In recent months, we have had many conversations with clients who are actively looking to buy distressed businesses. Why would they buy a distressed business you may ask? Typically, the primary motivators are the opportunity to buy an underperforming business at a competitive price, with a confidence that under the right management the business can be restored to strong performance.
Most buyers of distressed businesses are good at negotiating a bargain deal – it comes with the territory; a distressed owner looking to exit as soon as possible, and a typically commercially astute buyer who can drive a hard bargain. What we have noticed however, is that many buyers of distressed businesses fail to undertake diligence in key areas which will determine their success or failure in turning the business around. In this article, we look at three considerations that must be made if you are planning on buying a distressed business.
First though, a word of caution: buying distressed businesses is normally a highly risky exercise. Considering the matters discussed in this article as part of a distressed business acquisition in no way guarantee that your investment will be successful – in many cases, distressed business buyers lose money as a result of their investments. Hence, seek out professional advice if you are considering undertaking a risky investment such as this.
1. Understanding the Competition
Too often, businesses fall into a state of distress due to factors outside of their immediate control. The most common of these factors is competition from other businesses. As a rule, one of the first matters of diligence on a distressed business must be to properly assess the business’ competitors – look at their price points, their service offerings and their cost structure – can you transform the business to compete effectively with its competitors? If the answer is not an emphatic YES, then you should consider walking away from the opportunity.
2. Having a Comprehensive Working Capital Budget
Turning around a distressed business is normally quite expensive. Beyond investing money in upfront acquisition costs, there will normally be a requirement to inject additional cash or debt into a distressed business in order to make the requisite improvements such that it becomes a great asset once more. Too often we find that the working capital costs of turning a business around are underestimated, and what’s more, these costs are often ignored as part of value and price considerations. In our opinion, it is of integral importance that a comprehensive working capital budget is prepared prior to committing to a purchase, with this included into return on investment calculations to ensure that the proposed investment is a good one.
3. How Much Worse Will It Get Before Getting Better?
Buying a distressed business requires optimism. It’s important however that this is diluted with a strong dose of commercial acumen and practical insight. This is particularly important when assessing the likely turnaround timeline for a business. The time taken to turn a business around, and in particular the losses that the business may incur during this time are vital to calculate. These calculations should be undertaken on conservative, likely and optimistic scenarios too so that you can be certain that even if it takes a long time to turn the business around, you will be able to see it out!
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Groves & Partners are expert business transaction advisors and valuers, with significant experience in conducting due diligence and valuation advice for the purchase of distressed businesses.