Four tips when buying a distressed business

With the ‘easy credit’ party well and truly over, and businesses facing uncertainty in the face of the difficult economic climate, many opportunities are arising for companies to buy distressed businesses – businesses which are financially troubled – or their assets, at discounted prices.

With the recession being so drawn out, even companies with strong financial reserves have fallen into trouble. In particular, construction, retail and healthcare services have seen a lot of accelerated M&A, although distressed purchases are taking place across all sectors.
Identifying, assessing and completing a distressed purchase opportunity can be a daunting process presenting a number of risks and potential problems not always found in a traditional acquisition. So how can you acquire a distressed business or some of its assets successfully? We’ve highlighted four tips to help you make the most of this valuable opportunity.

1. Understand who you are buying from
Many distressed businesses will be owned by a bank, or a bank will be the key stakeholder driving the sale. When buying a business’s non-core assets, the process can be fairly straightforward and the selling business may well want to accelerate the sale.

However, when buying a whole entity where the bank is effectively the owner, the process can be longer and more complicated. Banks will likely have different priorities from those of corporate sellers, and it may even be that a distressed company is being sold by a syndicate of banks, which will add complexity.

Being clear about who the seller is and understanding their priorities is vital. Bear in mind also that sellers won’t always go for the highest offer.

If, for example, the enterprise value is likely to break in the bank debt (so the bank is the beneficiary of any consideration) and there are two offers on the table, of which one is higher value but has a deferred element (meaning the bank will have to stay in the game for a few years to realise that benefit), then it may well opt for the lower, more secure offer.
Again, it’s important to understand the type of offer that is most likely to appeal to the seller.

2. Ensure you have the right fix
If you can genuinely understand what the going concern issue is then you will be far better placed to make an assessment of whether you have the right solution for turning that business around.

Ask yourself: have you got what is required to fix the company, either through operational improvement capability, having the cash to resolve any funding issues, or through restructuring in a way that this company or the bank couldn’t or didn’t have the appetite to?
Ensuring you can fix the business and turn it around avoids ending up in the same predicament in six months’ time – or worse, putting your own business at risk.

3. Have a clear plan for management
One of the potential risk areas where some acquirers have fallen down, and are sometimes not properly advised, is around ‘management’.

Some buyers will assume that the existing management is locked in and will stay. If management leaves, however, it could impact on relationships with key customers or suppliers. This is particularly important in the service industry, where those relationships are fundamental to business value – and there’s not a tangible ‘asset’. Check carefully any such agreements and consider how you will incentivise management to work with you towards future success.

Similarly, if you are looking to replace a management team with one of your own, you may want to make sure that the removal of the existing team is appropriately taken care of, and that redundancy terms and costs are clearly dealt with in your offer. This area can give rise to costly mistakes.

4. Consider your fundraising options at an early stage
Fundraising for a distressed asset can be more complex than for an asset that has clear value. If you go to a standard bank, they will want to assess the value of that asset.
Getting funding in place before making an offer will help your purchase because sellers like certainty. Secured funding will add materially to your credibility as a bidder. If you try to acquire a distressed asset without funds in place, it will put you at a disadvantage.
In summary

It is clear that there are many benefits to be gained from a carefully planned and well thought-through distressed purchase. It’s important to gain a firm grasp of the assets you are buying and to approach the acquisition in a coordinated manner.

With the purchasing process for distressed businesses frequently being more time pressured than traditional acquisitions, and with a specific sub-set of risks, Grant Thornton has been working with a number of clients to guide them through the process, from beginning to end.