Buying a Distressed Business

As briefly mentioned in last month’s newsletter, this month we look at the opportunities that arise from buying a distressed business. Chris McKay, a Chartered Accountant, licensed insolvency practitioner and an Associate at McTear Williams & Wood, highlights the elements to consider before taking the plunge…

The current economic climate has produced more opportunities to buy on the cheap. But buying a distressed business is not for the faint hearted and should be approached with care. This brief article sets out some common themes from the perspective of an insolvency practitioner.

What constitutes a distressed business and where do you find them?

A distressed business is a business that cannot pay creditors as they fall due. Usually there is something fundamentally wrong with the business and as a potential buyer you need to know what that is and more importantly how can you fix it.

So the first question you should ask is, “Why I should want to buy a distressed business?” It is not always a get rich quick scheme. The purchase will require cash up front and a lot of effort in the early days to turn it around. Yes, the purchase price might be cheap but think about why. Industry expertise can be key. You need to understand the business and the market and have a clear plan.

Identifying business opportunities

Knowing your industry, your competitors and their financial position is the best way to identify targets. With luck you will be able to spot businesses in trouble before it becomes too obvious to the outside world and be in pole position when it comes to the deal. Alternatively sites such as www.ip-bid.com allow you to register your interest and will match you up to opportunities which are posted by insolvency practitioners. It helps to develop relationships with local insolvency practitioners who see opportunities all the time.

Understand what is for sale – assets vs share purchase

Sometimes the legal structure of the business is key – and it may be necessary to retain the legal entity. To most this is not an attractive prospect and they prefer to buy just the good bits: the business and the assets.

Issues that could derail the purchase

These could include employees claims under TUPE. What are you buying – check that the contracts that you think you are buying are included in the price and that they are properly transferred. Tax losses are not normally transferable from an insolvent company. Don’t expect an administrator or liquidator to offer any warranties – they never will. Do your own research. There will not be time for much due diligence but make sure that you understand the risks.

Consideration and timing

The importance of price cannot be overstated. Normally an administrator will not name an asking price but will look for best offers. Base the price on the value of the assets and expect to pay for goodwill – even if you think there is none. An administrator is normally looking for the best price and often has a number of interested parties, including the current management team. Beware if you are bidding against them – they will know more than you about the real value of the assets to the business.

If you intend to bring the management team on board they will be able to give you the best idea of price. Try to get an independent value of the assets. For an administrator – cash is king. Usually most of the sale price will need to be paid up front – if you want deferred terms expect to pay more. Sometimes an earn out is possible but it will need to be worth waiting for and have a reasonably good prospect of being paid.

Speed is of the essence. Often deals are completed in a matter of days. Use this to your advantage to negotiate a lower price. You will never have enough time to do all the due diligence that you would like to. Factor risk into a lower price.

Pre-packs vs short term trading and then a sale

Pre-packs are fashionable these days. The advantage of a pre-pack for a buyer is that you can often be ahead of the game and not face any competition. On the other hand the market value is untested and to cover themselves administrators are likely to demand a premium price. That premium is likely to be worthwhile if you assess that there is a high risk of a reduction in the value of the business from going through an administration.

Alternatively, an administrator can trade the business during the short term while he looks for a buyer. This is only possible where there are funds available to do so. By marketing the business the administrator ensures that he is achieving the market price. But for a prospective buyer this could mean that there is more competition for the business and hence a higher price will be needed to secure the deal.

Summary

There are good opportunities out there but always understand the risk and take advice early.

 
The information provided in this report is of a general nature and should not be relied upon in specific circumstances. Always take your own independent legal or other professional advice.
© McTear Williams and Wood 2009