Acquiring a Distressed Business May Be a Bargain but Beware Pitfalls
Hospitality Partners Association
Financial Services, Hospitality, Immigration Advice
The ongoing global economic turmoil has resulted in a deluge of distressed companies available at bargain deals. While these deals provide the opportunity to generate value, they can be risky as buyers overlook important objectives in favour of the attractive low price of the target company.
In addition to financial due diligence, which is as important in a distressed transaction as a healthy deal, the following areas require particular focus.
Many types of distressed transactions permit the buyer to leave working capital liabilities with the old entity and start afresh. From a valuation perspective this means that the company can generate profit from its inventory on hand and simultaneously continue buying new material on credit.
Therefore, relationships with suppliers need to be addressed upfront as any disruption can raise costs exorbitantly.
In any business, customers are the most important asset. In distressed situations, customer relationships may be strained as a result of supply disruptions or negative public perception. Therefore while not easy, evaluating customer relationships is critical. The buyer needs to take prompt action to amend customer concerns.
In some cases the relationship can be recovered simply by providing assurance that the business will be properly managed and capable of meeting expectations going forward. However, repairing the company’s image following negative publicity surrounding financial distress may require greater assurance to regain customers’ loyalty.
Management / Ownership
In many mid-sized companies, the shareholders also manage the business and are critical to the day-to-day operations of the business. In a typical deal, the buyer structures the purchase to retain necessary management, including the selling shareholder, for a period of time. Doing so ensures continuity of management and minimises business disruption.
However, retaining senior management in a distressed transaction is often not viable— whether out of concern for past performance or because of the nature of the transaction. It is therefore important to identify either an external management team familiar with that type of business or junior managers capable of taking over operational control. Both options introduce an added dimension of risk.
Most importantly, employees form the backbone of any successful business. Often, employee morale is low in a distressed business resulting from forgone pay raises, or caused by work load stress due to hiring freezes and loss of confidence in senior leadership.
A buyer must be aware of the employee situation at the target company as there might be a need to budget for immediate steps to address. These costs need to be considered as part of the evaluation process. Furthermore, a buyer needs to expect some attrition and plan accordingly.
Losing sight of your objectives when buying a distressed business can be costly. If a target company does not meet specific acquisition objectives, chances are it will underperform and potentially steal management attention from the core business.
Retaining knowledgeable advisors is highly recommended and provides the acquirer with the greatest chance at success, by preparing upfront and retaining proper counsel.
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