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Issues with selling and buying distressed businesses

As insolvency practitioners, we are regularly engaged in the process of selling businesses, but the process of selling a business in a distressed situation is quite different from what would normally be the process in a traditional business sale (M&A type) transaction.

In order to highlight some of the difficulties and issues faced in selling a distressed business from both the vendor and purchaser perspectives, we have created this newsletter.

The following factors create uniqueness in the manner a business is sold when it is in a distressed situation and the factors that impact upon price.

• Firstly, the management of the vendor are often in a distressed state and is often not able to, or are less willing to, assist in the manner that they would in a traditional business sale.

• Aligned to this, businesses that are failing, or in decline, traditionally do not have accurately maintained books and records, and the reliability with which vendor documents can be presented to purchases is reduced, transferring risk from the vendor to the purchaser.

• Distressed sales are often conducted in a time-compressed manner. That is, if you are appointed to a loss-making business that needs to be traded in order to be sold as a going concern, every day of ongoing trade is increasing losses and reducing the ultimate financial returns, and therefore a balance needs to be struck between value and speed. You will find that most distressed sales are completed over a timeframe of approx. 3 months.

• In addition, there are stakeholder pressures that influence the need to complete a sale with speed. Creditor stakeholders are looking for financial returns in situations where losses are likely, leading to time horizons more in the line of 3 months rather than what might be 6 to 12 months in a traditional sales transaction.

• Most traditional sales of businesses will be based upon a value that is created from a multiple of EBIT. In distressed sales, often the vendor has not been generating an EBIT, or the EBIT has been trending in a downward path, and as a result valuation models traditionally considered in M&A style transactions are replaced by a value akin to an “orderly liquidation value”, which is closely associated with the value of the physical assets.

• A lack of clear understanding of the laws prevailing for businesses sold in insolvency scenarios often results in vendors presenting businesses to be sold to purchasers who have different expectations of outcomes. For example, negotiating the terms of a business sale agreement containing extensive warranties that a purchaser would normally want in a traditional M&A transaction is fruitless, given the vendor does not have the financial capacity to honour any warranties that are being negotiated.

• An understanding from the purchaser’s perspective that the vendor is looking for a sale completed with speed, will help the purchaser place themselves in a better negotiating position. As a result, approaching negotiations with simplicity, speed and efficiency in mind will make the transaction easier to complete from the vendors perspective.

• Buyers often seek extended periods of due diligence to seek to understand the reasons for the failure of the business.  Understanding that speed of transaction is attractive, that the underlying reliability of the books and records cannot be assured, and that warranties cannot be given (or are valueless), suggests that the experienced purchaser will spend their time in due diligence considering how they can turn the business around rather than hours spent trying to analyse the reasons for business failure.

We hope that the above discussion helps set out some factors that impact upon the manner in which businesses are sold in a distressed situation, and the inevitable consequence of that on price.

That said, being experienced in selling businesses and having a clear understanding of the issues from both the vendor and purchaser perspective helps negotiations being conducted efficiently, preventing decision paralysis and promoting productive negotiation. As a result, selecting a practitioner who can demonstrate these attributes should be important to the directors and key stakeholders when selecting a proposed appointee.

Should you have questions with respect to the above, please feel free to contact us.