It is possible to obtain a cost-effective exit route which achieves a strong return to stakeholders by disposing of a distressed business by selling it.
Not all businesses are the huge success that owners expect them to be.
Entrepreneurs are risk takers, and the nature of business is that not every venture will take off. There are many reasons that a business might run out of cash. When the ship shows signs of sinking, the key priority is to return as much value to the stakeholders – who might be shareholders or creditors of the company
Maximising the sale value is of course a top priority for the seller, but may be counterbalanced by other constraints, such as the need to sell the business quickly. Both buyer and seller will try to leverage the situation to their advantage, whether negotiating the price up or down. The transaction often needs to be handled and managed carefully and within extremely tight time constraints.
Tactics, risks and opportunities of a distressed sale of a business
Handling a distressed sale or purchase takes tactical skill and expertise. This is not a standard sale and purchase transaction. On top of the key elements of a standard corporate deal, other considerations can significantly impact and influence the course of the deal.
Timing and transition
Time is always of the essence. With a distressed sale there is a finite amount of time before the cash runs out. You have limited time –perhaps weeks or even days – to complete the sale. In less pressured deal, the extra time enables the seller to ‘look under the hood’, discover any issues early on, and resolve them – a luxury that might not be available in a distressed sale
Where there is a tight time frame, buyers are not always able to get the man power ready to support the target company. A common problem area is finding the right IT service provider to support the target company.
A delay can completely change the structure of the deal. For instance, a deal to sell the shares of a distressed company might turn into an asset sale where the business (or some part of it) is sold and the liabilities are left behind.
Solvent vs Insolvent
The value that can be realised is largely dependent on whether the company is solvent or insolvent at the time of sale. A solvent sale will often generate value through the sale of shares whereas the sale of an insolvent business is normally on an asset basis and will follow a formal insolvency process.
Selling a solvent business
If the business is not yet insolvent, but in financial distress, the key is to act fast. When companies are on a knife-edge, the directors will be battling to keep the company afloat while preparing the company to come under the microscope of potential buyers. Getting a company’s affairs in order for a buyer to identify the value of the company suffering financial distress is the biggest of challenges.
Our team understands both businesses and buyers. It is important to be prepared. Key considerations include:
- What’s the story? Demonstrate the business model and an attractive turnaround recovery strategy and/or restructure.
- Forecast the finances – diminishing cash reserves need to be controlled carefully.
- The management team – the ‘team’ must be in it together and prepared to see it through.
- Management of employees – due consideration must be given to employees, particularly to avoid being inundated with complaints or TUPE issues.
The economic climate is shifting. We are seeing a rise in flourishing businesses mopping up distressed businesses, often at prices that would have been impossible in previous years. The key is to address concerns early and find the root cause of issues. A quick sale can salvage a company.
Selling an insolvent business
A buyer of an insolvent business generally has the bargaining power and the deal will normally be an asset purchase. This enables the buyer to mitigate its risk and leave behind certain liabilities.
The critical elements are knowing what you are buying (buyer beware) and speed. Put simply, make sure due care is taken to ensure the buyer is clear on exactly what is being purchased. Completion can normally happen in a number of days when the sale is organised.
There is little security in actions against a seller where an asset is not fit for purpose, for breach of a warranty, or for reducing the price. Risks can materialise when physical due diligence is taking place and matters that cannot be neglected which could cause a dispute are:
- The risk of employee liabilities being transferred;
- The right to occupy property;
- Obtaining relevant licences and permits to enable the quick continuation of trade after completing; and
- The correct transfer of contracts.
- There are many competing factors and having the right experienced guidance is essential.
Warranties, indemnities and Warranty & Indemnity Insurance
As with any sale or purchase of a business, there is always a focus on due diligence. However, given the tight constraints of a distressed sale, there is often much less time to allocate to a due diligence exercise. This does not mean that a prospective buyer should not still be aware of what they are buying.
In a distressed sale situation, warranties are unlikely to be available to cover gaps in the information or due diligence. Therefore, the buyer may not be able to insist upon the warranties and indemnities that would ordinarily form part of a share or asset sale. This makes negotiating the terms of sale a far quicker exercise.
An option is to obtain warranty and indemnity insurance in order to afford the buyer a greater degree of protection and security. This type of insurance is limited by the level of liability and what the areas of known risk are.
Legal aspects for buyers and sellers
We appreciate and understand there are different objectives when acting for a seller or buyer of a business.
When we act for a buyer, we know to use tactics to help drive down the purchase price and mitigate risks. Our team are eagle-eyed and actively identify high risk or problem areas to help negotiate the best possible outcome for a buyer. A buyer has the bargaining power and we have the ability to utilise this in the best possible way.
When we act for a seller, it is important to seek out and resolve the issues early so that problems do not come out of the woodwork, therefore reducing the amount you can realise. There are many competing objectives that need to be managed carefully, including creditors, stakeholders and the cash (if any) in the bank. Confronting potential problem areas is not a pleasant experience for the management team, but we work closely to support the business to achieve the best possible outcome.
Whether it is maximising the value for the seller or minimising risk for the buyer, we work with and understand both ends of the spectrum. We have an accomplished and experienced team ready to go.
A distressed sale often produces a number of unexpected issues. The pressure is always on and we have an expert team who can strategise and tactfully structure the deal quickly and smoothly. Call our team on 0207 438 1060.
Catherine is well known for turning complex problems into solutions. No case is ever easy but she will find a way. In her spare time she runs Gannons a very successful law firm.