Recognizing the need for change, developing a plan for change, and gaining support for change are all necessary steps in a successful business transformation. Necessary, but not sufficient. An actionable business transformation plan, especially in the middle market, must also grapple, in the harsh glare of objectivity, with the cost of transformation and how best to fund it.
The question of how to fund a business transformation can test leadership teams that already feel themselves at the razor’s edge of endurable pressure, and for too many companies the question of funding is where a promising business transformation runs aground, as that same leadership team finds itself unable or unwilling to think through or engage outside support to advise on how best to chart a path to the desired outcome in light of available resources.
Timidity in the face of resource constraints, and the scarcity mindset it implies, serves only to narrow the horizons of those most desperately in need of a business transformation. Luckily, engaging proactively with the sources and uses of funding does not need to serve in any way as an inhibitor of aims. Rather, the discipline of addressing resource constraints and funding sources upfront can serve as a valuable spark to the creative process, yielding a more capital efficient, and oftentimes more ambitious in the long-run, business transformation.
An Umbrella When the Sun is Shining
The result of an extended period of below trend (or any) profitability for a company is that ambitious business transformation initiatives become increasingly difficult to fund just as they become increasingly more necessary. For many leadership teams, the answer to this quandary is simple: borrow.
Efforts to borrow in order to fund a business transformation often run into a frustrating challenge. Companies find that the ease with which outside funding can be procured for a business transformation project is inversely correlated to the importance of the project’s success for an organization’s future. Capital for low-risk, high return projects is abundant, but for those business transformation initiatives that truly represent a do-or-die crossroads, capital is more scarce and much more costly.
Mark Twain famously quipped that: “A banker is a fellow who lends you his umbrella when the sun is shining and wants it back the minute it begins to rain.”
The availability and sophistication of risk capital has certainly increased since the late 19th century, but the central point that Twain was seeking to make remains as true today as in his own time: for the majority of lenders, and certainly the sources of the cheapest outside capital, the most attractive candidates for a loan are those that do not need the money. Luckily, there are lenders active across the risk spectrum, and prospective borrowers have no need to limit themselves to banks.
Middle Market leadership teams often have less exposure to the capital markets, and hence are more susceptible to shock when they realize the challenges that come with certain types of funding sources. Absent expert support, this shock can impose costly delays on, and even derail, promising and even existential business transformation projects. In order to prevent this, it is important to consider the internal sources of funding available to any company, and the pros and cons associated with that source.
- Operating Expenses. Too often leadership will view an existing cost structure as a fact of life, rather than a set of circumstances that can be easily changed. The inadvertent misallocation of resources is unfortunately the norm throughout the middle market, and as a result the gains to be achieved through a rigorous assessment and reprioritization of spending are considerable.
- Working Capital. The capital tied up in an organization’s operations represents an immense opportunity and is one of the lowest cost sources of funding for a business transformation initiative. Too often management teams severely under-estimate the magnitude of the opportunity that working capital management represents, and so fail to consider working capital as a viable source of funding.
There are pros and cons to funding a business transformation via internal sources of funding. Among the pros are the high level of control that companies have on both their internal cost structure and in their approach to working capital management. Cons include declining employee morale, dissatisfaction among customers and suppliers, and increased strain on management. Regardless of whether or not internal sources of funding ultimately utilized for a given business transformation initiative, they should always be considered.
The ultimate source of value creation in a company is improved performance. Industry, positioning, and timing all matter, but robust profitability and cash flow enables an organization to maintain control over its own destiny. The funding of a transformation project should be looked at as a question of carefully assessing the project, how and why it is expected to improve performance and moving forward aggressively with any transformation project that makes sense. Faced with a compelling business transformation initiative, leadership teams have several viable avenues to explore for funding, and so should not allow their horizons to be narrowed. In business two things are certain: change is constant, and the returns to controlling your own destiny are enormous.
About the Author
David Johnson (@TurnaroundDavid) is Founder and Managing Partner of Abraxas Group, a boutique advisory firm focused on providing transformational leadership to middle market companies in transition. Over the course of his career David has served as financial advisor and interim executive to dozens of middle market companies. David is also a recognized thought leader on the topics of business transformation, change management, interim leadership, restructuring, turnaround, and value creation. He can be contacted at: firstname.lastname@example.org.