Are you thinking of selling a distressed business? If so, it’s important to understand that the process is vastly different than when selling a healthy one.
Consider time, for example. Usually, it’s much less than for a “regular” sale. How long can unsecured creditors’ legal actions be postponed so a sale can be completed without complications they might introduce? Are better days ahead, either due to market changes or changes to the business? If so, will waiting lead to a higher sale price? Is the business bleeding cash, so that cash put into the business to fund a sale process reduces the net proceeds?
Whatever the specifics, there generally isn’t much time, so the sales process will be an abbreviated one.
Most distressed sales are asset sales. Rarely is the equity sold, or controlling equity injected, or debt converted to equity. Why? Because the liabilities come with the equity and buyers want the assets needed to run the business (not the liabilities). A restructuring that doesn’t pay all creditors in full can happen in an old fashioned — but expensive — bankruptcy. But even bankruptcies these days are usually asset sales, with the old company then wound down. Occasionally, such a restructuring/sale does happen outside of bankruptcy, but only when it makes economic sense to pay off trade creditors in full. Those situations usually apply to businesses with some heft. So, the focus here will be on asset sales.
Identify the Value
For starters, figure out what is most valuable in the business. Often it is the customer list, either to expand the buyer’s geographic, product, or market presence, or to increase utilization at an existing facility.
For example, I sold a high-end party rental company that focused on billionaire party’s and the fund-raising galas these folks attended. The large local competitor struggled to compete in the billionaire market and so was willing to step up and make a purchase. It hired the customer-fronting people but only cherry-picked the rental inventory. These new customers were serviced from the buyer’s existing facility.
Similarly, I am currently working with a manufacturing company where the prospective buyers want the customers in order to better utilize existing plants — plants that operate with lower labor costs than those of my client.
Work with Experienced Professionals
Because the process of selling a distressed business is different, it’s important to use an investment banker or business broker that has experience in this area. These professionals must be familiar working under a shortened time frame, and because pricing is lower than for a healthy, similar-sized business, many that normally serve companies of your size will not be interested.
Likewise, both the seller and buyer will benefit from legal counsel that is experienced in distressed sales, as the terms are different. Representations are minimal and there are no warranties. The terms, in essence, are “you get what I got.”
Buyers want protection from creditor claims, so the choice of legal mechanism for the sale is usually a negotiation between the buyer and the senior secured lender, with the seller acting as the “man in the middle.” The strongest protections involve noticing all creditors, such as in a formal bankruptcy process or in what is known as an “Article 9 Sale.”
But secured lenders are focused on certainty and speed of close, and noticing unpaid creditors takes time and risks disrupting the sale. In the Party Rental company situation mentioned earlier, my client and the senior secured lender said “No.” Fortunately, and at the last minute, the buyer agreed to pay many of the suppliers because it used the same vendors and was concerned about supply disruption.
Pay Attention to Customer Contracts
When a key item of value is customer contracts, the sale process can get a bit dicey. That is because contracts have to be assigned to the buyer, and outside of bankruptcy, that usually requires customer consent, a process that takes time.
To illustrate, I advised a non-distressed client on the asset sale of its specialty chemicals business to an investor in such businesses. The buyer intended to operate the plant with existing employees and most customers had contracts. So, as a condition to closing the asset sale, a key customer had to agree to assigning its contract to the buyer (“NewCo”). “OldCo” continued to exist and operate the plant under an agreement with NewCo, until all of the remaining contracts could be assigned.
In a distressed situation, however, there is an extended time period where angry trade creditors can take legal actions that make continuing to operate the business difficult. There can be solutions to these types of challenges — in the example above, the buyer will likely produce the product and act as a contract manufacturer while the contracts are being assigned — but things can quickly get complicated.
Winding Things Down
The remaining step is to wind down the company. There are two parts to this: monetizing what is left and formally winding things down.
Monetizing. It’s often the case that all assets are not sold in a distressed sale; the buyer doesn’t want them. Sometimes they are significant, such as accounts receivable, inventory, and equipment. Typically, inventory and equipment are sold off at auction. In the case of stores, there are “going out of business” sales as well as special liquidators for consumer products, whether owned by a retailer or owned by the manufacturer/distributor.
Sometimes, there are “nuggets,” something I have
written about before
. Nuggets are typically intangibles, such as brand names, proprietary software, and so forth. Consumer brands can bring in surprisingly large amounts of money. Some of the nuggets I have come across include rare IP addresses (for the internet-savvy, these were “B blocks”), internet domain names, and a unique set of stock trading data that was in millisecond increments.
Things that can’t be monetized are usually abandoned. If it’s something physical, it becomes the landlord’s problem.
Formal wind down. The winding down of what is left
can have pitfalls that snag owners, directors, and management. All fiduciary taxes such as sales tax and withheld employee taxes must be paid, or the government can and often does pursue owners and officers in particular. Unpaid wages can become the personal liability of owners, directors, and officers. Tax returns should be filed as final for all taxes; retirement plans such as 401k plans must be properly and formerly ended (the Federal Department of Labor is known to pursue whomever is listed as plan administrator). Consider buying
tail D&O coverage to protect yourself against suits from creditors and others.
In the end, selling a business that is in financial distress
as a business
— rather than as just a bunch of pieces — often yields the best recovery for creditors. If you find yourself in such a position, go into the process with your eyes wide open and use advisors that have been through this before.
