Fallouts of COVID-19 continue into 2023 with many opportunities arising for purchasing a distressed business. Investors and business owners operating in the same vertical are quickly snapping them up as opportunistic strategic acquisitions.
Although potential buyers should move quickly to purchase these companies, they should also do the necessary due diligence. M&As in any sector or size involve getting the best value from the deals. But, when it comes to purchasing a distressed business, several additional factors come into play.
That’s because troubled companies could be facing myriad problems which is why they are coming up for sale. Lack of liquidity resulting from falling sales volumes, non-paying customers, and inability to cut back on expenses despite falling revenues could be some of the issues.
Insufficient cash flow could result in the business falling behind in payments to suppliers, vendors, loan providers, and creditors. Programs like the Paycheck Protection Program (PPP) helped business owners with temporary relief.
But without improvement in economic conditions, the next solution is to file for bankruptcy or find an acquirer. From the buyer’s perspective, you’ll find out everything you can about the targeted company before making an offer.
Identifying the causes of its distress helps the acquirer put together a plan for turning the purchased company around. You can also drive a hard bargain and drive down the pricing with the assistance of your M&A advisors. Here are some of the key considerations when assessing the targeted company.
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Determine the Reasons Why the Company is Faltering
Several reasons can result in the company faltering and being available for sale. Acquirers should start by identifying the unique reasons and working out if the purchase is viable. Some key factors include:
- Losing a significant customer base because of the new innovations and technologies leading to its current offerings becoming redundant.
- The company facing expensive litigation leading to significant costs and loss of brand value and customer confidence.
- High fixed costs and slowing revenues resulting in a smaller bottom line. This figure may include the company’s earnings, earnings per share (EPS), net income, and profits.
- Difficulty in managing the company’s debt.
- Heating up competition with price wars and competing brands offering better value for money.
- Failing customer service and consequently, lower customer satisfaction.
- Disagreements among the co-founders and owners
- Difficulty in maintaining cordial relationships between the company’s stakeholders
- Loss of core talent and skill sets because of employee dissatisfaction and attrition.
Methodical and Meticulous Due Diligence Before Purchasing a Distressed Business
Due diligence before purchasing a distressed business involves additional concerns that buyers must focus on. Acquirers often make the mistake of rushing through the process to grab the opportunity.
While capitalizing on the targeted company’s deteriorating value is an attractive proposition, it is critical not to overlook the pitfalls. Sellers may want to close the deal quickly if they are on the verge of bankruptcy. Their objective is to look for buyers who have industry-specific expertise, financial strength, and the capabilities to revive the business.
Before making an offer, acquirers would want confirmation that the deal is viable. If the company’s valuation post-liquidation is higher than if it were operating, they might want to rethink the purchase.
If the objective is to salvage the company and keep it running, you’ll want assurance that it can be done. Here are the core areas that buyers focus on:
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The company’s financial statements are of key importance during due diligence. You’ll retain the services of expert accountants to go over the balance sheets, profit and loss accounts, and other documentation. This strategy helps detect any possible manipulation of the books and information.
Faltering companies may attempt to present higher profitability and revenues or conceal liabilities on paper. The experts will dive into historical data to find records indicating when the company started faltering and its reasons.
For instance, delaying payments to suppliers and vendors to show higher cash balances and stretch accounts. Accountants will check reports to determine the interval for which invoices have been outstanding. Not only will this step clarify the cash status, but it also indicates weakening working relationships with them.
In an attempt to get customers to pay up quickly or boost sales, distressed companies offer perks. These may include cashbacks, discounts, or package deals that can affect the revenues. Buyers must examine these sales strategies to determine how they affected the company’s bottom line.
Companies typically incur overhead costs for services such as fees payable to accountants, lawyers, investment bankers, or others. Faltering businesses may exclude these unpaid, accrued costs or outstanding dues from their accounts, which is another area of focus.
Yet another strategy for showing higher cash balances is to delay tax payments. Buyers need to pay special attention to this aspect since outstanding tax liabilities can result in fines and audits. Or the company may not be aware of the taxes it owes to the state and federal governments.
Reviewing payroll tax returns, corporate tax, income tax, sales tax, and other returns is crucial. If the management is hesitant to provide any information, that could be a red flag to rethink the transaction.
Businesses in today’s times must comply with Environmental, Social, and Governance (ESG) rules and regulations in their operations. Cash-strapped companies may overlook these rules and thus, run the risk of fees and penalties. Potential buyers must assume these liabilities when purchasing a distressed business.
Before completing the sale, you’ll examine the company’s operations for these issues and work on resolving them. This exercise could result in additional costs and paying government dues.
Company Workforce Problems
Any company’s most dynamic resource is its workforce and struggling organizations may have their employees leaving to look for alternate opportunities. Delays in paying salaries and perks, and holding back on health benefits, and bonuses can lead to disgruntled workers.
During the due diligence process, you’ll identify the core talent and restructure their roles to assimilate them into the surviving company. That’s how you can retain skill sets and prevent attrition, which is crucial for acquirers looking for acquihires.
Faltering company operations eventually leads to higher stress levels and a weakening culture that spreads through the different management tiers. The toxic work environment may transfer to the new surviving company or permeate the acquirer’s organization.
You’ll avoid this possibility by examining the factors that affect the culture and taking steps to reform the situation.
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Other Potential Issues
A distressed company may be facing difficulties because of pending litigation and damage claims. Before finalizing the purchase, you’ll make sure the seller resolves these claims. You’ll also assess the extent of the risk you’ll assume if the claims are not sorted before the closing.
When a business is struggling, its working relationships with suppliers and customers tend to take a hit. Buyers must examine the reasons behind souring relations and come up with a game plan to reverse the damage. They’ll also explore the potential risks to the ongoing performance of the firm.
Before purchasing a distressed business, acquirers should get professionals to evaluate their capital assets and ensure they are in working condition. You’ll check them to assess the potential expenses you’ll incur to have them up and running again. Chances are the seller delayed repairs to save costs. You’ll also check for possible liens and ensure clear ownership titles in case of venture leasing deals.
Companies enter into contracts and agreements with third parties during their operations. Buyers should examine them to ascertain whether the contracts automatically transfer to them. Or if they need to enter into fresh contracts to continue working. You’ll also check for outstanding payments and dues.
Potential Value and Synergy from the Acquisition
Even though you’re negotiating for purchasing a distressed business, you’ll also focus on the potential value it brings to your organization. Acquirers examine the facets they can turn around to extract its underlying value.
A company that has inherent assets and value can eventually turn a viable profit for the buyer. That’s what you’ll look into when assessing the resources you’ll invest to salvage the faltering company. Here are some of the factors to consider:
- List the assets the company owns and evaluate them. If they are generating revenues, you can keep them. But if they have more value from being sold, that’s what you’ll do. Add up the revenues you can get from the sale.
- List the company executives and board and examine their performance. Next, you’ll work out the roles they can play in restoring the company. That is, once they have access to the cash and resources infusion that you’ll provide.
- List the company’s Intellectual Property including the patents, copyrights, trademarks, and trade secrets. The brand name, logo, and other assets may drive value and have yet to be monetized effectively. Work out how to extract this value.
- Closely examine why the company ran into difficulties and its past performance until the point.
- Review upcoming industry trends and how the company is likely to perform in future economic downturns or upturns.
- List the potential opportunities for synergies and how purchasing a distressed business can contribute. For instance, cross-selling products, economizing on costs, or top-notch talent. Acquirers can also benefit from the IP and intangible assets the faltering company brings to the table.
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Salvaging a Distressed Company Post Purchase – Getting Started
When purchasing a distressed business, you’ll initiate aggressive negotiations early on. Since the seller is facing difficulties, they might be anxious to enter into a deal as the company falters further. Once the seller files for Chapter 11 that will give you an additional edge.
Reach out to the company’s lenders and other creditors to explore the terms under which they will allow an exit. Contacting the board and management and urging them to step up to their fiduciary obligations is also a great strategy.
If not an outright purchase, you can offer alternative terms to the struggling company. For instance, buying specific assets, intellectual property, or a subsidiary. Acquiring customer lists or core talent is also an option the seller might consider.
Turning the Company Around
Acquirers who intend to turn the company around and restore it to regular functioning must come up with a detailed plan. Here are some of the steps to get started.
- Examine the company’s cash reserves to ensure it has adequate balances and reserves. Also, estimate the cash it will need for the day-to-day operations. That’s how you’ll ensure that the scarce reserves are well-managed and the company runs without snags.
- Interact with the management to get their buy-ins for the purchase and company salvage. A team that is committed to and believes in the company is likely to work harder to restore it. Also, check if they have input about the reasons why the business faltered. And what can be done to reverse the mistakes.
- Set up a robust HR unit to communicate with the employees and keep them in the loop. Make sure they are engaged in the turnaround and open to adopting changes and solutions. You’ll also want to reassure them about their positions in the company and salary structures.
- Work with your advisors to develop a new business model for the ailing company that deals with its challenges. Work out the improvements you can make and how to integrate them. A new resilient business model entices investors to back the company.
- Purchasing a distressed business typically involves a fresh infusion of cash. Any financing strategies you develop should address the key pain points and resolve the problems.
- The company’s status as a faltering organization may result in costs rising because of a lack of credit. Partnering with a reputable acquirer instantly restores its creditworthiness giving it a new lease of life.
Purchasing and reviving a faltering business needs well-planned strategies and meticulous due diligence. Acquirers must engage top-notch professionals to dive behind the lines and extract all the relevant information before the closing.
Identifying the areas that need improvement is the best first step to turning the failing business around.
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