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18

Chapter Eighteen

The Entrepreneur and the Troubled Company

Results Expected

Upon completion of this chapter you will have:

1. Examined the principle causes and dangers signals of impending trouble.

2. Discussed both quantitative and qualitative symptoms of trouble.

3. Examined the principle diagnostic methods used to devise intervention and turnaround plans.

4. Identified remedial actions used for dealing with lenders, creditors, and employees.

5. Analyzed the “EverNet Corporation” case study.

Teaching Pedagogies

There are four pedagogical options the chapter that you can consider when conducting class sessions. These notes are organized to enable you to create whatever format and blend of these teaching plans that you’d like. The four pedagogies are:

1. a lecture or mini-lecture

2. the traditional case study

3. the use of exercises or role plays

4. a combination of the above.

The syllabi earlier in this Instructor’s Manual (pages 28-53) also illustrate how some in-structors have blended the pedagogies.

Lecture Outline

I. When the Bloom Is off the Rose.A. Many times in the history of the U.S. companies have experi-

enced times of economic trouble.

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1. Mid-2002 was such a period.

2. Managers need a new and special set of skills to lead through difficult times.

B. Getting into Trouble—The Causes.

1. Trouble can be caused by external forces not under the control of management such as recession, interest rate changes, inflation, and industry/product obsolescence.

2. Turnaround specialists have found that external forces are rarely the sole reason for a company failure.

3. Most causes of failure are found within company man-agement, such as inattention to strategic issues, general management problems, and poor financial/accounting systems and practices.

C. Strategic Issues.

1. Misunderstood market niche: Failure to understand the company’s market niche and to focus on growth without considering profitability.

2. Mismanaged relationships with suppliers and customers: Failure to understand the economics of relationships with suppliers and customers.

3. Diversification into an unrelated business area.

a. A common failing of cash-rich firms is diversifica-tion into unrelated business area.

b. These firms use the cash flow generated by one business to start another without good reason.

4. Mousetrap myopia: firms may look for new markets for “great products” without analyzing the firm’s opportu-nity.

5. The big project.

a. The company gears up for a “big project” without looking at the cash flow implications.

b. There may be trouble when expected sales do not materialize after adding capacity.

c. Sometimes the big project is required by the nature of the business opportunity.

d. The firm may need to grow quickly to achieve a public market.

6. Lack of contingency planning.

a. Firms need to prepare for the possibility that things can go wrong.

b. There needs to be plans in place for layoffs and ca-pacity reduction.

D. Management Issues.

1. Lack of management skills, experience, and know-how:

Results Expected #1Examined the principle causes and dangers signals of impend-ing trouble.

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As companies grow, management need to change their management mode from doing to managing to managing managers.

2. Weak finance function: In a new company, the finance function may be nothing more than a bookkeeper.

3. Turnover in key management personnel is a critical con-cern in businesses that deal in specialized or proprietary knowledge.

4. Big-company influence in accounting: Some companies focus on accruals, rather than cash.

E. Poor Planning, Financial/Accounting Systems, Practices, and Controls.

1. Poor pricing, overextension of credit, and excessive leverage.

a. A company may use excessive leverage when growth outstrips the company’s internal financing capabilities.

b. Another cause is using guaranteed loans in place of equity for startup or expansion financing.

2. Lack of cash budgeting/projections is a frequently cited cause of trouble.

3. Poor management reporting.

a. Financial reporting just tells where the company has been; it doesn’t help manage the business.

b. Important management reports—inventory analy-sis, receivables aging, sales analysis—are usually late or not produced at all.

4. Lack of standard costing.

a. Many emerging businesses have no standard costs against which they can compare the actual costs of manufacturing products.

b. The company cannot identify problems in process and take corrective action.

c. Engineering, manufacturing, and accounting may each have a different version of the cost of material.

5. Poorly understood cost behavior.

a. Companies often do not understand the relationship between fixed and variable costs.

b. The fail to identify desirable tradeoffs.

c. According to one turnaround specialist, almost all costs are fixed.

F. Getting Out of Trouble.

1. An important asset for a company in trouble is a set of advisors and directors who have been through this in the

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past.

2. An outside “vision” is critical to adapt speed of action, control systems, and organization.

3. An opportunity-driven firm’s crisis is usually the result of management error.

4. Many companies—even companies that are insolvent—can be rescued and restored to profitability.

G. Predicting Trouble.

1. Crises usually result from an accumulation of fundamen-tal errors over time.

2. If the entrepreneur, employees, and significant outsiders can see trouble brewing in time, they can take corrective action.

3. Predictive models need to use information available in common financial reports.

4. These approaches use easily obtained financial data to predict the onset of crisis.

a. For the smaller public company, these models can be used by all interested observers.

b. With private companies, they are useful only to those privy to the information.

5. These predictors both use the figure for total assets, which is often distorted by “creative accounting.”

H. Net-Liquid-Balance-to-Total-Assets Ratio.

1. This model was developed by Joel Shuman to predict loan defaults.

2. Shulman’s approach explicitly recognizes the importance of cash.

a. Shulman distinguishes between operating assets (such as inventory and accounts receivable) and fi-nancial assets (such as cash and marketable securi-ties.)

b. This same distinction is made among liabilities; notes payable and contractual obligations are finan-cial liabilities, and accounts payable are operating liabilities.

3. Shulman then subtracts financial liabilities from financial assets to obtain the net liquid balance (NLB.)

4. This “uncommitted cash” is available to meet contingen-cies.

5. The NLB is then divided by assets to form the predictive ratio.

I. Nonquantitative Signals.

1. Turnaround specialists also use some nonquantitative sig-

Results Expected #2Discussed both quantitative and qualitative symptoms of trou-ble.

Text Exhibit 18.1“Net-Liquid-Balance-to-To-tal-Assets Ratio” presents a model that is used to calculate the net liquid balance.Also:Transparency Master 18-1“Net-Liquid-Balance-to-To-tal-Assets Ratio” (Text Ex-hibit 18.1)

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nals as indicators of trouble.

2. Once any of these surfaces, then trouble is likely to mount.

a. Inability to produce financial statements on time.

b. Changes in behavior of the lead entrepreneur.

c. Change in management or advisors, such as direc-tors, accountants, or other professional advisors.

d. Accountant’s opinion that is qualified and not certi-fied.

e. New competition.

f. Launching of a “big project.”

g. Lower research and development expenditures.

h. Special write-offs of assets and/or addition of “new” liabilities.

i. Reduction of credit line.

Transparency Master 18-2“Nonquantitative Signals” lists some nonquantitative sig-nals that indicate trouble is likely.

II. The Gestation Period of Crisis.A. Crisis rarely develops overnight.

1. The time between the initial cause of trouble and the point of intervention can run from 18 months to five years.

2. When the organization members think only of survival, not turnaround, a demoralized and unproductive organi-zation develops.

3. In hindsight, it is possible to see problems based on key statistics.

a. Sales growth slows, followed by increasing rises in expenses.

b. When the growth doesn’t continue, the company still allows the growth rate of expenses to remain high so it can “get back on track.”

B. The Paradox of Optimism.

1. Typically, the first signs of trouble go unnoticed or are written off as minor.

2. Although management may miss the first signs, outsiders usually do not and wonder why management does not re-spond.

3. By the time management admits that trouble exists, valu-able time has been lost.

a. The lead entrepreneur is emotionally committed to people and to projects.

b. Instinct argues against cutting back because the company will need these resources when the good


times return.

4. As the company continues its downward fall, the situa-tion becomes stressful.

5. Decisions the entrepreneur makes during this time often accelerate the firm’s downward course.

6. The entrepreneur may make statements that are untrue or may make promises that cannot be kept.

C. The Bloom is off the Rose—Now What?When an organization is in trouble, some telltale trends appear.

1. Entrepreneurs ignore outside advice.

2. People have stopped making decisions and stopped an-swering the phone.

3. Nobody in authority has talked to the employees.

4. Customers are becoming afraid of new commitments.

5. An unusual combination of general malaise and high stress exists.

D. Decline in Organizational Morale.

1. The employees usually notice trouble developing and wonder why management does not respond.

2. Often the entrepreneur talks optimistically or hides in the office.

3. Employees lose confidence in the formal communications of the company.

a. The grapevine takes on increased credibility.

b. Company turnover increases, and morale erodes.

4. With their security threatened, employees lapse into sur-vival mode.

5. Intervention is usually forced by the board of directors, lender, or a lawsuit.

a. The bank may call a loan, or suppliers may insist on cash terms.

b. Creditors may try to put the firm into involuntary bankruptcy.

III. The Threat of Bankruptcy.A. The heads of most troubled companies regard bankruptcy as

failure and do not understand the benefits of bankruptcy law.

1. Bankruptcy law merely defines the priority of creditors’ claims when the firm is liquidated.

2. Bankruptcy can provide for the liquidation of the busi-ness or can provide for its reorganization.

3. Facing the prospect of dealing with a company’s bank-ruptcy, creditors are often willing to negotiate.

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B. Voluntary Bankruptcy.

1. When bankruptcy is granted to a business under bank-ruptcy law, the firm is given immediate protection from creditors.

a. The current management is usually allowed to run the company.

b. However, sometimes an outsider, a trustee, is named to operate the company.

2. The greatest benefit of Chapter 11 is that it buys time for the firm.

a. The firm has 120 days to come up with a reorgani-zation plan and 60 days to obtain acceptance of that plan by creditors.

b. Debt also can be restructured.

c. Debt holders may accept convertible options to compensate for increasing risk.

3. If liquidation is the result of the reorganization plan, partial payment ranging from zero of 30¢ on the dollar is the rule.

C. Involuntary Bankruptcy.

1. In involuntary bankruptcy, creditors force a troubled company into bankruptcy.

2. A firm can be forced into bankruptcy by:

a. any three creditors whose total claim exceeds the value of assets held as security by $5,000.

b. any single creditor who meets the above standard when the total number of creditors is less than 12.

D. Bargaining Power.

1. Bankruptcy is a tremendous source of bargaining power for the troubled company.

a. Once protection is granted to a firm, creditors must wait for their money.

b. They are no longer dealing with the troubled com-pany but with the judicial system.

2. Many creditors conclude that their interests are better served by negotiating with the firm.

3. Since the trade debt has the lowest claim, these creditors are often the most willing to negotiate.

4. Secured creditors:

a. The secured creditors, with their higher priority claims, may be less willing to negotiate.

b. Factors affecting their willingness to negotiate are the strength of their collateral and their confidence in management.

Transparency Master 18-3“Types of Bankruptcies” il-lustrates the difference between voluntary and involuntary bankruptcy.


5. Bankruptcy can free a firm from obligations under execu-tory contracts.

a. Some firms use bankruptcy as a way out of union contracts.

b. Since bankruptcy law conflicts with the National Labor Relations Act, the law has been updated and a good faith test has been added.

c. If a company has inflated overhead, the firm may use this approach to reduce it significantly.

IV. Intervention.A. Troubled companies will usually want to use the services of an

outside advisor who specialized in turnarounds.

1. The advisor usually finds that the company is technically insolvent or has negative net worth.

2. As the situation deteriorates, creditors may be trying to force the company into bankruptcy.

3. The advisor’s critical tasks are:

a. To quickly diagnose the situation.

b. Develop an understanding of the company’s bar-gaining position with its many creditors.

c. Produce a detailed cash flow business plan for the turnaround.

4. A turnaround advisor usually quickly elevates the finance function and puts some payments on hold until problems can be diagnosed and remedial actions decided upon.

B. Diagnosis.

1. Diagnosis can be complicated by the mixture of strategic and financial errors.

2. Strategic analysis.

a. Analysis tries to identify the markets in which the company is capable of competing.

b. With small companies, turnaround experts state that most strategic errors relate to the involvement of firms in unprofitable product lines or customers.

3. Analysis of management.

a. This involves interviewing members of the man-agement team and subjectively deciding who be-longs and who does not.

b. This judgment is the result of judgment that comes from experience.

4. The numbers.

a. A detailed cash flow analysis will reveal areas for

Results Expected #3Examined the principle diag-nostic methods used to devise intervention and turnaround plans.

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remedial action.

b. Determine available cash.

• The first task is to determine how much cash the firm has available in the near term.

• This involves looking at bank balances, receiv-ables, and the confirmed order backlog.

c. Determine where money is going.

• In a subaccount analysis, every account that posts to cash is found and accounts are ar-ranged in descending order of cash outlays.

• Patterns can indicate the functional areas where problems exist.

d. Calculate percent-of-sales ratios for different areas of a business and then analyze trends in costs.

• Trends may show where relative costs have changed.

• This can pinpoint which products are not pro-ducing satisfactory returns.

e. Reconstruct the business.

• The next step is to compare the business as it should be to the business as it is.

• What is essentially a cash flow business planis created.

f. Determine differences.

• Finally, the cash flow business plan is tied into pro forma balance sheets and income state-ments.

• Comparing planned income statements to ideal income statements may reveal where expenses can be reduced.

5. The most commonly found areas for potential cuts/im-provements are:

a. working capital management.

b. payroll.

c overcapacity and underutilized assets.

6. More than 80% of potential reduction in expenses can usually be found in workforce reduction.

C. The Turnaround Plan.

1. The turnaround plan not only defines remedial actions, it also provides a means to monitor and control turnaround activity.

a. Short-term measures may not solve the cash crunch, and a turnaround plan gives a firm enough

Transparency Master 18-4“The Turnaround Plan” sum-marizes the key elements of a turnaround plan for a troubled company.


credibility to buy time to put other remedial actions in place.

b. The turnaround plan helps address organizational issues.

• The plan replaces uncertainty with a clearly de-fined set of actions and responsibilities.

• It helps get employees out of their survival mode.

• An effective plan breaks tasks into the smallest achievable unit, so successful completion in-creases morale.

c. The turnaround plan is an important source of bar-gaining power.

• It helps the firm’s advisors approach creditors and tell them how and when they will be paid.

• If the turnaround plan is beneficial to creditors, they will most likely be willing to negotiate their claims.

2. Quick cash.

a. Ideally, the turnaround plan establishes enough creditor confidence to buy the turnaround consul-tant time to raise additional capital.

b. It is imperative to raise cash quickly.

c. The working capital accounts are the best source of quick cash.

d. Accounts receivable can be factored.

• A quicker approach is to discount receivables.

• Accounts that serve as security for a loan are less flexible.

• Receivables over 90 days old can be discounted as much as is needed to collect them.

• A common method is to offer a generous dis-count with a time limit on it.

• It is better to offer too large a discount than too small a one.

• The firm may have to get on the squeaky-wheel list of the slow-pay customer to get attention.

e. Inventory is not as liquid as receivables, but still can be liquidated to generate quick cash.

• An inventory “fire sale” may not work because excess inventory is often obsolete.

• Much inventory is work in process and requires money to put in salable form.

• Discounting finished-goods inventory may cre-

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ate customer resistance when margins are re-stored.

• The sale of raw materials inventory to competi-tors is generally considered the best route.

f. The company may also ease credit terms.

• It is possible to borrow more against receiv-ables than against inventory.

• By easing credit terms, the company can in-crease its borrowing capacity to get cash to fin-ish work in process.

• The firm’s lenders may veto these arrange-ments.

g. Current sales activity should seek to:

• Increase the total dollar value of margin.

• Generate cash quickly.

• Keep working capital in its most liquid form.

h. The overall idea is to favor cash first, receivables second, and inventory third.

i. Putting all accounts payable on hold eases the cash flow burden.

• The most important uses of cash at this stage are meeting payroll and paying lenders.

• Getting suppliers to ship is critical.

• Suppliers are the least likely to force the com-pany into bankruptcy because they have a low priority claim.

3. Dealing with Lenders.

a. The next step is to negotiate with lenders.

b. At the point of intervention, the company is most likely in default on its payments.

• Many of the firm’s assets are likely to have been pledged as collateral.

• The troubled entrepreneur has probably been avoiding his or her lenders.

• Credibility has been lost.

c. The lender is usually willing to work things out.

d. There are two sources of bargaining power.

• Bankruptcy is an unattractive result to a lender.

• The firm that has diagnosed the problem and produced a detailed turnaround plan is in a bet-ter bargaining position.

e. There are also two tactical sources of bargaining

Results Expected #4Identified remedial actions used for dealing with lenders, credi-tors, and employees.


power:

• The strength of the lender’s collateral.

• The bank’s inferior knowledge of aftermarkets and the entrepreneur’s superior ability to sell.

f. The text gives the example of a firm with obsolete inventory which worked with its lender to obtain additional financing to enter a new market.

g. In another example the firm’s bank requested that key members of management give liens on their houses; the firm refused and prevailed.

h. Lenders are often willing to advance money for a company to meet its payroll.

i. When the situation starts to improve, a lender may call the loan.

4. Dealing with Trade Creditors.

a. In dealing with trade creditors, the company has a strong bargaining position.

• Trade creditors have the lowest priority claims should a company file for bankruptcy.

• In bankruptcy, trade creditors often receive just a few cents on the dollar.

b. The existence of a turnaround plan is also a bar-gaining chip.

• Trade creditors have a higher gross margin than a bank.

• It helps to pay them a little money on a fre-quent basis.

c. Trade creditors will often work with a troubled company if they see it as a way to preserve a mar-ket.

d. The relative weakness in the position of trade credi-tors has allowed some turnaround consultants to negotiate impressive deals.

e. The second step is to prioritize trade creditors ac-cording to their importance to the turnaround.

f. The third step is to switch vendors if necessary.

g. The fourth step is to communicate effectively.

5. Workforce Reductions.

a. Layoffs are inevitable in a turnaround situation.

b. Some turnaround specialists recommend that lay-offs be announced as a onetime reduction in the workforce and be done all at once.

c. They recommend that layoffs be accomplished as

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soon as possible.

d. They further suggest that a firm cut deeper than seems necessary to compensate for other more dif-ficult remedial actions.

D. Longer-Term Remedial Actions.

1. If the turnaround plan has created enough credibility, longer-term actions can be implemented.

a. Systems and procedures can be improved.

b. Asset play: Assets that could not be liquidated in a shorter time frame can be liquidated.

c. Creative solutions need to be found.

2. Many companies—even companies that are insolvent or have negative net worth or both—can be rescued and re-stored to profitability.

V. Chapter Summary.

Answers to Study Questions

1. What do entrepreneurs need to know about how companies get into and out of trouble? Why?

Trouble can be caused by external forces not under the control of management such as re-cession, interest rate changes, inflation, and industry/product obsolescence. However, turnaround specialists have found that external forces are rarely the sole reason for a company failure. Most causes of failure are found within company management, such as inattention to strategic issues, general management problems, and poor financial/accounting systems and practices.

2. Why do most turnaround specialists invariable discover that it is management that is the root cause of trouble?

Most causes of failure can be found within company management. Lack of management skills, experience, and know-how contribute the company’s decline. As companies grow, man-agement need to change their management mode from doing to managing to managing managers. In a new company, the finance function may be nothing more than a bookkeeper. Although turnover of key management personnel can be difficult in any firm, it is critical concern in busi-nesses that deal in specialized or proprietary knowledge. Also, some companies focus on accru-als, rather than cash.

3. Why is it difficult for existing management to detect and to act early on signals of trou-ble?

Typically the first signs of trouble go unnoticed or are written off as teething problems of a new project. Although management may miss the first signs, outsiders usually do not. Banks, board members, suppliers, and customers see trouble brewing and wonder why management does not respond.


Soon management has to admit that trouble exists, but valuable time has been lost. The lead entrepreneur is emotionally committed to people, projects, or to business areas. To cut back in any of these areas goes against instinct. As the company continues downward, the situation be-comes stressful. Stress can cause avoidance on the part of an entrepreneur. He or she is frozen and can take no action. A person under stress does not understand the problem and replaces the unpleasant reality with fantasy. It is common for an entrepreneur to deal with pleasant and well-understood tasks, such as selling to customers, rather than dealing with the trouble. Credibility is lost with bankers, creditors, and so forth.

The decisions the entrepreneur does make during this time often accelerate the company on its downward course. Finally, the entrepreneur may make statements that are untrue or may make promises that cannot be kept.

4. What are some key predictors and signals that warn of impending trouble?

Crises usually result from an accumulation of fundamental errors over time. If the entre-preneur, employees, and significant outsiders can see trouble brewing in time, they can take cor-rective action. Predictive models need to use information available in common financial reports. These approaches use easily obtained financial data to predict the onset of crisis. For the smaller public company, these models can be used by all interested observers. With private companies, they are useful only to those privy to the information.

These predictors use the figure for total assets, which is often distorted by “creative ac-counting.” One such predictor is the net-liquid-balance-total-assets ratio, developed by Joel Shul-man to predict loan defaults. Shulman’s approach recognizes the importance of cash and calcu-lates the net liquid balance.

Turnaround specialists also use some nonquantitative signals as indicators of trouble. Once any of these surfaces, then trouble is likely to mount. These include:

(1) Inability to product financial statements on time.

(2) Changes in behavior or the lead entrepreneur.

(3) Change in management or advisors, such as directors, accountants, or other profes-sional advisors.

(4) Accountant’s opinion that is qualified and not certified.

(5) New competition.

(6) Launching of a “big project.”

(7) Lower research and development expenditures.

(8) Special write-offs of assets and/or addition of “new” liabilities.

(9) Reduction of credit line.

5. Why can bankruptcy be the entrepreneur’s ally?

The heads of most troubled companies regard bankruptcy as failure and do not under-stand the benefits of bankruptcy law. Bankruptcy law merely defines the priority of creditors’ claims when the firm is liquidated. It can provide for the liquidation of the business or can pro-vide for its reorganization. Bankruptcy is not an attractive prospect for creditors because they stand to lose at least some of their money, so they often are willing to negotiate. The prospect of bankruptcy can be a foundation for bargaining in a turnaround.

When bankruptcy is granted to a business under bankruptcy law, the firm is given imme-diate protection from creditors. The current management is usually allowed to run the company,

370 Chapter 18

although sometimes an outsider, a trustee, is named to operate the company. The greatest benefit of Chapter 11 is that it buys time for the firm.

Bankruptcy is a tremendous source of bargaining power for the troubled company. Once protection is granted to a firm, creditors must wait for their money. They are no longer dealing with the troubled company but with the judicial system.

6. What diagnosis is done to detect problems, and why and how does cash play the central role?

Diagnosis can be complicated by the mixture of strategic and financial errors.

Strategic analysis tries to identify the markets in which the company is capable of com-peting. With small companies, turnaround experts state that most strategic errors relate to the in-volvement of firms in unprofitable product lines or customers.

Analysis of management involves interviewing members of the management team and subjectively deciding who belongs and who does not. This judgment is the result of judgment that comes from experience.

A detailed cash flow analysis will reveal areas for remedial action.

The first task is to determine how much cash the firm has available in the near term. This involves looking at bank balances, receivables, and the confirmed order backlog.

The next task is to determine where money is going. In a subaccount analysis, every ac-count that posts to cash is found and accounts are arranged in descending order of cash outlays. Patterns can indicate the functional areas where problems exist. Calculating percent-of-sales ra-tios for different areas of a business can reveal trends. Trends may show where relative costs have changed. This can pinpoint which products are not producing satisfactory returns.

The next step is to compare the business as it should be to the business as it is. What is essentially a cash flow business plan is created.

Finally, the cash flow business plan is tied into pro forma balance sheets and income statements. Comparing planned income statements to ideal income statements may reveal where expenses can be reduced.

The most commonly found areas for potential cuts/improvements are working capital management, payroll, overcapacity, and underutilized assets.

7. What are the main components of a turnaround plan and why are these so important?

The turnaround plan not only defines remedial actions, but because it is a detailed set of projections, it also provides a means to monitor and control turnaround activity. Because short-term measures may not solve the cash crunch, a turnaround plan gives a firm enough credibility to buy time to put other remedial actions in place.

Key elements of the turnaround include quick cash, dealing with lenders, dealing with trade creditors, and workforce reductions.

Ideally the turnaround plan establishes enough creditor confidence to buy the turnaround consultant time to raise additional capital. It is imperative to raise cash quickly. Accounts receiv-able can be factored or discounted. Inventory can be sold or discounted. The overall idea is to leverage policy in favor of cash first, receivables second, and inventory third.

The next step is to negotiate with lenders. The lender is usually willing to work things out. Bankruptcy is an unattractive result to a lender. The firm that has diagnosed the problem and produced a detailed turnaround plan is in a better bargaining position.


In dealing with trade creditors, the company has a strong bargaining position. Trade cred-itors have the lowest priority claims should a company file for bankruptcy. They will also often work with a troubled company if they see it as a way to preserve a market. The next step is to pri-oritize trade creditors according to their importance to the turnaround. The third step is to switch vendors if necessary. The fourth step is to communicate effectively and honestly.

Because workforce reductions represent 80 percent of the potential expense reduction, layoffs are inevitable in a turnaround situation. The layoffs should be a onetime reduction and be done all at once. They should be accomplished as soon as possible.

If the turnaround plan has created enough credibility, longer-term remedial actions can be implemented. These actions can include systems and procedures, asset plays, and creative solu-tions.

Notes on Case

“EverNet Corporation”

Preparation Questions

Students are asked to consider the following questions:

1. Evaluate what Kenefick has accomplished with his new company, EverNet.

2. Examine and contrast Jim’s leadership skills and strategies for NET-Tel’s financ-ing strategies, deal structures, and progress to date.

3. What is your assessment of NET-Tel’s financing strategies, deal structures, and progress to date?

4. What is your assessment of the investment opportunity in NET-Tel as a private eq-uity investor in mid-1999?

5. What should Kenefick do now, and why?

Case Overview

This case continues the saga of James Kenefick begun in the case in Chapter 2. The out-come of Kenefick’s first entrepreneurial venture, Keystone Corporation, was less than successful. His partner, Dick Thompson, took legal action to remove Kenefick from his position in the com-pany. As a result of the forced sale, Kenefick was left with sufficient capital to live a life of leisure. Like most entrepreneurs, he quickly tired of the inactivity. His basic creative and compet-itive nature led him to start another company, EverNet Corporation.

EverNet is a long-distance and Internet service provider in an industry created by the deregulation of the telecommunications industry. In a market dominated by industry giants like AT&T, EverNet has found a market niche with huge growth potential. The firm offers a bundled service providing long-distance, interenet access, and local access on one bill.

The lessons learned with the earlier venture have been applied to the new company. Jim Kenefick failed to create a buy-sell agreement with Thompson—this time all the necessary legal documents were in place.

The crisis facing EverNet is of a different nature—EverNet is out of cash, and fund-rais-ing is stalled. The company has committed huge amounts of capital to build its own switching networks and to move into a larger corporate headquarters. One of the signals of trouble for any

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company is initiating a “big project.” The costs and disruption of such a project can rapidly de-plete available capital when the expected revenues are slow to materialize.

Kenefick has devoted a large percentage of his time to seeking capital financing. He clearly love the challenge and competition of the hunt. By creatively negotiating with capital providers, he has obtained commitments from several equity and debt sources, but is lacking the critical last building block, the lead investor. It is the venture capital firm Palmer and Moore, owned by his friend Wally Arhol, that finally takes on the leadership role.

With the lead investor in place, Kenefick is able to negotiate with other potential in-vestors from a position of strength. He is able to force the large investment bank CIBC to offer a sweetened financing deal.

Now that financing is in place, Kenefick must convert the advantage into solid future earnings. Currently the majority of the revenue stream is coming from “causal calling,” the ven-ture’s first market model. In order to justify the huge investment involved in building the switch-ing network, EverNet needs to increase sales of its bundled services while growing new market opportunities. The future looks optimistic—the market for business-to-business electric com-merce was expected to grow to $1.4 trillion by 2003.


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