Value Investing: This Might be Right Time to Buy a Business
Christopher Porter
Plant Magazine
October 2008
For value investors in the stock market, turbulent times offer opportunities to buy stocks of impressive companies at reasonable prices. For business leaders looking for value, there are similar opportunities to buy companies that offer future growth.
As the global credit crunch affects more businesses in the coming months, there are likely to be increasing numbers of highly leveraged manufacturers eager to exit due to escalating financial pressures. For prospective purchasers who are prepared to act quickly and decisively, buying a company in financial distress may offer impressive value. This could be an ideal time to acquire or strengthen strategic advantages: geographic expansion, a diversified customer base, updated equipment, a proprietary formulation, trained employees, an experienced management team, a brand, a trademark – the potential is unlimited.
While buying a financially-challenged business can be less expensive than purchasing a profitable company or investing in internal growth, it can, of course, be riskier. Thus, it is important to understand why a company is struggling, what needs to be fixed, and to have the expertise, commitment and financing to turn it around.
Since distressed companies are often cash flow negative and unable to secure additional working capital on a timely basis, purchasers need to be prepared to act quickly. In particular, due diligence must be compressed; the purchaser has to quickly identify and focus on key issues and deal breakers. Further, the vendor may not be able to give or back up representations and warranties. This means a merger or sale will typically be carried out on an "as is, where is" basis with limited representations and warranties.
Numerous transaction strategies, however, can limit and control risks. These include purchasing assets rather than shares and/or passing the transaction through an insolvency process to separate assets from certain liabilities. Since transactions must be completed within constrained time frames, the objective advice and skills of transaction advisors can be invaluable during this process. They can assist with: identifying potential acquisitions; developing the appropriate transaction structure; facilitating the sale process; preparing and negotiating the purchase agreement; assisting with financial due diligence; identifying sources of financing; managing key stakeholder relationships including creditors, suppliers, customers and employees of the selling company.
Professionals can also assist with court-approved insolvency processes -- a common method for conveying the assets of a distressed business. The Companies’ Creditors Arrangement Act and the Bankruptcy and Insolvency Act are often utilized to restructure a distressed business in order to sell it as a going concern. Restructuring proceedings under these Acts can provide sellers of distressed businesses time to reorganize operations by, for example, eliminating unprofitable units or selling redundant assets – while developing a plan for creditors and enabling the business to continue. A purchaser can acquire the assets through a “vesting order” from the court, for example, which vests the assets with the buyer free and clear of liability to unsecured creditors
In other cases, a seller may institute restructuring with a buyer already in place. If there is a delay in closing the transaction, the purchaser can enter into a management agreement to operate the business and keep it going until the closing of the transaction. Sometimes purchasers may also buy the shares of the company in order to utilize tax loss carry-forwards.
As important as the transaction itself is the integration of the acquired business. It is crucial to focus on the benefits and challenges of integration and to prepare for them. For example, if the purchasers wish to retain key employees or to continue key customer relationships, they need to know if these goals are realistic.
Structuring the financing of a transaction is also vital to a successful outcome. Generally, the purchaser relies on its own resources or the combined balance sheet of the new entity to finance the transaction. In some situations, a purchase may be partly financed by the seller through, for example, a vendor take-back or the assumption of certain debts and liabilities. In other situations, a vendor’s secured lender may support the new owners of the business if they can demonstrate that it has better prospects of full repayment due to, for example, stronger security and a reduction of debt. When a business is purchased through a Receiver or Trustee, the transaction must generally be financed with cash. No matter how the deal is ultimately funded, however, prospective purchasers need to anticipate and prepare appropriate financing.
In fact, speed and efficiency are inherent to the success of any purchase when the seller of a business is struggling to continue operations while managing financial, creditor, customer, supplier and employee issues. Prospective purchasers need to be prepared to quickly grasp the opportunities and risks and to act promptly. For those who do, the purchase of a struggling company can often yield significant value and growth potential.
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.
