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When a business is in financial trouble, sometimes the best way out is to sell the business as some form of ongoing concern.
Such a sale usually yields more than a piecemeal liquidation of the assets. Losses to creditors are minimized, as are losses to guarantors of debt.
Usually, rather than undertaking a distressed sale, it is better to turn a business around so it is more profitable and will either sell more or generate cash to pay creditors.
However, selling is necessary when that option is not viable,
particularly in the eyes of secured lenders.
For example, the current owners may not be capable of turning the business around because they lack the skill to do so and/or they are not willing to invest more money to fund an operational turnaround. Often, this means the business is in enough of a financial hole that an outside investor is not willing to put equity in the company to fund a turnaround of the business that will enable creditors to be paid.
Of course, there has to be some form of business to sell.
A construction company client of mine went 12 straight months without winning any new contracts. So they completed the remaining contracts, sold a small stock of supplies and equipment, and shut the doors.
Distressed Sales Are Different
It is important to understand that
selling a distressed business is not the same as selling a healthy one.
These differences typically include:
- Negative cash flow during the sale process
- A lack of time to conduct a full-blown marketing process
- Poor records, reporting, and computer systems
- An inability to pay all creditors from the sale proceeds
- Nothing remaining post-sale to back up representations and warranties for the buyer
The consequence of this is that the sale process must be expedited.
Buyers will have little time or information to conduct extensive due diligence (and no effective recourse should things go wrong). Also, because buyers will have limited time to obtain financing, viable bidders are usually in the business and well financed.
Most Distressed Sales are Asset Sales
Rarely is the equity sold, 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). Typically, a restructuring doesn’t pay all creditors in full.
Two additional differences worth noting with a distressed business sale:
The waterfall.
Rarely does all the money go to secured lenders first. Instead, there are often
involuntary secured creditors
such as the IRS and States with tax liens that trump the lenders.
The legal documents and process.
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, such as bankruptcy, is usually a negotiation between the buyer and the senior secured lender, with the seller acting as the “man in the middle.”
Further Recommendations
Identify the Value
Often, the most valuable asset is the customer list.
This can help expand the buyer’s geographic, product, or market presence, or increase utilization at an existing facility.
For example, I sold a high-end party rental company that focused on billionaire parties 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.
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. Also, Article 9 sales and or bankruptcy takes special legal knowledge and skill.
Consider Additional Funding
Sometimes it makes economic sense to put additional money into the business to fund a longer sale process that gets a higher return.
Look for unencumbered assets to borrow against or a party that has the most to gain from a better recovery. Often, it is the creditor who sits below the creditor who will get paid in full. This can be an owner to minimize losses on a personal guaranty and/or pledged personal assets.
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.
In a distressed situation, there is an extended 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, but things can quickly get complicated.
The Final Step: Winding Things Down
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” — 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, 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 formally ended.
Consider buying
tail D&O coverage
to protect yourself against suits from creditors and others. Get these expenses funded from the sale proceeds.
In the end, the best recovery for creditors usually occurs when selling a financially distressed business
as a business
— rather than as just a bunch of pieces.
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.
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