Distressed companies for sale: weighing opportunities and risks

While the United States has experienced a strong economy for most of the past decade, companies and investors who have bought companies have focused on improving already successful companies. As the economy slows and companies suffer from persistent inflation, higher interest rates, supply chain issues, labor shortages and the end of pandemic-related aid (among other factors), many struggling companies will look for buyers or new investors. Private equity firms and companies with access to capital can acquire distressed companies at a discount, with the ability to transform their target companies into successful companies as a new platform or to enhance their current operations (as an add-on, bold-on or tuck- in acquisition). But these situations also present unique challenges that must be considered.

With a good understanding of the due diligence process, the right strategies and tactics to execute the transaction, and experienced advisors involved throughout the process, buying a distressed business can be a very successful endeavor.

The Challenge of Due Diligence

There are reasons why the target company is in distress and some of them create challenges in conducting the due diligence. One cause – or symptom – of stress is the victim’s poor financial, business, and legal records. Many buyers evaluating difficult situations become frustrated and choose not to bid if they cannot verify every number or contract as they would in a traditional full due diligence process. To avoid this problem, potential investors (regardless of whether it is a private equity firm or otherwise) should try to use their extensive network by consulting industry experts, financial advisors and legal advisors who know and help the market able to assess the financial and legal risks involved in purchasing the distressed company. Successful buyers of distressed assets focus on identifying risks, assessing the risks identified and working with specialists to redesign the business after removing the liabilities and other roadblocks that prevent the business from being successful.

Assess the situation and implement it with the right strategies and tactics

A potential buyer must not only familiarize themselves with their understanding of the business, but also focus on making sure their new investment isn’t burdened with the liabilities and other issues of the ailing company. There are a number of different formal and informal processes that the buyer can use to address this. Distressed assets may be acquired without formal proceeding, or they could be acquired through an Article 9 foreclosure proceeding, receivership, assignment for the benefit of creditors or other state or federal bankruptcy proceeding. Think of these as tools to effect the purchase of a distressed business, each with their own pros and cons. The right tool for the job depends on the situation. After analyzing the situation and working with advisors to review the various legal processes available, the investor can then decide which company is best to acquire at the best price. With proper planning, the distressed business can be acquired free of liens, claims, and other encumbrances on the assets from most creditors.

Before purchasing a distressed company, operational and other business risks must be considered. Troubled companies may have weak supplier relationships due to late payments or other issues. Likewise, customer relationships can suffer if the distressed company has not delivered as promised. In addition, management and employees are likely to feel stressed themselves about having to work for an employer that is in financial or operational distress. It is important that potential buyers and investors take these concerns into account. At the same time, there are ways to create an operational plan and communications strategy that proactively addresses these issues and positions the buyer or investor as a savior.

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