Fees, sweat and tears

Turnaround consultants exist for a reason – sometimes, no matter how much money and energy a private equity firm has put into a portfolio company, situations arise that the GPs do not anticipate. Turnaround consultants perform tasks for

While no general partner likes to admit the need for turnaround consultants, their deployment is better than seeing a portfolio company go under completely.

As the economy continues its rough patch, hundreds of portfolio companies wallow in the doldrums. This threatens the returns of private equity firms, as well as their abilities to raise follow-on funds. Increasingly, private equity firms are being forced to turn to turnaround specialists.

For these practitioners, who thrive when their clients don't, business is booming. According to a recent poll of members of the Turnaround Management Association (TMA), a US trade association comprised of turnaround consultants, lenders to companies undergoing a restructuring, lawyers and other professionals that service the industry, nine out of 10 respondents said their business had increased over the past 12 months. Firms that provide turnaround and related services make up one of the few growing sectors of the financial services industry, with 40 per cent of these firms telling TMA they recently added staff.

There is no shortage of business – 75 per cent of the poll's respondents said they had declined new opportunities in the past 12 months because a project had been judged too risky, it wasn't in the turnaround firm's area of expertise, or the client could not meet the firm's desired compensation levels. Manufacturing, distribution and services sector companies – many of them owned by private equity firms – are the most frequent clients of turnaround firms today.

Operations, operations. operations
Not only are more companies seeking the services of turnaround consultants, but they are increasingly in dire straights when they ask for help. According to the TMA poll, 41 per cent of respondents said they had noticed a deterioration of business fundamentals among companies seeking turnaround services.

A handful of private equity firms specialise in acquiring troubled companies. Mainstream buyout and venture capital shops, however, can be forgiven for feeling somewhat sheepish about needing the help of a turnaround advisor. After all, these consultants can be a reminder of a deal that went sour. But they can help save an investment.

“No one's ever glad to see us,” Peter Kaufman, managing director of New York-based turnaround consultancy Gordian Group, says. “No one likes to hire us. We're expensive. But, the sooner companies admit to a problem, the more options they have to resolve it and maximise recoveries for their shareholders.”

Management resists because they're afraid to be fired, they're afraid of what can happen, and they're embarrassed

Gordian, stresses Kaufman, only ever works on the equity side of a restructuring, not with bondholders, so as to avoid conflicts of interest. It focuses solely on financial restructurings, meaning they do not involve themselves with management or operational changes at a portfolio company. Other firms tout their operating experience. They like to point out that many private equity professionals are whizzes at playing with balance sheets, but inexperienced at actually managing a company through a business crisis.

One specialist turnaround service provider is Jefferies, a NewYork merchant bank, which runs a large restructuring and recapitalisation practice. Another US firm, offering hands-on, operating services, is Atlanta-based Grisanti, Galef & Goldress. Marvin Davis, a managing partner at this boutique, says the key to turning a company around is in its operations, not merely its capital structure. When times are good, this point often eludes private equity investors. “GPs are not operating guys,” Davis says.

Davis says that the sooner a company admits it needs help, the better. Many times, resistance to services provided by firms like Grisanti Galef do not come from the GPs themselves, but from the management of the underlying portfolio company.

“It is hard to be called in early,” Davis says. “Generally, private equity people don't resist. Management resists because they're afraid to be fired, they're afraid of what can happen, and they're embarrassed.”

The price of success
Private equity firms that invest in troubled companies enjoy a potential equity upside for a job well done. Turnaround consultants, by contrast, charge fat base fees, but also often negotiate significant “success fees” based on how much improvement they can bring to a company's performance.

Turnaround consultant fees vary widely, and are typically negotiated on a situation-by-situation basis. In the US market, hourly rates can range from $200 to $600, while monthly rates can range from approximately $75,000 to a few million dollars, depending on the client company and the type of turnaround required. Some consultant firms will also take an equity stake in the client company.

Not surprisingly, compensation is a hotly debated topic among turnaround specialists, with some saying excessive success fees may create a publicrelations problem down the line.

Buccino: fees mustn't cause client's demise

“Some crisis management firms have charged $20m to $30m,” per project, says Greg Rorke, managing partner of New York-based RKG Osnos Partners, a crisis management firm. “I think a lot of boards should be tougher in negotiating success fees. They've allowed some consultants and crisis managers to earn excessive fees, not unlike M&A firms in the 1980s and 1990s.”

It is difficult, however, to find a turnaround consultant who does not claim to deserve every cent earned through the restructuring and renewal of a client. “We're not cheap and we don't intend to be,” says Gary Sbona, chairman and chief executive officer of San Francisco-based Regent Pacific Management Corp., a turnaround firm which also operates out of New York, London and The Hague.

Sbona adds that consulting is a business where paying a smaller fee invariably leads to a lower quality of results. “If you have the need for open-heart surgery, are you willing to pay $100,000 for a heart doctor or $25,000 to a proctologist just because he's a doctor? What you wind up with is one hell of a scar,” Sbona says.

Jay Marshall, who leads the performance improvement practice for worldwide turnaround consultancy AlixPartners, says his firm typically takes a success fee based on the results his firm creates for a client. That success fee may be on top of an hourly fee, but the firm is willing to lower the hourly fee for more performancedriven upside.

If you need open-heart surgery, are you willing to pay $100,000 for a heart doctor or $25,000 to a proctologist?

Marshall stresses that his firm does not charge for ethereal advice, but for results. “The emphasis of our team will not be on telling [a client] how to do [the work]; we actually do it,” Marshall says. “In many ways, we don't think of ourselves as restructuring consultants, we're management consultants. [Our clients] have been happy to pay us more because they got tangible results.”

Tangible results are important to turnaround consultants, because a broke company has trouble paying its bills. One-time financially strapped clients are able to pay fees to turnaround firms because of the greater savings and increased revenues their services bring in. Like doctors, turnaround consultants live by a “First, do no harm” ethos. “We are able to help a company cut back cash expenses rapidly to help pay our fees,” Gerald Buccino, president and chief executive officer of New Yorkbased Buccino & Associates. “If we walk into a matter that can't be fixed, we don't want to cause the demise of the company with our fees.”

What to tell the LPs
Investors in a private equity fund may be concerned with a turnaround consultant's involvement in a portfolio company, and with how that involvement will affect their capital account.

For the most part, consultants believe limited partners welcome their arrival because it means a general partner is doing everything possible to save an investment.

“GPs eventually have to tell people we've been utilised,” Grisant, Galef & Goldress' Davis says. “A lot of times, it's a positive. Our objective is to save the company.”

However, some private equity firms would just as soon not alert the world to the presence of a turnaround consultant at one of their portfolio companies.

“In the majority of cases, restructuring professionals are unknown to investment partners of the private equity firm,” Regent Pacific's Sbona says.

Dale Meyer, a partner at placement agency and capital management firm Probitas Partners, which has offices in San Francisco, New York and London, says a ‘don't ask, don't tell’ policy exists in the private equity market, where general partners do not go out of their way to obscure the hiring of a turnaround consultant, while at the same time, many limited partners do not go out of their way to find out if such services have been used. “I would say [LPs] are only aware if they try hard to be,” Meyer says. Even when LPs have a large staff, they still may not know what is going on at the company level, he adds. “That's why they hire a manager in the first place.”

Kelly Deponte, Meyer's colleague at Probitas Partners, says most LPs realise that some investments will go bad. He argues the most important thing for an LP to see is that the firm is doing something about the situation. “What I want to know is how the GP handles problems,” Deponte says. “A consultant is just a potential tool in a tool kit.”

In a down market, general partners often talk about triage – the task of assessing which portfolio companies are in the most critical condition so as to best assign scarce resources. But triage takes time – time that could be spent on new deals and on activities to which the general partners are better suited.

“The main thing we bring is speed,” Alix Partners' Marshall says. “The business a general partner is in is raising money and deploying money. Getting into a company takes time away from that.”