Buying a Business in Difficulty

Considering the trouble that most people go to through in the process of due diligence and business purchase financing to ensure that they are buying a business is healthy and with good prospects why might you or a distressed equity firm want to do the opposite and buy a business in difficulty? The answer lies in the potential to add significant value.

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A business in distress or at a high risk of failure is unsurprisingly less valuable than a stable business with good prospects. It therefore follows that if you can find a business for sale which is in distressed condition; which you are then able to turn around into one with good prospects and strong growth, then you should be able to achieve a huge increase in the business’s value.

Many people who believe they have the qualities to turn a business around are therefore interested in finding opportunities to buy business in this condition with a view to making a significant capital gain.

There can also be other advantages in buying business in difficulty in that the business’s problems may be very obvious. Furthermore, if the business is already going through a formal insolvency process some of these may already be being dealt with, while the effect of washing a business through an insolvency may in practice give the buyer of such a business in much ‘cleaner’ and safer purchase as most liabilities will be captured in the insolvency.

Against this a business that has been in difficulty is likely to have suffered a significant worsening of its trading and strategic position having lost its relationships with its suppliers, suffered severe problems with staff morale with the most employable seeking positions elsewhere and with its reputation amongst customers and market share severely diminished.

Businesses in difficulty will be in one of three states:

in difficulty but not (yet) in a formal insolvency procedure. Of these, some businesses will be refusing to recognise that they have a problem, some of them will be being actively advised by professional advisers with a view to rescue, and some may simply be in the process of heading into insolvency;
in a formal insolvency procedure directed towards the rescue of the business or company such as a Company Voluntary Arrangement (or ‘CVA’) or an Administration; or
in a formal insolvency procedure directed towards the realisation of the businesses assets in order to fund a payment to its creditors, such as a Compulsory Liquidation ordered by the court or a voluntary liquidation by the company on grounds of insolvency (a Creditor’s Voluntary Liquidation or ‘CVL’).

Which of these categories a business falls into will have a significant impact on both how it may be sold, what will be for sale, and the risks involved in buying it.

There are a number of routes to finding a business in need of a turnaround before insolvency:

through normal business for sale adverts as if they have realised the difficulties they are in, the owners may be trying to sell in order to get out before it’s too late, although they obviously won’t be advertising it on that basis;
actively searching for businesses in financial distress using credit checking or CCJ monitoring services or following news in the trade press about problems. Even if you can spot a business in need of a turnaround you will then run into the problem of overcoming the directors’ normal denial that there is any problem at all and reaching a realistic business valuation;
spotting where your suppliers or customers are getting into difficulty from changes in how they are dealings with you (but buying a customer that has failed owing you money can however be a case of sending good money after bad);
being invited in as a turnaround executive by a bank or VC house to sort out the problems, however this requires a significant investment of time and effort in networking yourself to potential introducers;
being directly contacted as a potential buyer for a distressed situation for which you will need to network yourself to both the insolvency and corporate finance partners in the larger accountancy firms who will deal with such situations; or
join a business angel network specialising in turnaround situations.

If you are considering making an investment into a business in difficulty, it goes without saying that you must look very carefully at the commitment you are making, the likelihood of recovery and the impact it will have on you should the business fail. Be warned, businesses in difficulty often seek to raise injections of cash from outsiders as the management desperately try to stave off the inevitable failure.

When buying into a business in difficulty you should generally:

never buy a minority stake as you will want to ensure you have control over the business and how any cash you invest will be used; and
never accept a directorship unless you’re taking over active control of the company with a view to putting in place your turnaround plan.

Finally if you are looking at buying a business that is in difficulty, always consider whether you are better off waiting with a view to buying the business out of a formal insolvency. Remember also that if you are in discussion with the business that is unwilling to accept your offer, you can always simply wait as you may soon have an option to buy it out of insolvency.

Given the level of both technical detail and risks involved in buying a business in difficulty this is an area more than any other where you will need good advisers and access to specialist sources of business purchase financing and distressed equity investors.