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How to buy a distressed business

Comet store

After a half-decade of the direst economic turbulence since the 1930s there are plenty of distressed businesses whose owners are keen to offload as soon as possible.

As ever in business, the woes of some protagonists create opportunities for others. With credit still scarce and countless businesses struggling to sustain cash flow, there has hardly been a better time to secure some distressed businesses at a knockdown price.

Adverse trading conditions have endured for so long that even some of the deepest financial reserves have been exhausted. 

These tips should be particularly useful for anyone in the construction, retail and healthcare services which have high rates of distressed businesses. These sectors "have seen a lot of accelerated M&A, although distressed purchases are taking place across all sectors," according to Grant Thornton, one of the world's leading organisations of independent assurance, tax and advisory firms. 

Buying a distressed business poses a different, more complex set of challenges than a regular acquisition, so these tips are invaluable.

Can you turn the business around? You can't determine whether you have the skills necessary to steer the business out of its tailspin until you understand the cause of its decline.

When buying a business's non-core assets, the process can be fairly straightforward and the selling business may well want to accelerate the sale

From an article by Grant Thornton

It could be a tired brand, incompetent management or simply the fact that it's selling a product or service demand for which is in seemingly inexorable decline - DVD retail for example. 

You need to assess whether you have the right skills and experience for the task ahead and how much it will cost to make the changes necessary to spark a recovery in the business's performance.

The seller's identity has a great bearing on a prospective deal's complexity. "Many distressed businesses will be owned by a bank, or a bank will be the key stakeholder driving the sale," says Grant Thornton. "When buying a business's non-core assets, the process can be fairly straightforward and the selling business may well want to accelerate the sale. 

"When buying a whole entity where the bank is effectively the owner, the process can be longer and more complicated, however. Banks will likely have different priorities from those of corporate sellers, and it may even be that a distressed company is being sold by a syndicate of banks, which will add complexity."

Sellers rarely divulge a full, accurate picture of their business's situation. It's therefore crucial to agree on a decent period of due diligence to give you time to adjust your offer downwards as problems come to light. 

However, Grant Thornton points out that "sellers won't always go for the highest offer.

"If, for example, the enterprise value is likely to break in the bank debt (so the bank is the beneficiary of any consideration) and there are two offers on the table, of which one is higher value but has a deferred element (meaning the bank will have to stay in the game for a few years to realise that benefit), then it may well opt for the lower, more secure offer."

Convincing a bank that you can resuscitate an ailing business is naturally a bigger challenge than persuading it to loan you money to acquire a business which is already profitable.

"Getting funding in place before making an offer will help your purchase because sellers like certainty," suggest Grant Thornton. 

Many an acquisition has stung buyers whose expectation that the previous management will advise offer advice post-sale is wrong.  

The sudden, unexpected departure of the old management team can have a disastrous impact on relationships with key customers or suppliers. Already distressed, it won't take much to send your acquisition into liquidation. 

"Check carefully any such agreements and consider how you will incentivise management to work with you towards future success," advises Grant Thornton.

"Similarly, if you are looking to replace a management team with one of your own, you may want to make sure that the removal of the existing team is appropriately taken care of, and that redundancy terms and costs are clearly dealt with in your offer. This area can give rise to costly mistakes."

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