Business Management Articles
The Future is Now:
Affordable Strategic Advantages for Sale
Christopher Porter
Management Magazine
January 2009
The grapevine is working overtime these days. Unpredictable stock markets and a global recession have transformed us into news junkies. We all want to know who’s doing well and who’s struggling.
For small and mid-size businesses with ambitious growth plans, this is a good time to stay close to that grapevine. If your organization has cash, borrowing room or unencumbered assets, it could reveal some timely opportunities to shop for strategic advantages.
Companies that are highly leveraged and struggling in today’s tight capital markets are often willing vendors of assets representing a competitive edge for purchasers: critical mass, geographic expansion, product diversification, a long-term customer base, intellectual property, a skilled work force, a respected brand and others.
Well capitalized small and mid-size businesses have another advantage over larger organizations in today’s market – they tend to be agile, able to make timely decisions and complete deals quickly. This is necessary when acquiring a company with liquidity challenges. While purchasing such a business obviously carries risks, many of these can be managed through the appropriate transaction structure and process. Therefore if you are looking for affordable strategic advantages, here are some suggestions to keep in mind.
First of all, it’s important to be aware that the acquisition process will likely be compressed and may be opportunistic. When an organization is struggling to remain afloat financially, decisions must be made without delay. Thus it’s important to clearly define goals before initiating an acquisition search in order to readily determine which buying opportunity may achieve them.
It’s also helpful to plug into that grapevine and find out how competitors, suppliers, customers or others in the industry are faring. If a purchaser prefers to maintain a low profile while doing so, transaction advisory professionals can do confidential inquiries on the buyer’s behalf to determine whether a company may be interested in selling. This approach can also help to prevent a sale price from escalating in situations where a potential vendor becomes aware of the identity of a prospective purchaser.
Often, due diligence will also have to be conducted quickly in order for a purchaser to mitigate weaknesses arising from an acquisition’s escalating financial challenges. But it’s still essential to complete the necessary reviews. A lawyer and financial advisor experienced with mergers, acquisitions and insolvency proceedings can ensure this happens. A financial advisor can even sign a confidentiality agreement with the vendor and build a relationship in order to focus on the areas of the prospective acquisition that are of most interest to a buyer. This individual can meet with management, investigate financial statements, customer relationships and financing arrangements and conduct a search under the Personal Property Security Act to determine which parties have title, security or claims on assets.
Under the restrictions of a confidentiality agreement, professionals would not be able to provide a prospective purchaser with detailed information about the vendor organization, however a buyer could have a level of comfort regarding whether the opportunity would be worth pursuing. If the purchaser then decides to move forward, much of the due diligence would have already have been completed and purchaser and vendor could focus on the most important issues such as the integration of the businesses.
In fact, effective integration is key to the success of most business acquisitions. It’s vital to look at the nature of both organizations and identify where and how they need to be integrated. Some of the most common challenges relate to the workforce, customers, products and brands.
Since financially-challenged companies are often leaking cash and unable to secure additional working capital, purchasers usually want to minimize assumed liabilities. A variety of transaction techniques can be used to limit and control risk. These include purchasing assets rather than shares and/or using an insolvency process to disengage liabilities from assets.
Most vendors prefer to sell shares since this generates capital gains. These have a lower effective tax rate and vendors may be able to use the lifetime $750,000 capital gains exemption. As well, some purchasers prefer to buy shares in order to utilize tax loss carry-forwards. When a company is experiencing financial difficulties, however, most buyers will opt to purchase assets in order to avoid creditor or employee claims or litigation. There are a number of ways to separate liabilities from assets. A purchaser can acquire the assets through a “vesting order” from the court as part of an insolvency proceeding, for example, which provides a buyer with the rights to assets free of liability to unsecured creditors.
When purchasing assets, a buyer must comply with the Bulk Sales Act. This legislation protects creditors when a company disposes of its assets: buildings, inventory, equipment, fixtures, etc. The legislation is intended to prevent owners from pocketing the proceeds from the disposition of these assets and leaving creditors empty handed. Compliance requires the vendor to pay creditors at closing or to demonstrate to the court that creditors will be paid. If the proceeds of the sale will not be sufficient to pay creditors, they must be paid to a receiver or a Bulk Sales Act trustee. If a purchaser completes a transaction without bulk sales compliance, the buyer may be responsible for creditor claims. Purchasing through an insolvency proceeding is a common way of dealing with the Bulk Sales Act issue.
Some vendors and purchasers also make use of the Companies’ Creditors Arrangement Act (CCAA) in order to restructure a financially challenged business and sell it as a going concern. By filing for protection under the Act or by issuing a Notice of Intention to make a Proposal under the Bankruptcy and Insolvency Act, a company may be able to stay creditors long enough to close the transaction. A financial advisor experienced with insolvency proceedings can help the vendor operation maintain cash flow until this happens. If there is a delay in closing the deal, the purchaser can sometimes enter into a management agreement to operate the business until closing.
An insolvency proceeding can also allow a company to restructure prior to a transaction. The organization might shut down unprofitable divisions, disclaim leases, adjust employment levels, or dispose of redundant assets to make the business viable.
While structuring a transaction appropriately can limit a purchaser’s acquisition risks, it’s also important to be realistic about the limitations of representations and warranties. In a standard purchase and sale agreement, these terms are usually extensive, specifying the rights and obligations of vendor and purchaser related to a range of issues: capitalization, financial statements, accounts payable/receivable, inventories, condition of properties, withholding taxes, undisclosed liabilities, intellectual property, contracts, litigation, insurance, employee benefit plans, and more.
Given the financial situation of a business in financial distress, however, reps and warranties would be limited. Many such businesses are sold on an “as is basis.” An experienced insolvency lawyer can help a buyer achieve a comfort level with the scope of possible representations and warranties.
Like much in business life, purchasing any company is a leap of faith. If we thought too long about these decisions, we’d probably never make them. Purchasing a struggling business, however, offers opportunities to accelerate long-term plans. One service company, for example, recently purchased the assets of a business, which included an office location and most of the sales force and employees. The purchaser was able to expand its product distribution into new markets within weeks. If that buyer had instead recruited, hired and trained a team of this size, months of intensive effort and a substantial investment would have been needed.
With defined goals, professional support and decisive decision making, you may be able to accelerate your own future plans by purchasing cost effective strategic advantages today.
Christopher Porter, MBA, CA•CAIRP, is an associate in the Transaction Advisory Services practice of BDO Dunwoody Ltd. (www.bdo.ca), which provides corporate finance and mergers and acquisitions services. You can reach Christopher at (416) 369-3062 or cporter@bdo.ca.
