals.
TYPICAL GOALS FOR THE ENTREPRENEURIAL VENTURE (cont.)
Personal goals of the entrepreneur

• The initial motivation for starting a venture varies widely from
the need just to survive (survivalist or necessity entrepreneurs)
to the drive to develop a new product and achieve financial
independence (opportunity entrepreneurs).
• A combination of several motives often prompts the
entrepreneur to start the venture.
• In developing countries, many survivalist entrepreneurs are
forced to pursue venture establishment in order to provide for
their basic needs for survival on a day-to-day basis.
Personal goals of the entrepreneur (cont.)
• Entrepreneurs frequently start a venture with the idea of

becoming their own boss.
• Long hours and tedious work however create feelings of
dejection and disappointment.
• The ideal picture that they had in mind did not materialise.
• They then have to re-evaluate their goals.
• Although they are not a failure yet, such entrepreneurs may lose
motivation and determination, as they are not really doing what
they want to do.
Personal goals of the entrepreneur (cont.)
• Non achievement of personal goals lowers effort and input.

• This leads to the next level of non-achievement, namely the
financial goals of the venture.
• Control over the resources within the venture may be
important and also serve as a personal goal.
• According to Timmons (1999), ownership of resources should
not be paramount.
• However, many entrepreneurs have a control mindset.
• When a venture fails, the entrepreneur normally also loses
control over the assets of the venture.
Financial goals of the venture

• Depending on the type of business venture, the financial goals
of the entrepreneur may differ.
• A survivalist venture refers to a business activity which a
person enters into to earn an income for physical survival on a
day-to-day basis – the income is normally irregular in amount
and timing.
Financial goals of the venture (cont.)
• The micro enterprise may be able to generate regular profits

over a more sustainable period of time – venture may not have
the potential to grow, but can sustain the entrepreneur’s
financial requirements.
• Also referred to as a “lifestyle” venture, and such entrepreneurs
become a manager of their own small enterprise which supplies
the required income levels to satisfy their lifestyle goals.
• Financial goals for small and medium-sized ventures require an

understanding of why people invest their funds in a business
venture.
• Typically entrepreneurs want their own funds to grow and
generate more funds – thus an investment decision.
• These people are shareholders who take the risk of investing
their money in the venture.
• External investors may also seek growth in the venture’s assets
through sales and market share.
• The financial goals of shareholders that are relevant here

typically include the following:
 Return on investment (ROI) for shareholders.
 Increased sales and revenue.
 Increased market share.
 Continued growth in profits and size.
• It is important to realise that there are different stakeholders

with financial interests in the venture.
• These include the following:
 The entrepreneur’s own equity.
 Other equity holders (external shareholders such as family
or partners).
 Lenders and suppliers of credit to the venture.
• All the financial goals serve these stakeholders in some or other

way.
• Employees (not necessarily shareholders) are beneficiaries of
the venture and have no rights with regard to the determination
of the financial goals.
• The financial goals of the venture are driven by the
shareholders’ requirement for ROI as they take the risk of
investing their funds in the business.
• ROI is the key financial goal while the others complement it.
Strategic goals of the venture

• Strategic goals of the venture refer to the utilisation of the
opportunity and the achievement of a fit between the venture
and its environment to ensure long-term profitability.
• Underlying the strategic goals are the financial and personal
goals.
• Firstly, the opportunity of the venture is based on the original
idea which is converted into an entrepreneurial opportunity –
this brings value to a target market for which it will pay.

Strategic goals of the venture (cont.)
• The venture thus presents the target market with a concept

offering that will meet the needs of the market.
• The objective of the venture is to develop the ability to adapt its
offerings to the changes that may occur in the target market’s
needs and requirements.
• Ventures must respond to a change in needs and/or anticipate
changes in needs – thus serving the target market successfully.
Strategic goals of the venture (cont.)
• The second strategic goal of the venture is to ensure long-term

profitability by meeting the needs of customers.
• Decisions should therefore focus on the long-term profits rather
than short-term profits.
• Strategic goals have to do with the continuous long-term
existence of the venture.
LEVELS OF FAILURE IN VENTURES
• Failure has different levels when evaluated in the business
environment.
• Each level in between is characterised by a different set of
circumstances.
Figure 16.1: The venture failure slide

LEVELS OF FAILURE IN VENTURES (cont.)
The venture that is performing well

• The venture gets a green light at this level and there are no
obvious problems.
• All the goals are being achieved, including personal, financial
and strategic ones.
• This is the level that all ventures aspire to.
• At this level of performance, the shareholders are satisfied with
their investment.
• The entrepreneur, who is a shareholder, is motivated by the
venture’s performance, and external stakeholders want to
improve relationships and benefit more to share in the
The underperforming venture

• Underperformance in the venture means that some goals are not
achieved but, overall, there are no visible differences between the
well-performing and the underperforming venture.
• Underperformance is usually seen when comparing the financial
statements over a period of time.
• The venture that is underperforming gets a yellow light, serving as
a warning that something bad may be coming and that the
entrepreneur should rectify what is wrong.
• Underperformance suggests that you are running your business
badly and/or because efficiencies are not being achieved.

The underperforming venture (cont.)
• As the venture moves in the direction of complete failure, more

and more signs become visible, provided that the necessary
records have been properly kept to be able to identify them.
• Financial statements should be made available as soon after the
end of the month as possible.
The underperforming venture (cont.)
Figure 16.2: Performance indicator levels associated with venture failure

Distress in the venture (difficulty)

• Ventures in distress get a red light, the entrepreneur must stop
and evaluate the situation immediately before taking
corrective action.
• This phase is also known as distress.
• The signs are fairly clear but often the entrepreneur does not
want to acknowledge that something is wrong.
• They work harder in the hope that the problems will
disappear.
• This usually never happens and things only get worse.
• Before long, the venture moves into in crisis, which is more

Distress in the venture (cont.)
• The key signs of distress are decreasing net margins and early
irregular cash flow patterns.
• Characterised by liquidity problems.
• Venture comes close to being insolvent when its liabilities are
greater than its assets – likely to encounter legal and financial
problems.
• Full insolvency is the next phase.
• NB: There is hope for the venture to turn the situation around
when it is in distress, but it becomes very difficult once the
distress turns into a crisis.
The venture in crisis

• During a crisis, the irregular cash flows associated with distress
in the previous phase become worse and are constantly
negative for long periods.
• Rapidly declining sales and market share will confirm the
trends of a possible continuous decline the venture is
experiencing.
• Loss of confidence by stakeholders and employees.
• Next creditors will apply for bankruptcy to be filed against the
venture.
The venture that failed (irreversible distress)

• Once insolvent and not operating anymore, closure becomes
inevitable and the entrepreneur finally loses control of the
venture.
• Depending on the specific situation, a plan is prepared for
salvaging what is left, but it is rarely possible to save a venture
at this stage.
Context effects
• Research has shown that ventures do not necessarily “slide”
down from good performance towards distress.
• Contexts may change overnight, which takes the business from
performing well directly into a distressed situation.
• Especially when environments change rapidly, as they do in this
era, the effects may be very quick.
• Entrepreneurs need to be aware that when they look at their
venture, they identify its relevant position on the slide as at that
moment.
KEY ISSUES OF BUSINESS SUCCESS
OR FAILURE
• Venture failure is seen as the opposite of the success achieved
by the business venture.
• Success is defined as the achievement of the venture’s various
goals.
• Different factors determine the success of a business.
• A lack of these success factors in a venture will contribute to its
failure.
• The more they are lacking, the further the venture will slide
down the failure scale.
KEY ISSUES OF BUSINESS SUCCESS OR FAILURE (cont.)
• There are five keys that lead to successful business ventures.

• These factors are interrelated and impact on each other in
different ways.
• It is crucial to consider how they fit in and affect the venture’s
profitability and growth.
• Each has to do with the signs and causes of failure.
• Mastering the concepts associated with each of these keys will
help the entrepreneur to make a success and halt the failure
slide.
• Understanding these keys will lead to more questions and
answers, which will eventually distinguish you from the average
person in business.
Figure 16.3: Key factors and their relationship to venture failure

Attitude and motivation

• The first of the five keys to business success is to have an
attitude of success and be motivated to achieve.
• Attitude of success refers to the following:
Means having a positive outlook and feeling about being
successful in business.
Having a high “locus of control” exhibited by successful
entrepreneurs.
It is a personal choice to have a positive outlook.
If you are a negative person who is always complaining, it is
better to not try and start a business.
The longer an attitude is held, the stronger it becomes.
Attitude and motivation (cont.)
A positive attitude will give you a new perspective of the

problems that come your way.
Focus on how to make things work rather than on why they
cannot work.
Refers to the frame of mind with which individuals approach
tasks and problems.
The way you think and how you approach life and work will
determine your success.
Think positively about everything and the negatives will stop
following you.
• Perseverance refers to the following:

Refusing to give up or let go of your objectives, especially in
the face of obstacles and discouragement.
Means that you are energetic and positive about your plan
and the goals you pursue.
You are driven to achieve them.
Accept that giving up is not an option.
• Perseverance, does not mean that you should be stubborn, bull-

headed or plain stupid about things that cannot work.
• Answer the following questions to get an indication of whether

or not you have what it takes:
Have you recently blamed someone or something for what
happened to you?
How often have you given up something important to you?
Why?
Are you willing to work 18 hours per day, six days a week to
achieve your goals?
• If there are low levels of attitude and achievement motivation,
the chances of failure are higher, both at the personal and the
venture level.
Positioning
• Very few people understand the notion of positioning (the value
proposition of the business model).
• Positioning largely takes place in the minds of the consumers.
• It is how they see a product (their perception); it is also what

one believes the customers will value and what one can
provide.
• The needs of the target market therefore determine what
“value” the concept can give the market, and therefore the
entrepreneur has to understand the needs of the market well.
• Positioning has a lot to do with the target market one selects to
serve.
Positioning (cont.)
• Compare KFC, Nando’s and Chicken Licken.

How do they position their concept offerings?
Studying their advertisements.
Compare set-ups.
Study pricing strategies.
Compare apparent target groups.
Listen to feedback from their managers.
• KFC – Positioned as a “convenience” product.

• Nando’s – Focuses on giving people a “memorable experience”.
• Chicken Licken – Positions its product as basically good food
which is a fair-sized meal at a low price.
Economic model
• The economic model describes the relationship between selling
price, cost, volume and fixed expenses.
• If the economic model is not sound, there is no basis for the
business venture to exist.
• To test the venture’s economic viability, three key questions
should be asked:
Is the business model economically sound?
How many concept offerings (products) can be sold in the
market?
How many fixed expenses are required to produce the
required number of products?
Economic model (cont.)
Is the business model economically sound?

• Know what the margin is for the concept offering (or product).
• The margin is the difference between the selling price [S] and
variable cost [C] of one unit of a product or service.
• The margin is always calculated per unit.
• Example: If one can of soft drink costs R2.00, but sells for R2.50,
the margin is 50c.
• In composite goods, the variable cost consists of all the
materials one requires to make it.
How many concept offerings (products) can be sold in the

market?
• For the economic model to be sound, one has to know whether
there are enough people who need the concept offering and are
willing to pay for it.
• One needs to know how many items can be sold [N].
• If the number of products that one can sell is too small to create
a viable business, one should then combine this product with
other products in a different business model.
How many fixed expenses are required to produce the

required number of products?
• Fixed expenses [F] involve facilities, equipment, salaries,
overhead costs such as telephone, rent and repayments.
• This is not part of the cost of sales [N × C] and must be
considered separately.
• By answering these questions, one can calculate the sales
income [N × S] and the sales cost [N × C], which are both
important values for one’s planning.
• Combining these into one formula gives the contribution
margin = ∑N[S – C], which must be positive.
• A positive contribution margin can then be used to cover

the fixed costs [F].
• Combining all of the above gives the profit formula: P =
∑N[S – C] – F.
• The number of products [N] is vital to the profit.
• Economic viability indicates that the venture can be

profitable and can be pursued meaningfully.
• If the concept is feasible and viable, one can seriously plan
to implement it.
Sales and market share

• If the profit of the venture is calculated as P = ∑N[S – C] – F, it is
clear that it can be improved in the following ways only:
By increasing the sales volume [N].
By increasing the margin, which can be done by:
increasing the selling price [S].
decreasing the cost price [C].
By decreasing the fixed costs [F].
• The relationship between the variables makes it difficult to

change any one variable independently without affecting some
of the others.
Sales and market share (cont.)
• Example:
If the selling price [S] is increased (to make more profit).
Number of products [N] demanded by customers will
probably decrease accordingly.
This leads to reduced profit.
• Example:
If fuel costs increase [C], the margin drops.
• Example:
If labour cost [F] increases, the profit drops if there is no
improvement in sales [N] or the selling price [S].
To improve profits, one should therefore find ways to
increase N and S, or decrease C and F, without affecting the
other variables.
• Many factors may affect the demand for one’s concept

negatively and influence the sales volume [N].
• Some of the factors include:
Competitor actions.
Competitor products.
Changes in customer tastes.
Changes in customers’ disposable income.
Economic changes in interest rates.
Inflation changes.
The list is non-exhaustive.
• For every concept, different events and actions have different

effects.
• One should not make generalisations but research the specific
concept offering and relevant factors well.
• The basic issues of demand and supply are very relevant when
studying the relationship between N and S, which is responsible
for the income part of the venture.
• The C and F factors are expense issues that indirectly influence
the income and margin issues.
• The economic model and the sales forecast require an

understanding of the relationships between the various factors
– this is crucial to business success.
• It is important to know how these factors interact.
• Each factor should then be studied individually.
• Incorrect forecasting of sales that do not materialise after start-
up is reported to be the second most important reason for
business failure.
• Prospective entrepreneurs typically overestimate the number

of product concepts [N] that they intend to sell – this makes the
venture look more viable.
• The higher the forecast N, the higher the profit will be.
• During the forecasting stage, one should rather err on the
conservative side than overestimate.
• One should strive to be as accurate as possible.
• Market research need not necessarily be highly sophisticated
and expensive – try to keep it simple.
• Market research is done to ensure that you can project your

future sales as accurately as possible before you start.
• Financiers will probably also want to be assured that your
projections are correct.
• Certainty about future sales create fewer problems in the
future.
• These guidelines are also true if you want to increase your sales
when you are already in business.
• Remember, one of the four ways to increase profit is to increase
volume [N].
Cash flow
• The final key to success is understanding the venture’s cash
flow situation.
• The two important issues about cash flow are “flow” and
“timing”.
• There are two kinds of flow, namely inflow and outflow.
• Inflows:
Inflows into the enterprise primarily come from payments
received from customers.
Other inflows can be capital from different sources, as
discussed earlier, and normally occur at the start (= timing)
of the enterprise.
Customer payments are made regularly during and mostly at
the end of the month (= timing).
Cash flow (cont.)
• Outflows:
Are monies paid for stock and fixed expenses.
Typically, an enterprise must buy the inventory before it can
sell it.
This means that the money must be paid before selling can
be done and therefore the inflow follows long after the
outflow.
If this time gap is too wide, a cash flow problem may arise
unless provision is made for it by obtaining bridging finance.
• Businesses that have initial outflows and a large time gap
before inflows struggle with cash flow.
SIGNS OF DISTRESS
• As the venture moves between the levels of distress, the

different signs appear and serve to warn the entrepreneur of
impending distress and its severity.
• These signs, however, do not follow a set sequence, which
makes it difficult to follow the pattern of distress.
• The signs are explained in the general pattern, but can appear
at any stage because they are interrelated, and are affected by
many external issues.
SIGNS OF DISTRESS (cont.)
Decline in gross margin

• The first sign to look for is a decrease in the gross margin.
• This requires a comparison of the current gross margins with
those of previous periods.
• One looks for trends that appear after three consecutive periods
(normally months).
• If there is a decrease over three consecutive periods (months),
it signals the start of a trend.
• The reasons for this should be investigated through a more
detailed analysis of the factors determining the margin.
Decline in net margin

• The second sign to look for is a decrease in the net margin.
• The net margin considers the fixed expenses that are related to
the operation of the venture.
• This requires a comparison of the current net margins to those
of previous periods, and one should look for trends that appear
after three consecutive periods.
• Again, if there is a decrease over three consecutive periods
(months), it is the start of a trend, and the reasons for this
should be investigated.
Irregular cash flow

• A second sign, which is difficult to notice and follows the
decrease in net margin during the early stages of failure is
erratic cash flow at this point.
Faltering value proposition and sustainable

competitive advantage
• Value proposition is all about concept positioning.
• It is necessary for the venture to have a certain competitive
advantage (CA) in its concept offering.
• CA is the advantage a venture has over its competitors which is
difficult to copy, follow, and distinguishes it from the others.
• Examples:
Brand name or patent.
Access to a distribution channel.
Access to a supplier network or raw material.
Unique production facilities, special technical know-how and
new technologies.
Faltering value proposition and sustainable competitive advantage (cont.)
• A competitive advantage becomes sustainable (SCA) only if it

can be sustained for a long period of time and is virtually
impossible for the competition to follow.
• Thus competing at a low price cannot be a CA – not sustainable.
• This is exactly what is referred to when SCA falters.
• Customers value a competitors offering more than yours,
resulting in sales volume (N) decrease.
• This leads to drop in selling price (S) = drop in margin.
• The whole economic model comes under pressure and the
venture slides down the failure scale.
Sales decrease and drops in market share

• The entrepreneur should constantly monitor sales volumes.
• Sales volumes impact on cash flow and other factors in the
economic model.
• The entrepreneur should monitor it constantly and be able to
give reasons for any deviations from the projected sales figures.
• When market share starts to drop, it means that a lower
percentage of the total number of customers supports your
venture, therefore more of them probably support your
competition or have found a different concept to meet their
needs.
Sales decrease and drops in market share (cont.)
• Sales decrease may have several detrimental effects on the

venture, for example:
You buy less from your suppliers and therefore lose
discounts based on volume, which increases the average
variable cost [C].
You transport fewer products and therefore the variable cost
[C] increases due to the higher transport cost per item.
Advertising cost per unit increases.
Complementary impulse buying of products decreases as
customers do not patronise your venture as frequently as
before.
Cash flow issues

• A further sign on the continuum of failure is irregular cash flow.
• Irregular cash flow indicates underperformance.
• Most flows are out of the venture, and the entrepreneur has
difficulty in creating a constant stream of inflows.
• There could be several reasons for persistent negative cash
levels.
Cash flow issues (cont.)
• The most common reasons are mentioned below:

Fixed expenses that are out of proportion and often labour
related.
Sales levels that are too low due to changing demand.
Higher costs for delivery, etc. that were not calculated at the
beginning.
Slow payments by credit customers.
More debtors.
Slow stock turnover.
Overextension of debt, and interest rates changing for the
worse.
Change in demand for the current concept positioning.
• When irregular cash flow turns into regular negative cash flow,
the problem is more pronounced and the venture moves into
the distress stage.
• When the negative cash flow continues for prolonged periods,
the problem forces the venture from the distress into the crisis
stage where turnaround is very difficult, if at all possible.
• Major refinancing is required to effect a turnaround
successfully.
• Cash flow problems are often cited as the most important

reason for venture failure; however, this is a mistake.
• Cash flow is really a sign and not the cause of the problem.
• The real cause should be investigated from following the signs.
• Part of the problem is that causes are not easy to observe.
Figure 16.4: Cash flow visibility and related elements

• The underlying factors that determine cash flow are as follows:

Debtor days. Refers to the time it takes to collect the money
owed to the venture for credit sales. Debtor days longer than
one month are bad for the venture and could lead to a cash
flow shortage.
There are three reasons for slow credit days:
• Poor collection mechanisms. This refers to the venture’s
own inability and lack of drive to collect its income.
• Slack credit policy. This refers to the giving of credit to
customers without proper credit screening and who
eventually turn out to be poor payers.
• Bad debts. This refers to monies that cannot be collected
as those who owe it to the business are unable to pay.
Inventory turnover (stock turnover). This refers to inventory

that stays on the shelves for long periods. The inventory is
paid for, but it sells slowly and therefore the cash of the
venture is locked in the inventory.
Creditor days. These refer to the time it takes for the venture
to pay its suppliers (creditors). Normally, most small
ventures are forced to pay cash and sell on credit, which
makes the gap between creditor and debtor days too long.
This leads to a negative cash flow problem.
• Most financial books contain formulas that can be used to
calculate these values and assist the entrepreneur to monitor
their status, provided that the venture has a proper
bookkeeping system.
Confidence levels drop

• Confidence in the venture and the entrepreneur is crucial for
handling financial distress when it comes.
• When confidence is lost, the distress has normally reached
crisis level and is very difficult to rectify.
• The core people whose confidence should be looked after are
the shareholders and thereafter the financiers.
• When external shareholders of a small venture lose confidence,
they want to take their funds out to reinvest them in a safer
option.
• This pressurises the entrepreneur to find alternative sources of
finance, such as loans, which makes the financial pressure even
worse.
Confidence levels drop (cont.)
• Once the external shareholders want their investment back, the

financiers become aware of the situation.
• They tighten control and access to further funds to ensure that
they do not lose their investment.
• The overall pressure mounts.
• Finally, the suppliers who sell to the venture on credit become
aware of the distress and they put the venture on cash terms to
ensure that their income is safe.
• For the venture, this is the last straw as it widens the cash
outflow-inflow gap even more.
Core employees leave

• Employees will become aware of the problem and will be aware
of the extent of the crisis.
• The good ones find other jobs and leave as soon as they can.
• The venture is left with the weaker employees.
• The customers start to ask questions and look for new
suppliers, as they realise the venture’s reliability and service
are below their requirements.
• Normally, once employees start to leave, the distress has
become irreversible.
Non-measurable signs
• Non-measurable signs can be used to identify looming distress
without having access to the facts and figures of the venture.
• These signs are particularly relevant for picking up distress in
the ventures of your suppliers and especially your credit
customers.
• It is always better to be the first to identify the signs, as a few
days may determine how severely you will be affected by the
impending distress.
• These signs are especially relevant for the person in charge of
finance and/or creditors.
Non-measurable signs (cont.)
• Typical signs include the following:

The person who normally signs your cheque/payment is
replaced by someone unknown, or an absence of the
signatory for long periods, or messages that are not
returned.
If a creditor cannot meet your regular payment period of 30
days.
An unexplained change in financier or in creditors or
suppliers will raise suspicion.
A change in the order patterns of customers from monthly to
weekly and smaller quantities, or a sudden increase in order
size when they want to maximise discounts.
A change in payment patterns from one regular payment to

several smaller and irregular payments can indicate cash
manoeuvring. Requests for extensions must also be noted.
A sudden change in director or key financial officer may
indicate that institutional or financial controls have been
instituted to ward off cash flow problems.
An irregular supply of certain products may indicate that the
supplier is moving between providers to optimise its own
volume discounts and special prices.
Low stock levels and disarray in the yard or premises of the
supplier or customer may be a sign of distress.
Empty shelves are proof of low buying levels, which is

already a serious problem.
A change in payment beneficiary may indicate that the
supplier wants to channel funds out of an ailing business.
Even a change in address must be noted and questioned.
Customers are not willing to accept a reasonable resolution
of queries as in the past.
Suppliers request urgent payments.
There are rumours in the industry from sales
representatives, other creditors and even staff.
• When any of these signs are observed, it is necessary to

investigate.
• Often it is best to ask directly and to act immediately.
CAUSES OF DISTRESS
• Distress develops over time and typically results from an

accumulation of fundamental errors.
• It is also necessary to understand the possible causes
responsible for the failure.
• Many causes underlie the signs of distress and severity.
• It is necessary to explore and categorise these causes for
greater understanding.
• The causes are also fundamental in guiding the strategies and
action plans to be pursued by the entrepreneur, turnaround
professional or business rescue practitioner.
CAUSES OF DISTRESS (cont.)
Strategic issues
• Strategic issues are typically concerned with the effectiveness of the
venture within its environment.
• Selecting the correct positioning for the target market and satisfying
the opportunity that has been identified are important aspects.
• Several issues should be considered Timmons (1999: 536):
 Misunderstood positioning (market value niche) refers to
pursuing the needs of a target market that is insufficient in size
and growth potential.
 Mismanaged relationships with suppliers and customers
regarding payment terms and delivery agreements can hamper
growth opportunities due to one-sided decisions.
 Diversification into an unrelated business. Profits and cash are
invested in unrelated ventures that make no sense for the current
operation.
Strategic issues (cont.)
Being idea driven instead of opportunity driven means that

the entrepreneur has an idea which is excellent but which
cannot be converted into an opportunity.
Focusing on big projects without considering the cash flow
impacts of the development may lead to capacity creation
before the associated sales materialise (higher outflow +
lower inflow = cash flow problems).
No contingency planning – Thus a lack of analysis of the
things that determine the venture’s success, its environment
and what could go wrong.
Lack of specific sectoral experience.
Unreal and unfounded expectations of the market potential
may exist.
Management issues
• The following management issues contribute to the venture’s
slide into failure:
When an owner loses interest in the business.
Underestimating the importance of the financial aspects of
the venture may lead to slow financial feedback and control.
The margins, cash flow and overall economic model must be
monitored.
Turnover in key management personnel, especially in the
core of the business (e.g. operations and finance.)
Wrong management focus – aiming for asset accrual rather
than cash can be a mistake for the small business. Focusing
on cash generation is important.
Having no proper management structure to control the
business can also be detrimental to the management of the
venture.
Poor planning and financial systems, practices

and controls
• The systems, practices and controls referred to have to do with
the decision making and governing of the venture.
• Several relevant factors include:
Pricing is all about setting the correct price as part of the
concept offering. If the pricing is wrong (too low or too
high), the target market may not be interested and demand
will drop.
Credit-granting policies are poor.
There is poor use of leverage (debt). When debt is too high, it
places unnecessary strain on the venture.
The lack of cash budgets and projections. It is necessary for
the planning of expansion and growth.
Poor planning and financial systems, practices and controls (cont.)
Poor management reporting refers to a focus on financial

reporting instead of management reporting which could be
used by the entrepreneur to make decisions.
Lack of standard costing refers to the inability to cost items
correctly, especially for manufacturing ventures.
Poorly understood cost behaviour refers to a poor
understanding of the economic model of the venture.
• Strategic issues are more likely to affect failure during the early
and later venture life cycle (VLC) stages, while management and
system issues are more relevant during the middle and later
stages.
Poor planning and financial systems, practices and controls (cont.)
Figure 16.5: Directional and typical times when distress could be expected during the
venture life cycle
Environmental issues
• Environmental issues include customers, suppliers, competitors
and intermediaries from the venture’s market environment.
• On top of these are the political, economic, social, technological,
globalisation and physical factors from the macro environment
that govern the market environment.
• A change in one factor alone is hardly sufficient to lead to total
venture failure, but due to the interactions of these factors with
one another, a change in a few interrelated factors may influence
the venture quite severely.
• Several factors have already been discussed, as they relate
especially to strategic issues that cause venture failure.
Environmental issues (cont.)
• All these factors affect the economic model, mainly through the
influence on sales volume [N] and selling prices [S].
• Economic factors such as interest rates and exchange rates may
also impact on the economic model, but through fixed expenses
[F], variable costs [C], etc.
Environmental issues (cont.)
Figure 16.6: Environmental factors impacting on profit

WHEN GROWTH LEADS TO DISTRESS
(OVERTRADING)
• Faster than anticipated growth during the start-up and growth

phases can lead to difficulties.
• When one gets a larger response for one’s goods or services than
anticipated, the natural reaction is to accommodate what is being
asked for because one’s economic model requires that sales volume
[N] must be as high as possible.
• It is important to realise that higher sales [N] have a severe cost [C]
and fixed expense [F] effect.
• One has to calculate the additional sales and consider the associated
additional costs.
THE SIZE OF THE VENTURE AND
SIGNS OR CAUSES OF DISTRESS
• The size of a venture is relevant to the visibility of the signs, as

well as to establishing their causes.
• The survivalist entrepreneur often keeps no records, so the
determination of gross and net margins is already difficult
when such ventures have constant cash flow problems.
• Micro and very small ventures have only a basic recordkeeping
system.
THE SIZE OF THE VENTURE AND SIGNS OR CAUSES OF DISTRESS
(cont.)
• The signs of failure are probably the same for all sizes of
business, although in some their measurement and visibility
may be impaired due to a lack of records and if records exist,
their integrity is often questionable.
• When the causes are universal, they are expected to have a
more pronounced effect on the smaller venture.
• The remedies available for turnaround will also be limited for
the smaller enterprise. (This aspect will be explored in the
discussion on turnaround.)
FRANCHISING AND FAILURE
• Franchisors claim that when a franchisee gets involved in a

franchise organisation, the chances of failure are decreased.
• What, then, does the franchise system do to reduce failure?
• The monitoring systems that franchisors implement to control
their franchise operations help them to detect signs of failure
early.
• Early detection is very beneficial for action, as the slide into
failure has no time to gain momentum.
FRANCHISING AND FAILURE (cont.)
• Being part of a franchise organisation also contributes to early

warning through the problems that are observed with the other
members, which the rest of the group are made aware of.
• The franchisor is normally a relatively bigger organisation with
the means to assist on the strategic front, which benefits the
smaller franchisee who gains through the group effect.
SUCCESS SIGNS THAT OPPOSE
FAILURE
• The following generic signs point to a successful venture:
A sensible financing structure that incorporates the
utilisation of debt and equity.
A strong cash position.
Above-average profitability measured as return on assets.
Rapid growth in sales revenue.
Attractive market segment with expansion possibilities.
Seeking to lead the industry from a specialist vantage point.
A strong brand name or franchise.
A significant research budget.
A competitive advantage that is not price based.
Operating in close relationship with its customers.
Well managed with good expertise.
CONCLUSIONS ABOUT FAILURE
• Failure is not merely the non-achievement of goals.
• An integrated model is proposed to understand failure.
• The usefulness of the model lies in its core components of signs,
levels, causes and action to be taken.
• Each constructs is influenced by several other factors to present
the whole picture of failure within the business environment.
• There are signs that indicate the severity of the distress and
relate to the cause of it.
• Insight into the operations of the venture in normal and
abnormal conditions is required.
CONCLUSIONS ABOUT FAILURE (cont.)
Figure 16.7: Integrated model for understanding failure of ventures

TURNAROUND
• To turn around an ailing venture is challenging.
• Micro and very small businesses are even more challenging to
turnaround.
• Typically, in small businesses, the entrepreneur is part of the
problem responsible for the slip along the failure slide.
• The earlier the signs of failure are observed, the easier it is for
the turnaround process to be effective.
• The turnaround procedure essentially requires a decision to
engage in the process of turning around.
• Quick diagnosis is required as time is a valuable asset.
TURNAROUND (cont.)
Core principles or focuses of the turnaround

• The turnaround process requires the consideration of most of
the factors that are pertinent to failure.
Diagnoses
• During this phase, a quick (sometimes superficial) evaluation is
made to establish the status quo.
• One needs to gain an understanding of the level of the failure
and whether it is still possible to reverse the slide.
• Turnarounds become more difficult during the distress stage
and very difficult once the venture is in a crisis.
• For complete failure, there is almost no chance of turning
around.
TURNAROUND (cont.)
Diagnoses (cont.)
Figure 16.8: The basic turnaround procedure

TURNAROUND (cont.)
Diagnoses (cont.)
Figure 16.9: Integrated model for the turnaround of a venture

TURNAROUND (cont.)
Intervention decision
• Following the diagnosis of the level of failure, a decision has to
be taken.
• This decision is based on the outcome of the diagnosis, which
determines the level of failure as well as giving an indication of
the possible causes of the status quo.
• This is normally when it comes to the crunch.
• It is always better to get an outsider in the form of a turnaround
specialist or at least a mentor to assist with the decision.
• The entrepreneur may not want to acknowledge the
seriousness of the situation because it may reflect on him or her
personally.
TURNAROUND (cont.)
Intervention decision (cont.)
• The entrepreneur’s inability to acknowledge that the business

is in distress leads to unsuccessful turnaround attempts.
• Time is a crucial asset and action should be taken.
• There are also other options to pursue if turnaround is not
viable.
• The decision relies on the vision created by the entrepreneur
for the enterprise.
• This should reflect the goals of the entrepreneur and venture.
• An entrepreneur without motivation for the business should
not be forced into a turnaround process.
TURNAROUND (cont.)
• The entrepreneur will require a serious change in attitude

when the decision is in favour of turnaround.
• This is so because further decisions during the process are
mostly very painful and absolute commitment is therefore
required.
• The best is for the entrepreneur to accept the blame for the
status quo and commit to the plan of the turnaround specialist.
• There should be a close working relationship between the
entrepreneur and the specialist.
TURNAROUND (cont.)
• Key to answering the turnaround question is whether the

opportunity is still a good one or not.
• The following six elements that should be considered:
Market demand (consumers that need/want the concept).
Concept offering (value that the customer is buying).
Economic model (can it be done profitably?).
Team and resource fit (right people to execute).
Competitive environment (alternative options for the buyer
of your concept).
Financing required to give a positive cash flow.
TURNAROUND (cont.)
Figure 16.10: Elements to consider for an opportunity analysis

TURNAROUND (cont.)
Stabilising the venture

• Once the decision is made to embark on a turnaround, quick
action should be taken to stabilise the business.
• Management, finance and systems are key components of
stabilisation.
• The stabilisation phase is generally driven by a cost-and-cash
focus after the establishment of a proper management team.
• Stabilising requires acceptance that cost is enemy number one,
thus going back to the basic economic model.
• Serious cost cuts should be implemented as fast as possible.
• Any turnaround strategy has cost as its base.
TURNAROUND (cont.)
Stabilising the venture (cont.)
Figure 16.11: Factors driving the turnaround process

TURNAROUND (cont.)
• Quick decisive action is required to save an ailing business.

• At the centre is cost reduction.
• Start with the large cost items first and cut down relentlessly.
• Normally a priority list will contain the following cuts:
Fixed expenses.
Reduce management salaries.
Look into wages and unproductive workers.
Reconsider rent of premises.
Reduce interest on debt by reducing debt.
Look at inefficient marketing costs.
Examine consulting fees.
Cut unnecessary overhead costs.
There may be uncontrolled pocketing from the cash
registers.
TURNAROUND (cont.)
Variable costs.
The cost price of items may require an investigation into
the supplier used and whether the supply relationship is
a long-standing one.
Inventory levels should be reduced to a minimum where
“out of stock” is tested occasionally but not to the point
where the shelves appear empty.
Leverage volume rebates optimally.
Improving economic quantities and delivery times
should reduce distribution costs.
Discontinue low-margin lines unless they contribute
through spare capacity.
Investigate the current cost recovery system to ensure
that all costs are passed on to the customer.
TURNAROUND (cont.)
• Simultaneously with cost cutting – cash flow must be improved.

• Improved cash flow can be achieved as follows:
Lowering creditor days through:
Improved collection and billing to optimise cost recovery.
Stricter policy for credit advancements.
Stretching debtor days by negotiating better terms.
Increasing cash sales.
Negotiating better payment terms with vendors and
suppliers.
Reducing debt and its associated interest by:
Selling old inventory.
Selling unproductive assets and equipment.
Selling non-core business units (this may follow the
strategic analysis phase).
TURNAROUND (cont.)
• Stabilising focuses on straightening out the management team,

controlling the costs and improving the cash flow.
• If all the proposed actions are pooled it can make a significant
difference to the economic model of the venture.
• Once cost and cash are under control, the strategic analysis can
be undertaken.
• Time is the most important factor – cut deeply and finally.
• Once this part of the process is completed, morale will improve.
• Stabilising focuses on the expenses side of the profit equation.
• The strategic analysis has to do with the income side of the
equation.
TURNAROUND (cont.)
Strategic analysis
• This focuses on the sales (income side) and positioning aspects
of the venture.
• The other drivers of a successful turnaround process include:
Focus.
Repositioning.
Time.
Speed.
• The main outcome of the strategic analysis is to determine the

core business (focus and positioning) of the venture and what it
should focus on.
TURNAROUND (cont.)
Strategic analysis (cont.)
• Anything that is revealed by the analysis to be non-core

business should be outsourced as quickly as possible.
• An extensive opportunity analysis should be undertaken for the
core business.
• The analysis considers the market, concept offering and
competitive environment that will determine the potential sales
of the venture.
• The team and resource fit, the economic model and the
financing required for the venture will also indicate whether
the opportunity should be pursued any further.
TURNAROUND (cont.)
Strategic analysis (cont.)
Figure 16.12: An example of an extensive opportunity

analysis applied to a pipe factory
TURNAROUND (cont.)
Identification of the core issues

• The core issues that should be focused on will emerge from the
strategic opportunity analysis.
• The core issues have to do with positioning and sustainable
competitive advantage.
• Key question to be answered is whether the venture serves an
opportunity or not.
• If yes, the turnaround is well supported and could be refined
only by restructuring.
• If no, a new focus should be selected based on the correct
business strategy.
• The analysis should indicate where the turnaround should take
TURNAROUND (cont.)
Restructure decisions
• The decisions on the core issues help the venture to focus and
direct the application of funds, whether own or borrowed.
• Priorities are set and listed for immediate implementation.
• Time is still crucial.
Action
• Action should be taken through action plans so as to keep a
record of the intervention.
• Action plans help everyone to focus on the new end goals of the
venture.
PRINCIPLES OF A TURNAROUND
PROCESS
Management focus
• The management team is crucial.
• The turnaround strategist can play only a supportive role.
• Key decision making lies with the entrepreneur.
• In larger businesses, people responsible for marketing or
operation can be added.
• The motivation and attitude of the entrepreneur are absolutely
crucial, a point which cannot be emphasised strongly enough.
• The entrepreneur should focus on the turnaround and a viable
economic model.
PRINCIPLES OF A TURNAROUND PROCESS (cont.)
Cost and cash

• Cost deals with the expenses of the venture and include all
control issues.
• Costs must be reduced at all levels, starting with the
important cost elements first and working down the list.
• A turnaround strategy is cost driven.
Focusing on the core business

• Determine the core business and focus on it.
• Differentiation should not be pursued at all.
• Once cost is controlled, the core business will determine
what strategy can be employed.
• Differentiation is a trap for the business in distress and
PRINCIPLES OF A TURNAROUND PROCESS (cont.)
Strategy
• Clear strategy should be established.
• Strategy determines the application of funds, manpower and the time
and energy of everyone within the venture.
Time factor
• Time and money are crucial for a successful turnaround process.
• The faster the process can be completed, the better for the venture,
shareholders, stakeholders and personnel.
• Cost reduction measures should be implemented immediately.
• Quick implementation indicates to the personnel that there is a
definite plan.
OPTIONS OTHER THAN A
TURNAROUND
Harvesting alternatives
• Harvesting alternatives cannot be contemplated for a venture
that has slipped too far down the failure slide.
• Growth can be achieved by taking a new direction after a
successful turnaround and with the new strategy in place.
• There are various way the entrepreneur can consider moving or
letting go of the venture.
OPTIONS OTHER THAN A TURNAROUND (cont.)
Harvesting alternatives (cont.)
• The following ways are available:

Outright sale of the business venture.
To another entrepreneur.
To a firm looking for acquisitions.
To a competitor (strategic sale).
Forming an alliance with another venture.
Merging with another venture (offensive merger).
Going public through shares on the stock exchange.
• If failure progresses too far, the venture is left at the mercy of

the buyer – harvesting potential is very low.
• Divestment alternatives could be a better option.
OPTIONS OTHER THAN A TURNAROUND (cont.)
Divestment alternatives
• Divestment alternatives are pursued when the option to harvest
or turn the venture around is no longer possible.
• This is a choice of last resort but should still be considered, as
there are not many alternatives.
• The available alternatives include the following:
Closing the business and selling the assets.
Entering into a defensive merger, which leaves no bargaining
power.
Splitting the business into functional/workable units and
selling to interested parties, such as employees who could
proceed as outsourced ventures to bigger clients.
• As seen from the above, the venture that is in crisis mode does
BUSINESS RESCUE
• In South Africa, legislation has been passed to govern business
rescue in a formal legislative process.
Background to rescue in South Africa
• Chapter 6 of the Companies Act 71 of 2008 introduced a rescue
procedure.
• A business in financial distress must file for rescue through a
formal process as governed by the Act.
• A business rescue practitioner (BRP) is appointed for the
business.
• In South Africa, rescue practitioners are licensed conditionally
for a specific rescue project.
BUSINESS RESCUE (cont.)
Background to rescue in South Africa (cont.)
• The Act comprehensively describes the following for business

rescue:
The process and circumstances of filing for rescue.
The conditions for filing or not.
The qualifications of the business rescue practitioner (BRP)
and his or her remuneration.
The tasks and powers of the BRP.
The tasks, rights and responsibilities of the shareholders,
employees and creditors.
The components to be included in the rescue plan.
Alternatives for different circumstances if and when
applicable, such as the removal of a BRP, meetings to be held,
discharges of debts and more.
LOOKING BACK
1. List the core elements of the integrated failure
model.
• Level of failure.
• Signs of failure.
• Causes of failure.
• Action to handle failure.
• Turnaround.
LOOKING BACK (cont.)
2. List the levels of failure.
• Performs well.
• Underperforms.
• Distress.
• Crisis.
• Failure.
3. What are the goals that can be used to evaluate

failure?
• Personal goals.
• Financial goals.
• Strategic goals.
4. Name the indicators that determine the different

levels of failure.
• Gross margin declines.

• Net margin declines.
• Positioning falters.
• Sales and market share drop.
• Confidence disappears.
• Personnel leave.
• Other.
5. What are the causes of failure in a venture?
• Strategic issues.
• Management issues.
• Systems issues.
• Growth problems.
6. What are the actions available to the venture in

trouble?
• Turnaround.
• Harvesting.
• Divesting.
• Selling to investor.
7. What are the environmental factors to consider

during business failure?
• Macro environmental factors such as political,

economic, sociocultural, technological, global and
physical environments.
• Competitors.
• Customers.
• Suppliers.
• Intermediaries.
8. What are the core elements of the turnaround

process?
• Diagnosis.
• Intervention decision.
• Stabilisation.
• Strategic analysis.
• Core issues.
• Restructuring decisions.
9. What are the core issues that should be

considered for an opportunity analysis?
• Market demand.
• Economic model.
• Concept offering.
• Competitive environment.
• Team and resource fit.
• Financing.
10. What are the directional movements of distress

over the venture life cycle?
• Strategic trouble is more relevant during start-up and

early growth stages.
• Management distress is more prevalent during later
growth and maturity stages.
• Systems trouble is more prevalent during the growth
and maturity stages.

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Chapter 16:

• When growth leads to distress (overtrading).

• The size of the venture and signs or causes of distress.

• Franchising and failure.

• Success signs that oppose failure.

• Conclusions about failure.

• Principles of a turnaround process.

• Options other than a turnaround.

7. Understand the causes of failure.

• Success is defined as the achievement of realistic goals.

• Success will be measured on a continuum between success and

• To evaluate whether entrepreneurial ventures fail or succeed

would therefore require the goals of the venture to be assessed.

• What are realistic goals for a venture?

• Are these goals also the goals of the entrepreneur?

• Venture goals vary significantly, depending on the type of

Personal goals of the entrepreneur

• Entrepreneurs frequently start a venture with the idea of

• Non achievement of personal goals lowers effort and input.

Financial goals of the venture

of the entrepreneur may differ.

• A survivalist venture refers to a business activity which a

person enters into to earn an income for physical survival on a

day-to-day basis – the income is normally irregular in amount

• The micro enterprise may be able to generate regular profits

• Financial goals for small and medium-sized ventures require an

• The financial goals of shareholders that are relevant here

• It is important to realise that there are different stakeholders

• All the financial goals serve these stakeholders in some or other

Strategic goals of the venture

opportunity and the achievement of a fit between the venture

and its environment to ensure long-term profitability.

• Underlying the strategic goals are the financial and personal

• Firstly, the opportunity of the venture is based on the original

idea which is converted into an entrepreneurial opportunity –

this brings value to a target market for which it will pay.

• The venture thus presents the target market with a concept

• The second strategic goal of the venture is to ensure long-term

Figure 16.1: The venture failure slide

The venture that is performing well

The underperforming venture

achieved but, overall, there are no visible differences between the

well-performing and the underperforming venture.

• Underperformance is usually seen when comparing the financial

statements over a period of time.

• The venture that is underperforming gets a yellow light, serving as

a warning that something bad may be coming and that the

entrepreneur should rectify what is wrong.

• Underperformance suggests that you are running your business

badly and/or because efficiencies are not being achieved.

• As the venture moves in the direction of complete failure, more

Figure 16.2: Performance indicator levels associated with venture failure

Distress in the venture (difficulty)

• Before long, the venture moves into in crisis, which is more

The venture in crisis

The venture that failed (irreversible distress)

• There are five keys that lead to successful business ventures.

Figure 16.3: Key factors and their relationship to venture failure

Attitude and motivation