Navigating turbulence
Acquiring a target in financial distress
With slowing economic activity coupled with decade-high inflation and interest rates, and no sign of imminent improvement, increasingly companies are experiencing financial distress.
“Rescuing” a company in distress can provide opportunities for buyers to pick up assets at attractive prices. However, distressed M&A is often very different to acquiring a financially healthy business and buyers need to go into these processes with their eyes open.
Buyers of distressed assets (or from distressed sellers) will often find that they are expected to rely on a due diligence process that is limited and carried out in a compressed timescale. The speed of the sale process is driven by the distressed entity’s cash-needs and the demands and/or patience of creditors, without the protection of the customary warranties and indemnities which would be expected from a seller.
As a distressed M&A process tends to be an imperfect one, it is imperative that buyers and sellers are ready and able to act quickly.
External influences
Distressed transactions throw up a number of different challenges to those in a normal M&A scenario. Before buyers embark on the process, they need to understand the differences of approach and the drivers for the stakeholders involved.
Before buyers embark on the process, they need to understand the differences of approach and the drivers for the stakeholders involved.
The transaction timetable will be driven not by what the parties want, but by outside influences such as the distressed entity’s availability of cash to keep the business running, and the length of time creditors are prepared to wait before taking action to protect their own positions. Often the timeframes are very compressed, leaving little time for due diligence and the negotiation of contracts.
Often the timeframes are very compressed, leaving little time for due diligence and the negotiation of contracts.
Other outside influences can also affect the process and deal structure. For example, where the sale involves a transfer of employees, the relevant provisions of local laws need to be taken into account. This is particularly the case in cross-border transactions where local laws requiring employee consultation do not make exceptions for processes involving a distressed entity.
Robust due diligence
M&A usually involves a willing-buyer and a willing-seller. In a distressed scenario, it is more likely to be a forced seller. The seller is also unlikely to be around for very long after the deal, so customary warranty and indemnity protection is unlikely to be available. Buyers therefore need to rely almost entirely on their due diligence exercise and on making deductions from the price where liabilities are identified.
Buyers therefore need to rely almost entirely on their due diligence exercise and on making deductions from the price where liabilities are identified.
“Ransom creditors”
There is a view that distressed M&A can be carried out by buying a business and its assets, leaving behind unwanted liabilities. The reality is more often that there are a number of creditors, referred to as “ransom creditors”, who are key to the continuation of the business and need to be paid off if the buyer wants to continue with the target business as it was.
Avoiding insolvency
It is usually preferable to try and keep an entity out of a formal insolvency process to avoid value loss and reputational damage, including with key suppliers and customers. However, using a formal process can be beneficial in allowing the deal to be delivered safe from the threat of action from objecting creditors.
