Find Opportunity in Distress
February 10, 2010
The current economic turmoil is giving businesses more opportunities to benefit from competitors and vendors financial troubles, but there are also increased risks. When you venture into this Wild West of distressed asset acquisitions, you need guides who know how to navigate this complex territory. In the world of distressed asset acquisitions, deals close in days and transactions that would typically include 60 pages of documentation are sealed with something much less.
It's important to know your exposures and liabilities," says Steve Roemer, president and CEO of Solid Asset Solutions, LLC.Steven M. Weiss, a partner in the Corporate Practice Group and the Restructuring & Insolvency Service Group at Levenfeld Pearlstein, LLC, adds, "If you do everything the conventional way, deals just can't be done with speed, and you won't be seen as an experienced buyer."
Smart Business spoke with Roemer and Weiss about how to prepare for the unique challenges of distressed asset acquisitions so you don't end up with no deal, or, worse, a bad deal.
What are the biggest mistakes businesses make in distressed asset acquisitions?
Worst case scenario: Choosing the wrong structure. Take, for example, the story of an inexperienced buyer who went into a deal with inexperienced counsel. They started with a seller-financed deal that had great potential. But because of their mutual inexperience, they chose the wrong structure (an equity purchase agreement instead of an asset purchase agreement) and unknowingly exposed the buyer to assuming liabilities that were not contemplated by the deal. As a result, each month the buyer had a costly reminder of the mistake when he had to fulfill the lease obligation for a building the company didn't occupy. If the deal had simply had a different structure, the buyer never would have assumed that liability.
Are there times when companies should consider a joint bid with another firm?
There are times when finding a partner for the deal may help get the transaction done and also reduce risk. For example, if both inventory assets and intellectual property assets are for sale, the seller may view a bid for both more favorably than a higher bid for a single asset class. So to be the winning bidder, you may need to partner with a firm interested in buying another portion of the assets. When joint bidding occurs in a conventional transaction, the two companies negotiate a joint venture agreement and generally form a new legal entity for the purpose of the transaction. But when two parties approach a joint bid in a distressed situation, standard operating procedures often change. Often the joint venture consists of nothing more than a general partnership (with no state law charter and liability protection) and a short-form partnership agreement.
What financial preparation can help prevent you from losing a deal?
If you have a successful bid, you may need to fund the entire purchase price in cash within days. That means that prior to the deal, you need to prove financial wherewithal and make sure the funds are available for immediate transfer. If you don't, you could lose the opportunity.
Why is due diligence so critical, yet so difficult, to conduct in distressed asset acquisitions?
When a company faces dire financial difficulties, it can overlook the proper maintenance and safeguarding of assets, or, worse, internal problems can lead to fraudulent activity. During the due diligence process, buyers or their representatives need to scrutinize the book values and make sure they feel extremely comfortable with the assets to be purchased. In almost all of these deals, all sales are final. That means no practical recourse for post-closing issues, whether in the form of indemnification, set-off or otherwise. Due diligence in these situations requires special agility, skill and resources. Buyers can make due diligence requests with extensive checklists and hope that the seller will provide them with meaningful information.But buyers can't guarantee that sellers will respond, particularly on such a compressed time frame. We always recommend you contact your legal and financial advisers as early in the process as possible. Your advisers need some lead time to order and analyze searches on UCC filings, tax liens, pending litigation and the like. If the seller is in bankruptcy, counsel must review the bankruptcy docket and relevant filings and understand the procedures of the applicable bankruptcy court.
What should happen immediately following the purchase?
If you don't safeguard your investment, it could disappear. Make quick arrangements for the shipment and storage of assets – this helps ensure that you receive the full value of what you bought instead of items disappearing through the back door. In liquidations, you may need to vacate a leased facility within a short time frame. Make sure you can meet those deadlines or work out an arrangement with the landlord to avoid hefty per diem penalties or disputes. When possible, put a 24/7 security service on the premises after you complete the transaction. In a distressed asset transaction, conventional deal-making protocol may not necessarily get the deal done. However, buyers who can act swiftly and intelligently in this opportunistic context can reap significant rewards. With the right advisers, those who understand the nuances of this market, you can turn other businesses' losses into gains for your business.