10 tips to consider in buying out distressed companies

22.12.2009

Toomas Prangli
Partner
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The global financial crisis is gaining strength and digging its claws deeper into other areas of the economy.

The effects are that many companies now face complex situations which are very difficult to cope with alone. On the other hand, sophisticated investors now have the chance to exploit the situation and acquire new companies at a discount.

For strategic investors, economic downturn is the right time to reinforce their market positions by winning competitors, clients and/or suppliers.

Naturally, investing in distressed companies involves significant risks, which may, however, turnout to yield substantial returns and successful results. The risks of investing into distressed companies are very much firm specific and each transaction has its own unique subtleties.  Below is a list of important tips to consider in acquiring distressed companies:

1. Investing in distressed companies requires a high degree of specialist knowledge and skill relating to management, investing, law, etc. Select your team members carefully keeping in mind the areas where you lack the required skills and knowledge.

2. Attain sufficient control over the company to reorganise it efficiently. Sufficient control may involve debt buyout, acquisition of qualified majority (preferably more than ¾), or other aspects.

3. Given that the new Estonian reorganisation act has not yet entered into force, it is important to reach an agreement with the rest of the key creditors as early as possible. Currently, any creditor may file a bankruptcy petition against a distressed company. The new reorganisation act, giving debtors additional measures (including stay of collection attempts) to reorganise the business and restore the company to health and then prosperity as an alternative to bankruptcy, has passed the first reading at the Estonian Parliament.

4. The timing of the transaction is of paramount importance. Wait for the right moment to gain control and then act quickly to complete the transaction and implement the reorganisation.

5. Consider the claw-back risk. The company may still become bankrupt at a later stage and under the bankruptcy act the court may declare transactions completed prior to the bankruptcy void if the transactions impaired the interests of the other creditors.

6. Be selective in buying distressed companies. Ensure that the value of the company is retained. Strategic investors need to consider if synergies exist and capitalise them.

7. Cooperate with the management of the company. However, avoid failures of the existing management and if necessary replace the management. Managers with reorganisation experience can bring new life to the company.

8. Conduct a thorough due diligence. Often a company's deficiencies and risks are much higher than the management acknowledges. Keep in mind that with distressed debt buyouts, the time for financial, legal, economic and other due diligence reviews is reduced to 1-2 weeks instead of the typical 1-3 months.

9. Keep a clear head and be ready to withdraw from the transaction at any time. The fact that you have already incurred costs in connection with a transaction is not an argument to continue with it if the transaction has no potential.  The same applies to the acquirer's ego.

10. Use experienced advisors. Complex, intensive and prompt transactions leave no room for trial and error or correction of mistakes.

For distressed companies, such acquisitions may be an efficient way to involve necessary capital. However, this is not the only approach available, and both the sellers and the management of the company should consider other alternatives to overcome their difficulties. Nonetheless, if a decision is made to sell a distressed company, all the parties must be dedicated to cooperation.

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