Buying A Business In Distress
It can be difficult enough to raise business purchase financing to buy a healthy business with good prospects
. So why why might you or a distressed equity firm want to do the opposite and buy a business in difficulty? The answer of course lies in the potential to add significant value by fixing the underlying problems.A business in distress or at a high risk of failure is unsurprisingly less valuable than a stable business with good prospects. So if you can find a business in distressed condition which is for sale; which you are then able to turn around into one with good prospects and strong growth, then you should be able to achieve a huge increase in the business's value.
Many people who believe they have the ability to turn a business around are therefore interested in finding chances to buy distressed businesses as an opportunity to make a significant capital gain.
A business in difficulty's problems may also be very obvious which can be an advantage. Furthermore, if the business is already in a formal insolvency process some of these may already be being dealt with, while the effect of washing a business through an insolvency may in practice give the buyer of such a business in much 'cleaner' and safer purchase as most liabilities will be captured in the insolvency.
Against this a business that has been in difficulty is likely to have suffered a significant worsening of its trading and strategic position during this period. Typically it will have lost or damaged its relationships with its suppliers, suffered severe problems with staff morale with the most employable seeking positions elsewhere and its reputation amongst customers and market share will have been badly hit.
Businesses in difficulty may be in one of three positions:
- in difficulty but not (yet) in a formal insolvency procedure. Of these, some businesses will be refusing to recognise that they have a problem, some of them will be being actively advised by professional advisers with a view to rescue, and some may simply be in the process of heading into insolvency;
- in a formal insolvency procedure such as a Company Voluntary Arrangement (or 'CVA') or an Administration, which is designed to allow the rescue of the business or company; or
- in a formal insolvency procedure designed to allow the business's assets to be sold off with the proceeds being distributed amongst its creditors. Examples of this type of process are a Compulsory Liquidation ordered by the court or a voluntary liquidation by the company on grounds of insolvency (a Creditor's Voluntary Liquidation or 'CVL').
Which of these categories a business falls into will have a significant impact on both how it may be sold, what will be for sale, and the risks involved in buying it.
There are a number of routes to finding a business in need of a turnaround before insolvency:
- through normal business sale adverts where the owners decide to sell up so as to get out before it's too late, although they obviously don't tend to say this in their advertising;
- actively searching for businesses in financial distress using credit checking or CCJ monitoring services or following news in the trade press about problems. Even if you can identify a business in need of a turnaround you may then have the problem of overcoming the directors' normal state of denial that there is any problem at all, and reaching a realistic business valuation;
- spotting where your suppliers or customers are getting into difficulty from changes in how they are dealings with you (but buying a customer that has failed owing you money can however be a case of sending good money after bad);
- being invited in as a turnaround executive by a bank or VC house to sort out the problems, however this requires a significant investment of time and effort in networking yourself to potential introducers;
- being contacted directly as a potential buyer for a distressed situation through having networked yourself to both the insolvency and corporate finance partners in the larger accountancy firms who will deal with such situations; or
- join a business angel network specialising in turnaround situations.
If you are considering making an investment into a distressed business in difficulty, it is critical that you look very carefully at the commitment you are making, the likelihood of the business's recovery and the impact it will have on you should the business fail. Be very careful however as business owners seeking to buy time will often look to raise injections of new cash from outsiders as part of their efforts to keep the business afloat.
When buying into a business in difficulty you should generally:
- never buy a minority stake as you will want to ensure you have control over the business and how any cash you invest will be used; and
- never take on a directorship role unless you are taking over active control of the company so as to implement your own turnaround plan.
Finally if you are looking at buying a business that is in difficulty, always consider whether you are better off waiting with a view to buying the business out of a formal insolvency. Always remember that you may have a choice if a business is unwilling to accept your offer, as you may simply be able to wait and see whether you will have an option to buy it from an IP instead out of an insolvency process.
Finally, given the level of both technical detail and risks involved in buying a business in difficulty this is an area more than any other where you will need good advisers from appropriately qualified specialists.
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