M&A Strategies For Acquiring Or Selling Distressed Businesses

Acquiring or selling distressed businesses are complex processes that involve significantly more challenges than a typical M&A deal. Turning around a troubled business needs well-crafted strategies such as re-branding and reviving customer confidence in the brand and its products.

Acquirers may need to restructure human resources and redesign and remarket products that have been unsuccessful in building a market presence. Not only must they invest capital in the faltering company but also assume its liabilities and debts. All these activities require cash inputs.

At the end of the day, buyers are concerned about accountability to their stakeholders and making profits from the deal. By purchasing a distressed business at low costs, they can hope to turn the company around and assimilate the synergies. Or sell it at a premium to recover their investment.

From the seller’s perspective, they must strike the optimum balance between convincing the buyers of the value of the deal. And, providing whatever information acquirers require about the reasons why the company is facing difficulties in keeping afloat.

At the same time, the management of the targeted company should be open to due diligence and scrutiny. They must provide all the relevant information to the buyer’s legal team and M&A advisors. Side-by-side, they must work to maintain regular operations and functioning.

So, how can dealmakers accomplish the optimum M&A deal where both parties stand to gain? What are the best strategies for acquiring or selling distressed businesses? Read ahead to find out.

Identify the Right Businesses to Acquire

The primary objective for acquirers is to look for companies priced well below their fair market value using several strategies. You’ll look for distressed businesses facing accounting issues or those that have oversold securities. Or, have shares trading well below their typical value metrics. Here are some other channels to explore.

• Industries and companies close to collapse and faltering are good targets for purchase. The changing business landscape could result in higher logistics and inventory costs. Or, changing federal and state legislations may lead to products and licenses becoming redundant. Look for companies affected by these conditions.
• Not all companies are agile and can incorporate innovations to remain competitive. Search around for competitors, vendors, or venture partners that have taken a hard hit because of product redundancies. Consider them for an acquisition.
• Explore both vertical and horizontal options within your business vertical. You’ll economize on expenses and improve profits.
• Keep open communication lines with vendors, loanmakers, investors, and customers for information about distressed businesses.
• Connect with investment bankers, bookkeeping and accounting agencies, and legal firms for companies that might be open to selling.
• Keep a close watch on competitor activities for information about upcoming retirements and board restructuring. Companies taking on too much debt, involved in litigation, or struggling to manage new projects are good targets for acquisitions.

Search Public Forums for Information About Distressed Businesses

Look up the company name on sites like Dun & Bradstreet and Crunchbase for an overview of the available business reports. This strategy can give you an overview of how the company is fairing. However, also keep in mind that the reports could be outdated and unreliable. That’s because the management may not release any unfavorable data on public forums.

The best sources of information include local news sites that list companies available for purchase. Also, check for press releases and legal announcements that indicate a particular business may be in trouble. Contacting local business brokers and participating in distress groups and events are good strategies for acquiring or selling distressed businesses.

You can leverage top-notch legal advisors and financial analysts to determine the profit-making potential of the targeted company.

Plan the Transaction Carefully – Chapter 11 Purchases

Acquirers looking to purchase Chapter 11 bankrupt companies are typically from the same or related business vertical. Accordingly, they have in-depth knowledge of the targeted company’s assets and their value. Historically, post-acquisition or merger, Chapter 11 businesses are likely to show marked improvements in their operating performance.

Understanding Chapter 11

Businesses facing financial difficulties may opt for Chapter 11 bankruptcy which helps restructure their debts and reorganize their operations. As a result, they can manage their debt and work out repayment plans.

The US Bankruptcy Code governs Chapter 11 bankruptcies. The company filing for bankruptcy puts forward a detailed plan that outlines how it intends to reduce its operational costs. It also specifies how it intends to secure more sources of income and revenues and improve profits.

Most importantly, the company seeks temporary postponement of the payments to its creditors until it has a sustained cash flow. Having filed for Chapter 11, the company need not liquidate its assets entirely but can continue to conduct business as usual.

As a result, the distressed company has time to come up with a plan to salvage itself. And reorganize the areas that are not performing well. On the downside, Chapter 11 is more time-consuming and may cost the company more in terms of transactional expenses.

Navigating the Acquisition of a Chapter 11

Before bidding for a Chapter 11 business, acquirers must consider several aspects such as:

• The timeline within which the M&A deal must conclude, which is before the targeted company runs out of liquid cash. Or, before its cash needs exceed the available resources.
• The targeted company’s debt and capital structure, single class or multiple classes of secured debt, and isolating the debt which could be fulcrum debts. Fulcrum debts are those that have priority to convert to or receive equity shares when the company goes through reorganization.
• Timelines of repayments of loans and bonds, production schedules, and deadlines for making payments under critical agreements.
• Possible costs and issues that need to be addressed urgently before the transaction closes. These contingencies can include maintaining relationships with key stakeholders including customers, investors, vendors, and employees.
• Need for getting consent for the sale from equipment lessors in the case of venture leasing, investors, and loan providers. The company may also need to get the go-ahead from landlords, the main customers, and any other third parties who own liens.
• In the case of cross-border acquisitions, acquirers may need to account for fixed and movable assets the company may have. Since the assets are in foreign locations, they are subject to the local jurisdictions and laws of that country.
  Restructuring plans submitted by the debtors or creditors.

How the Acquisition Proceeds

Acquirers can offer to purchase a company by co-sponsoring its Chapter 11 plan for reorganization and avoiding competitive bidding. But for that to happen, at least one class of creditors affected by the plan should approve the process.

Under the law, debtors have exclusive rights to request the Chapter 11 plan for the initial 120 days after the company declares bankruptcy. This time frame can be extended to 18 months from the date of the bankruptcy filing.

If acquirers purchase a company under Chapter 11, they can also avoid paying transfer taxes. This cost-saving can be beneficial to the creditors. On the other hand, creditors or a specific class of creditors may contest the valuation the acquirer offers. That is, if they have more competitive bids from other potential buyers.

The Chapter 11 plan is beneficial to acquirers who intend to merge the business into their company. Or, if they intend to raise additional capital for the purchased company after its reorganization. This they can do by offering rights to the company’s equity holders and/or creditors.

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Bring in Expert Teams and M&A Advisors

Before making an offer, you’ll value the company using any of the best valuation strategies. Factor in the company’s assets, liabilities, warranties, and other obligations. While you can rely on the seller to provide you with the relevant information, make sure to conduct due diligence.

Entrust the due diligence to expert teams who will scrutinize every aspect of the business meticulously. Having M&A advisors at the negotiation table also ensures that you assess the company’s true worth before arriving at a number.

Factor in the reasons why the business is up for sale and it is facing financial difficulties. Explore the comparable sales, assets included in the deal, economic conditions, and whether the seller will remain on the management board.

Most importantly, you’ll evaluate the potential integration challenges and synergies to be achieved from the deal. That’s one of the best strategies for acquiring or selling distressed businesses.

“Out of Court” Acquisitions

As long as the targeted company has a simple debt structure, acquirers can consider entering into a traditional sale. This M&A transaction can be similar to an asset purchase agreement. Here the seller need not obtain the consent of third parties and the government.

Even if consent is necessary, it is typically easy to obtain. Nor do the fiduciaries need to assume any liability in approving the sale. Entering into an “out of court” acquisition is easily executed without incurring too many transactional expenses and fees.

The deal closes quickly and seamlessly with the minimum risk of business disruption for the targeted company,

Other Strategies for Acquiring or Selling Distressed Businesses

Aside from the Chapter 11 bankruptcy acquisition and out-of-court purchase, acquirers can enter into other types of agreements. Distressed companies can offer equity purchases, acquihires, asset sales, or “ABC” or assignment for the benefit of creditors. A 363 prepackaged bankruptcy sale is an option.

Mergers or Equity Purchases

Equity purchases are possibly the fastest way of executing the deal and the process is completed within one day. This type of distressed company sale has several benefits including favorable tax treatment for the sellers. Most importantly, the management can complete the deal without too much negative publicity for the problems the company is facing.

Asset Purchases

Asset purchases are when the buyer assumes only the assets but not the legacy liabilities of the targeted company. Certain limits and conditions may also apply to the transaction, including the need to get approvals and consents.

Such transactions are more time-consuming, complex, and incur different types of taxes. Sellers and shareholders must pay income tax since they receive proceeds from the sale.

Acquihires

Acquihires are acquisitions where the buyer employs the targeted company’s workforce. These kinds of mergers occur when the seller’s company is unable to generate any real value. Or it is unable to get much of a market presence,

Executing such transactions is a quick process since neither side needs to conduct due diligence or engage in extensive negotiations. Since the acquirer is not taking on any of the company’s liabilities or assets, the risk factor is nil.

There is no exchange of Intellectual Property (IP) or intangible assets. However, your M&A advisor will recommend that you get a non-exclusive, perpetual license to the IP the workers may generate in the future. This simple step will help you avoid any potential infringement litigation.

ABCs and 363’s Purchases

If the proceeds from the sale of the company are inadequate and cannot cover the seller’s liabilities, they need other options. In that case, a 363 prepackaged bankruptcy sale or an assignment for the benefit of creditors (ABC) can be considered.

The buyer can also request these options to secure them from the risk of fraudulent conveyance or successor liability. In an ABC, the seller transfers all the company’s assets to a private-sector service provider.

This entity is a liquidator or assignee and conducts a solicitation process for such assets in the open market. The objective is to invite competing bids which may be higher than the buyer’s. If no such offers are available, the assignee sells the assets and remits the proceeds to the seller’s creditors.

In the case of 363, the dealmakers in the M&A transaction arrive at a pre-determined price for purchasing the company. Next, they take the deal to the bankruptcy court for approval, and the closing proceeds under the court’s supervision.

The key advantage to these strategies for acquiring or selling distressed businesses is that buyers can complete the deal with clear titles. They need not worry about the risk of liabilities or liens that might arise later.

The Takeaway!

Purchasing a distressed company and turning it around can be an attractive proposition for acquirers and investors. However, such transactions typically occur when the buyer hopes to extract adequate value from the deal for the transaction to make sense financially.

By deploying these strategies, buyers can streamline the purchase and profit from the deal.

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