Many people love the idea of turning around a business that is struggling or is in debt. Why is this attractive?
People often think that if a business is in trouble it is the fault of management and if they can just go in and sort it all out then they can make a fortune as the business they will buy will be cheap. They also believe that if the debt is written off in an administration then they can just take over and carry on. Whilst they are correct that often businesses do fail due to poor management it is very much more complex than this. The principal reason for the failure of companies is the lack of financial controls and poor organisation.
Many companies can downsize or shed costs quickly if the market turns against them or there is a loss of a big contract. However in order to do that you need to know the exact cash position of the business at any time and be able to adapt accordingly. This can be very difficult and requires financial skills and good information. The cleverest financial person ever cannot do their job properly if the figures are misleading or inaccurate. Poor information can be a symptom of a deep malaise in the business.
So who tends to actually buy or invest in businesses in financial distress?
Buying a business in difficulty is by its nature very risky as the business has already failed and it may well be that much that could be done at this stage has been tried and not worked, such as cut costs, diversify, change management team, rebrand, new marketing etc etc.
Generally speaking, due to the risks it tends to be large venture capital firms or so-called “vulture funds” that buy into these businesses. They will have invested in multiple companies which have issues and will hope to find a stand out performer that can pay for the other failures. Many investors will say things like “out of 10 investments 6 will fail, 2 will do OK and 1 or 2 will really fly!” The other thing that these investors have on their side is experience!
So in the first instance the advice really if you are thinking of buying a distressed business is to be prepared to lose all your money, especially if you are a first-time investor. It is important to realise that the shareholders are the last in line for any payout if the company does, in fact become insolvent.
So how do you go about finding a business that is distressed in the first place?
Ideally you need to contact a company that is in the early stage of distress as if things are left too late then there is a chance that value will be lost and creditors and suppliers will start to put too much pressure on the business.
How to get to these businesses is very difficult. In the main, it is via the old “who you know” route. Businesses that are in a bit of trouble may call in outside help such as finance experts, sales experts, or even loan providers. These people may be aware that the business owners might want to sell the business and concentrate on something else. They will then contact you if they think you could put in more cash to help the business either as an investor or a new owner.
Bear in mind that any new owner tends to need a strong track record of turnaround before any lender will be prepared to back them. In a distressed situation a lender will be looking for security and as they have the power to call in administrators then they will tend to call the shots.
Another way of contacting these businesses is once they are insolvent. At that point the company is in the hands of the administrators and one of the main aims of administration is to sell the business for the benefit of creditors. Once a company is in administration the fact is advertised in the press as required by law to ensure that it is marketed as much as possible to achieve the best price. Unfortunately though advertising the fact often ensures that customers leave and the business is put under even more pressure and value is lost altogether. In many cases it is usually sold to a connected party as they have a lower cost of acquisition and in many cases it is better the devil you know.
What do you have to look out for if you are investing in a distressed business?
Most importantly you have to ask the following questions:
- Why did it fail?
- How can the problem be fixed?
- Will all the creditors support the business going forward?
- Is the debtor book fully collectible, if not why not?
- Are the directors telling the truth about the business? (Unfortunately when a business is in distress many things are hidden from people asking questions. This can be simply be the fact that they are embarrassed about what they have done or perhaps more importantly they are desperate and don’t what to jeopardise the likelihood of someone giving them money! )
- Do the directors actually know what is going on!
- Are orders close to being finalised or are they a salesperson’s pipe dream.
- Can the costs be reduced even more without dragging down the company or people wanting to leave
- Can you work on the business without causing further delays to processes
- What is your vision for the business and does it match those already in the business from management to
- Is there a big spend that is coming up that you should be aware of like renewing equipment that has passed its warranty period or a new contract /lease that is due for renewal, a refurbishment of a showroom etc which might be expensive. Often essential spending is put off but it if the business is to continue then money will eventually have to be spent.
You need to remember the following;
If you buy the assets and goodwill of a distressed business or even one in administration you will be required to take on the contracts of all the staff under the TUPE rules. You will need to take legal advice on this aspect of EU law.
Bear in mind if the business is actually insolvent then the duties of the director’s change so you will need to be very careful if you do things like pay one creditor over another as everyone must be treated fairly. If the business is simply struggling then there is a good opportunity for a turnaround. However, once it is insolvent then you will almost certainly need to bring in other advisors such as insolvency practitioners and lawyers and time is often short.
In many instances the best way to take advantage of a business that has gone into administration is by buying their assets. It should be noted that most assets are handled by valuers and surveyors not by the insolvency practitioners themselves as they have to be seen to be getting the best price for the assets. In many cases assets are put up for auction at auction houses or online.
Images: ”A businessman’s face covered in paperwork. Business concept. /Shutterstock.com“
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