The Turnaround Assessment Test

In 1968, Edward I. Altman formulated a simple, path-breaking scoring mechanism that could predict, with high confidence, the probability that any one corporation would enter bankruptcy within two years. He called the mechanism the Z score and, by publishing in academic journals, allowed it to enter the public domain.

It has been, for many years, one of the most-studied and most-improved-upon models in financial history. It is also arguably the precursor to the consumer-oriented credit models we are so familiar with. If Ed Altman had started a ratings agency instead of an academic career, he would probably be one of the richest people on earth.

After I began consulting to companies wishing to improve financial results, I started to formulate my own predictive model. I called it “the humility business,” because I observed that large companies with big problems had two overarching conditions in place: large debt and an ambitious CEO.

And ambition was the leading indicator. The first time I thought of this I was watching a TV commercial for Eastern Airlines, which had just entered bankruptcy. The new CEO paid a bundle to blanket the airwaves with a commercial showing him standing in a hangar, announcing to the remaining employees that the company was entering a first-class-only marketing push.

That is, the company had already publicly and legally admitted that it could not pay its debt, and therefore was seeking court protection, and was going to spend cash that would otherwise go to its legal creditors in order to convert every plane in the fleet to his new and unproven venture.

“What audacity,” I thought, “unbalanced by any humility.” There was apparently no long-term financing plan, marketing, pricing, or costing. Just this guy on TV telling people how he was going to save Eastern.

The company folded permanently soon after the required financial reports got to the bankruptcy judge. Chapter 11 gives control of the business to management as long as they act as a fiduciary to creditors. Spending millions of dollars on new first-class seats when creditors were waiting for their old debt payments did not qualify as fulfilling that responsibility.

For a while after that, I would speak to business school classes on turnarounds and propose that we play a game, nominating and voting on companies that have high debt and overarching ambition. These, we would predict, would go into bankruptcy. Only later – perhaps months later – would we find out if we had correctly picked winners.

The predictions always came true. Federated Department Stores was a winner, as was Northwest Airlines. Another notable winner was Mr. Donald Trump, who won twice, once for a casino venture and another for a hotel venture. They both, in fact, entered Chapter 11.

In 2005, I stopped doing the game at business schools, because a class at the UW-Madison nominated and voted for the U.S. government going into the equivalent of bankruptcy. I thought the answer was foolish on its face.

Maybe, given the events of this week, I should have trusted the model more.

Anyway, now I work with middle-market companies and have come to another realization: Entrepreneurs do not easily ask for help. They are energetic, relentless problem-solvers and often feel that the issues that their companies face are close to being resolved.

They think they need just one more marketing call, one more new product push, one more new idea to implement.

As a matter of fact, entrepreneurs are so restless in their problem-solving that I have a good predictor for when someone might need some outside help: lack of sleep. When business problems are so pervasive that the businessperson goes over them obsessively throughout the day, thinking about them often continues past bedtime.

Not that the person complains. But a loved one will frequently put down his or her foot, strongly suggesting that that lack of sleep is a health hazard. Then I meet the businessperson, usually introduced via an attorney or accountant I have worked with before.

Is lack of sleep that best predictor of a middle-market company needing outside assistance? Probably not, because it is an emotional indicator, and not an objective one.

So I recently formulated a self-assessment questionnaire that might address the major issues of a middle-market company needing some practical help. It covers marketing, organization, safety, operations, and finances. It is not designed to be a scientific study – it’s more of a checklist for that restless entrepreneurial mind. But it also asks if sleeplessness is an issue.

I have a beta version on my website: It can be found here.

Feel free to look it over. I would appreciate any feedback you might have on the test, the conclusions, and what you might have learned from the exercise.

Sign up for the free IB Update – your weekly resource for local business news, analysis, voices, and the names you need to know. Click here.