Estimated reading time: 4 minutes

Punching Out! Acquiring a Distressed Company

Everyone loves a bargain. Are you looking to acquire a beat-up Pinto with four bald tires and 300,000 miles, a gently used Malibu that was recently tuned up and washed, or a brand-new Tesla? Just like buying an old car or a fixer-upper house, you can get a great deal, or sometimes you get what you pay for. Acquiring a distressed or underperforming business can be a great opportunity, or it can end up being such a bad deal that the acquiring company gets in trouble. Here are some thoughts on acquiring a distressed or underperforming business.

By distressed, we mean the company is losing money or breaking even, but still paying interest, accounts payable, and payroll. By underperforming, we mean the company is not making much profit over the owner’s market-based compensation. By seriously distressed, we mean in bankruptcy or heading into BK. Depending on the level of distress or underperformance, the company will require more radical changes and more or less scrutiny before acquiring. In some ways, acquiring a company in BK is better, but the company might be too far gone to be worth it; sometimes, it might be better to buy equipment at auction and hire any good employees.

Some of the key factors in looking at distressed acquisitions include:

• Will it cost more to fix than to buy a well-performing company?
• Did the business have bad luck, hit a one-time blip, or have something else occur that is easily fixable?
• Does it make sense to keep the business in place, or move it to the buyer’s existing facility?
• Are customers, suppliers, employees, and others still on-board, or have they started looking for alternatives?
• Is the owner realistic about the situation and willing to move quickly?
• Is the owner transparent about the issues that the company faces?
• Can the buying company support the distressed company during the acquisition and transition?

Buying a distressed company can be a great opportunity and a bargain compared to buying a well-performing company. Owners are usually flexible and willing to move quickly, and employees may be grateful that a buyer has come in to save the facility. Their customers may be loyal if they have stuck with the company during tough times and willing to look at buying more if the company gets on solid ground. It can be a great way for the buyer to expand into a new location, get new customers, and bring on trained employees.

On the other hand, what looks like a bargain can turn out to be a real mess. There may be years of catch-up investment needed. The employees may be the reason why the company got in trouble, and they may have foregone raises for years in order to help the old owner out. It may be difficult to change the culture. The company’s reputation with customers and suppliers might be terrible, and customers may already have one foot out of the door. Because time is typically limited if a company is heading down, due diligence might be rushed, and documentation can be incomplete. If the price is low, that leaves very little room for escrow or for other protection for the buyer if the situation turns out to be worse than it seemed. Even the best acquisitions take up a lot of the buyer’s time to close and integrate. Distressed deals can take up much more time and investment to bring the company back to life.

Here are some other items to consider when looking at a distressed acquisition:

• Have employees foregone raises and promotions, and have suppliers foregone price increases?
• Did the seller skimp on maintenance, software/cybersecurity upgrades, and other essential expenses?
• Is the company too far gone?
• Are the employees hanging on out of loyalty and/or ready to retire themselves?
• Is it the first acquisition for the buyer? It might be too much for first-time buyers to handle.
• Have owners been playing any unusual games in order to stay afloat?
• Ask advisors to look for red flags. They have probably been through several distressed deals.
• Will third parties—such as landlords, lenders, etc. —give consents? Ask for confirmation early on in the process.
• On the positive side, does the company have new products or customers that are starving for attention—diamonds in the rough?

Over the past few years, our firm has completed several transactions that involved distressed or underperforming sellers. Almost all of them required more work on the buyer’s part than originally anticipated. Some deals have worked out fine for the buyers, and the jury’s out for others. One thing is for sure—even if a deal looks like a bargain on the surface, you have to dive into the issues in order to figure out if it really is a good deal or a lemon that will leave you on the side of the road in a rainstorm.

Tom Kastner is the president of GP Ventures, an M&A advisory services firm focused on the tech and electronics industries. He is a registered representative of StillPoint Capital, LLC—a Tampa, Florida member of FINRA and SIPC—and securities transactions are conducted through it. StillPoint Capital is not affiliated with GP Ventures.