A threat to one company can be an opportunity for another. How can you turn a crisis for someone else into profitable growth for you and your stakeholders?
In this article Ken Titchen looks at how to buy an insolvent business from administrators.
An introduction to buying a distressed business
When a company is distressed, one of the options its directors are rightly advised to explore is a sale of the business. That provides an opportunity for a financial or trade buyer to acquire the business at a lower price than would otherwise be demanded, with a view to restoring it to profit as a streamlined and reinvigorated entity. A financial buyer may wish to add to its portfolio and rely on its restructuring skills and experience to turn the business around. A trade buyer may want to move into new markets, or remove a competitor and take over its key customers, or simply aim to boost turnover and profit by applying economies of scale.
So what is the process of buying a distressed or insolvent business, and how does it differ from a solvent merger and acquisition?
What is an accelerated merger and acquisition process?
As the buyer, you are likely to be involved in an accelerated merger and acquisition process. Usually the board of the distressed company will have already attempted to restructure the business and reduce costs, often with some financial support from its existing lenders and other stakeholders. Yet still the company’s 12 week rolling cash flow forecast may show a deficit looming, perhaps when a VAT or rent payment is due, and time is usually short to achieve a sale before the company runs out of cash.
The board is likely to have instructed specialist corporate finance and insolvency advisors to assist it to explore options for the business in a short period of time. The advisory team, working with the directors, will send out a teaser document to potentially interested financial and trade parties, and that may be the first you learn of the opportunity. The teaser will give high level information about the company without disclosing its identity, and interested parties will be invited to sign a non-disclosure (or confidentiality) agreement (NDA) before being provided with more detailed, sensitive, information about the company that is for sale.
Interested parties are given access to a data room, and must usually make indicative offers within a short timescale, with those making the most compelling proposals taken through to the next stage. As one of the preferred potential buyers you will be provided with access to management teams as you continue your due diligence, and will quickly be asked to make your best and final offer, with proof of funding, to the advisory team. The final deal structure will be determined and the successful bidder will move to negotiation of the transaction documents and completion. Remember this is all happening over a period of, usually, 6-8 weeks and you need to move quickly and devote the time and resources needed to complete the due diligence and deal negotiation on time.
If shares are acquired, the buyer of the insolvent business may need to look at a company voluntary arrangement or restructuring plan after completion to deal with the company’s historic liabilities. Therefore the most frequently used form of transaction for the sale of a distressed or insolvent business is via a pre-pack administration, and that is what we will focus on.
What to consider when buying an insolvent business from administrators
In a pre-pack administration, negotiations are carried out with the proposed administrators before they are in office, and if a new bidder comes in at any stage before completion with a better, deliverable proposal the administrators in waiting will consider it. There is no certainty of completing a transaction until the deal approaches completion and the administrators are ready to be appointed.
Click here to read more about pre-pack administrations.
The proposed administrators will want to see proof of funding at an early stage, and will prefer an offer where the purchase price is paid on completion rather than on a deferred basis. Funding may come from your own resources, from your existing high street or other mainstream lender(s), or from a specialist funder who only invests in, or provides funding for, the purchase of distressed businesses. Funding may be a mixture of equity, debt and/or asset-based lending depending on the nature of the business and the assets to be acquired, and will invariably be secured on the buyer and (as the buyer is often a newly incorporated company) supported by guarantees from group companies and directors. The key point is that funding needs to be available quickly.
The sale agreement will look different to M&A contracts you may be used to. Administrators will not accept any personal liability, and the seller will not give any of the usual reps and warranties, including as to title. If a third-party owner claims title to assets the seller will have to deliver them up with no reduction in purchase price. The buyer will be required to give indemnities to the administrators in respect of any liabilities they incur as a result of the sale. These are all points administrators will not concede in negotiations.
What risks should be considered when buying an insolvent business?
Employees
You must make sure your due diligence establishes the quantum of employee liabilities you are taking on. Employees who work in the insolvent business prior to completion will transfer to the buyer under the Transfer of Undertaking (Protection of Employment) Regulations 2006 (TUPE) (as they continue to apply after Brexit). If you want to make employees redundant as part of the deal the redundancy costs will fall on you. You will want to consult with staff on the business, the transfer and on redundancies, whereas the directors of the seller will be concerned about you destabilising their workforce. Often TUPE liabilities and risk are a key negotiating point on price, with the buyer looking to reduce the headline figure by the amount of the TUPE liabilities they may incur.
Suppliers
Stock you believe you are buying may be subject to retention of title claims, and you should look for this as part of your due diligence. You also need to think about where future stock will come from. A trade buyer may have its own supply chain that it can bring in but if you are relying on the seller’s suppliers you may have to make ransom payments and clear the seller’s arrears to be taken off stop.
Click here to read more about retention of title claims.
Property
The seller is likely to operate out of leased premises. The administrators can grant a licence to occupy that allows you to continue trading from the same premises for a short period, usually three months, on the basis that you pay rent accruing during the licence period. This gives you time to either agree terms with the landlord to take over the lease or to move the business into other premises. The landlord may demand payment of the seller’s rent arrears before it will agree to assign the lease to you.
Key contracts
Important contracts may terminate on administration of the seller, or the counter-party may not agree to assign or novate contracts to the buyer. You need to review this as part of your due diligence, including software and other licences.
Intellectual property and trade marks
You must confirm whether important intellectual property rights and trade marks are assets of the seller. They are often held by, or registered in, the name of a parent or group company and you must make sure there is an agreed mechanism for them to be assigned to the buyer.
Accruals and pre-payments
It is important that your due diligence identifies accruals and pre-payments. If a customer has paid in advance for goods or services you will want that payment transferred to the buyer if it is going to fulfil the order.
Transitional Services Agreement
You will need to think about how you are going to operate the business on day 1. You need to work out what practical support you may need to trade in the short term and agree with the administrators how the seller or its group can continue to provide those services until you can make your own provision. Merchant services are a typical example.
Book debts
The administrators are unlikely to sell the book debts to you but they may agree you can collect them. This avoids the risk of aggressive recovery action being taken against your new customers.
Name
Do you want to acquire and continue to use the same business name? If the distressed business is only one division of the seller’s group this might not be possible, and you must consider how much of the goodwill you are paying for is attached to the name. If the buyer is a company owned or run by the directors or management team of the seller, or if you wish to employ all or some of them in senior positions, you will need to think about the pre-pack regulations and restrictions on the use of a prohibited name.
What are the benefits to buying an insolvent business?
Despite the risks highlighted above, there may be fierce competition to buy a distressed business. They can provide experienced and well-advised buyers with the opportunity to acquire a sound, profitable business that exists within a distressed company for a keen price. When assets are acquired rather than shares:
- The buyer can cherry pick what it wants and leave behind assets that may be causing the distress, for example unwanted leasehold premises.
- The business can be restructured financially on completion. Save for any ‘ransom’ payments made for commercial reasons, all debts (save for employee and, in some instances pension obligations) are left behind.
- The business can be restructured operationally on completion. It is an opportunity to move forward from day 1 with a new management team and a lower cost base.
Buyer beware, yes, but don’t be put off from buying an insolvent business. Our Restructuring Advisory team frequently work with other advisors to distressed companies on accelerated sale processes. We can guide you through the process from start to finish to help maximise the opportunity presented to you. Please contact us if you would like to discuss any aspect of this article or series.