Do you see a future in a distressed business? Sarah O'Toole takes a look at what buyers need to think about when considering accelerated mergers and acquisitions (AMA) opportunities.
While the last two years have seen reduced levels of formal insolvency appointments, there's no doubt that the challenges experienced during the period have left many businesses in precarious financial positions.
Following the lifting of Covid-19 restrictions and the withdrawal of government support measures across the UK, it's likely that stakeholders looking to dispose of underperforming businesses will consider sales of shares, businesses, and assets through an accelerated disposal.
For the majority of companies facing insolvency, cashflow concerns will be the key driver. As a consequence, the immediate injection of new capital through the sale of existing businesses, or profitable elements of them, will frequently be the most attractive rescue option.
While restructuring by way of equity purchase or debt refinancing is appropriate in some instances, these types of transactions frequently require timeframes that many distressed companies simply cannot afford.
Most commonly, the purchaser will acquire the business and assets of the target company via a process referred to as a pre-pack administration. The purchaser takes on the salvageable part of the business while existing liabilities will be left with the insolvent estate to be handled by the administrator.
Distressed acquisitions often serve as a fresh start or rescue package for the target, but they also present a unique opportunity for the purchaser.
While the traditional reasons for acquiring a business may hold true, be it unlocking new markets, securing additional resource or protecting supply chain, distressed acquisitions offer two key attractions for the purchaser: value for money and speed of transaction.
When participating in a distressed AMA process potential buyers should be mindful of approaches, processes and issues which commonly arise during this type of deal.
Transaction speed and offer structure
In AMA situations cash pressures usually lead to limited timeframes for completing a transaction. As a consequence, there's unlikely to be time to undertake extensive due diligence. Any purchaser should also be prepared to accept that information from a distressed business may not be up to date and will likely be imperfect. A clear sense of the information that is essential, not just 'nice to have', is critical.
It's important to ensure the seller understands you are serious as early as possible. Distressed AMA processes can attract many parties who are chasing a bargain and sell-side advisors will seek to prioritise and deal with only a small number of serious bidders. Sell-side advisers will not spend time convincing reticent or disinterested parties to look at a purchase. If you’re after a deal, show you’re willing to work for it!
Non-disclosure agreements (NDAs) are commonplace in AMAs, particularly prior to receiving full information packs and access to detailed financial information, sites and staff. While you should always consider the details, you will have little time or scope to negotiate the NDA, and insisting on special treatment before you’ve seen detailed information will likely work against you. The best deal for a company in distress will not always be the highest offer – pragmatism, speed, structure and forethought are often just as important.
A lower offer with proof of available funds could be more attractive than higher offers without confirmation of immediately available funding. Depending upon the circumstances, it may be possible to agree deferred or ratcheted considerations, but it's important to show it's a serious offer. The seller and their advisers may also view an offer for all or most of the business more favourably than those seeking to cherry pick only the best assets.
Purchasers of distressed businesses never want to overpay and yet may not have time to obtain valuations or to do full diligence on the asset base. With this in mind, offering a deposit may, in certain circumstances, be a good way of demonstrating your intent.
Operational and financial risks
Of course, by its very nature, a distressed acquisition may carry more risk than a buyer would ordinarily deem acceptable, and an insolvent seller will not be able to offer any warranties in the event that problems arise. However, there are some common stumbling blocks to be avoided.
The business is in trouble for a reason, and while not always the case, appropriate reporting and controls may not be in place. There will inevitably be some skeletons in the closet or difficulties in the first six months of trading so a flexible response and forecasts with appropriate levels of contingency to deal with unexpected issues is vital.
You also need to beware that after you acquire a business, there are several other common issues you need to look out for.
Reputational risk
Even after a deal is done, protracted negotiation can still lead to reputational damage to the business being acquired or loss of customer trust. Rebranding may be an appropriate way to re-energise disenfranchised staff and approach the market.
Employee liabilities
There are significant protections in place to ensure employees are not prejudiced in the event of a distressed acquisition. Chief amongst these is transfer of undertakings (protection of employment) legislation which, broadly speaking, ensures that if a site or service line is acquired the staff go with it, retaining continuity of service and conditions. A potential purchaser therefore needs to be aware not just of the cost of salaries, but also any potential redundancy liabilities and benefits provision.
Post-completion funding
Cash to fund the acquisition is obviously vital, but equally important is working capital for the first few months of trade, particularly if existing credit facilities can no longer be relied upon. A full cashflow forecast for the first twelve months of trading will assist in identifying potential outlays and a provision may need to be included for additional expenses such as rental deposits, redundancy payments, rebranding costs, licences, software and Capex.
Suppliers
You also need to consider suppliers who may have suffered a loss as part of the previous company's insolvency. They may seek to impose increased pricing or impose other penalties as a condition of supply to the new company. Such costs will need to be factored in to cash flow forecasts, or alternative suppliers will need to be put in place.
Property
Leases will not generally transfer to a purchaser as part of an AMA transaction, so frequently administrators will continue the lease and offer a “licence to occupy” to the purchaser for a short period, while a new lease agreement is negotiated between the purchaser and the landlord. However, there is no guarantee or obligation for a landlord to agree to a new tenant, to offer the same terms, or even a lease at all, so contingency plans may need to be considered and early approaches to landlords are always advised.
Finally, there's no point buying a business if you don’t have the operational capacity to manage it going forward. Make sure the transition is as smooth as possible by ensuring new bank accounts are set up in advance of the purchase, any specialist operating licences have been secured (including those required for transport), regulatory matters have been considered, and the IT infrastructure is understood and fit for purpose.
While the risks discussed above are not insignificant, they are by no means insurmountable. Engaging the right advisers with experience in AMA scenarios will help to mitigate the risks and will also highlight willingness to do a deal.
To discuss a specific matter or your strategy regarding distressed acquisitions, get in touch with Jon Roden.
