Businesses can get into distress for many different reasons; poor management or the loss of key contracts to name just two. Just because a business is in distress, it doesn’t mean it should be avoided as a potential acquisition. In fact, businesses in distress can sometimes represent a good opportunity.
When buying a business in distress, the two most common options are either to buy the assets, often from an insolvency practitioner, or to purchase the shares of the company.
Here are some of the key factors to consider for both.
Buying the Assets
In addition to the physical assets of a business, there are also the non-physical assets for which a value will usually be attributed. These include the ‘goodwill’ of the business, ie. its name and reputation, along with existing clients / customer database.
When going down the route of purchasing a distressed business’ assets, time is usually of the essence and deals can often be completed in a matter of days. As a result, it is unlikely that there will be sufficient time to carry out all the due diligence that would normally be conducted. Where a business has been in distress for a while, other things may have been overlooked or allowed to slide; such as the state of repair of the physical assets.
It would be sensible to budget for a full audit post-completion, including the costs involved to rectify any issues.
Purchasing the shares
Where a business still has an intrinsic value, the owners will likely want to sell the equity. Going down this route can take longer, and it is also worth bearing in mind that there will usually be greater tax implications. Where a business is still operating, executing a purchase means you will also inherit any existing liabilities of the business, such as any outstanding debts or claims being made against the company. Despite these factors, some deals may be worth pursuing, particularly if the distressed business is a competitor you are looking to take out of the market or a cog in the supply chain of another business you own.
When buying the shares of a business as an ongoing concern, this will usually be as a pre-cursor to insolvency and the completion of the deal will prevent it going officially insolvent. Timeframes may therefore be tighter than buying a business under normal circumstances, which again places a limit on the due diligence that can be undertaken. Although you should be wary of any ‘bargain basement’ businesses (if it’s too good to be true, it usually is), there may well be good room for negotiation, especially bearing in mind the risk associated with an expedited purchase.
Other factors to consider
Owner managed businesses will usually have been built around that individual and they may have had certain skills pertaining to the nature of the business. Where the owner-manager is no longer in the picture, these skills will be lost and it may be necessary to recruit an individual with a particular set of skills or knowledge to take over.
Customers may have been loyal to the business owner and not the business, so the ability to retain customers under new management may also need to be borne in mind.
Buying a business that is in distress clearly carries a degree of risk. The purchase of a struggling business should only be undertaken if you understand exactly why the business is currently in trouble and you have a clear strategy on how to turn it around.
Each situation is different and it is down to smart negotiation and good advice on structuring any deal.
For further advice in relation to buying a business in distress or out of administration, contact James O’Donnell.