Due diligence is a fact-finding mission
or investigative exercise designed to
provide the information required to meet
a specific goal or objective. Typically, it
is used when a business is involved in a
purchase or sale or requires financing.
However, distressed organizations also
require due diligence to address the
decision to attempt a turnaround or to
liquidate the organization.
This decision is fundamental to
optimizing shareholder value. Executed
correctly, due diligence will provide a
solid platform that enables this process.
It will also provide useful information concerning ancillary objectives
such as divestiture or refinancing. If a
turnaround is the best choice, the due
diligence process will also provide the
basis for a viable plan.
Characteristics of Distress
Most organizations move along a
continuum. At one end is the custodial
environment of a relatively healthy
or robust organization. At the other
is distress or even crisis. There are
many points in between, and they are
not static. Though some movement is
inevitable, an irreversible decline is not.
Often there is an inflection point—a
“reversal of fortune” point. Examining
the organization in this light is the reason for due diligence in the distressed
The custodial environment, on one
end of the continuum, is relatively
stable and resource-rich. The organization is profitable and has growing revenues. Other financial indicators, such
as margins and market share, are likely
growing. The organization is producing quality financial information that
is timely, relevant and reliable. There
is particular emphasis on managerial
accounting and its integration into a
culture of performance management.
A competent and stable management
team uses the information. In these
circumstances, there are no threats
from creditors. Also, no other threats
represent a clear and present danger.
In contrast, the distressed environ-
ment is harsh, exigent and ambiguous. DUE DILIGENCE IN DISTRESSED PERFORMING ORGANIZATIONS REQUIRES BOTH DEPTH AND SCOPE IN THE INVESTIGATIVE PROCESS. HOWEVER, DISTRESSED ORGANIZATIONS POSSESS INHEREN T CHARACTERISTICS THAT BOTH IMPEDE THE PROCESS AND REDUCE THE TIME AVAILABLE TO REACH A CONCLUSION . READ ON FOR PRACTICAL OVERCOMING THESE AND USEFUL INFORMATION FOR CHALLENGES. DUE DILIGENCE IN DISTRESSED PERFORMING ORGANIZATIONS REQUIRES BOTH DEPTH AND SCOPE IN THE INVESTIGATIVE PROCESS. HOWEVER, DISTRESSED ORGANIZATIONS POSSESS INHEREN T CHARACTERISTICS THAT BOTH IMPEDE THE PROCESS AND REDUCE THE TIME AVAILABLE TO REACH A CONCLUSION. READ ON FOR PRACTICAL OVERCOMING THESE AND USEFUL INFORMATION FOR CHALLENGES. The organization is likely experiencing losses on operations, and all or many financial indicators are worsening. These may include margins, sales and market share. This decline has likely resulted in increased debt. The organization is also probably facing threats from numerous constituents. In this environment, the time avail- able to act is very limited because cash is limited. If threats from constituents become elevated, available time ef- fectively falls to zero with the onset of a full-blown crisis. Typically, demands for all resources adversely affect manage- ment’s information systems. Human fac- tors also impair the organization’s ability to deliver useful financial information. Denial, for example, is often pervasive. The result is a paucity of critical thinking and a reluctance to deliver bad news. The xtraordinary demands upon custodial management and a lack of perspective are powerful and negative forces. As a result, information systems frequently produce data that is late, erroneous, insufficient or incomplete. Distress: A Case Study A few years ago, I was the CRO and CFO for a group of nursing homes. This group had been family-owned for three generations and badly neglected for at least a decade. The last several years of operations had seen enormous operating losses, and the deterioration continued. Symptomatically: ◗ At the time of appointment, the company was experiencing a cash crisis. It was unable to meet payroll the next day. ◗ Monthly billing had dropped by about 20% due entirely to sloppy billing prac- tices rather than occupancy issues. ◗ The company was battling over 40 lawsuits or pending lawsuits. ◗ The secured lender had lost patience, and a demand was imminent. ◗ Quality of care was so substandard that the Department of Health was threatening to revoke the operating license. This impaired the ability to maintain occupancy. ◗ Morale was poor, and for some posi- tion categories, turnover was 100%. ◗ Accounting and MIS were dysfunction- al. Periodic financial reports were not prepared, historical financial informa- tion was suspect and balance sheet information was inaccurate. ◗ Emblematic of this lack of corpo- rate discipline, the company lost over $1 million simply due to a failure to provide requisite cost information to a payer.
This company was truly at the far
end of the continuum and in extreme
distress. In fact, as a late decline,
this situation was as bad as it gets. It
certainly seemed that the end was near
and liquidation was imminent.