Buying a struggling or distressed business is no different. The acquisition can prove to be very profitable for those who know what to look for and how to execute a turnaround. But a distressed business can also hide some fundamental flaws, turning a bargain into exactly the opposite.
The message is to do your homework, so you have a clear picture of what you’re looking at.
Such is why business experts suggest only buying a struggling business if you understand exactly why the business is currently in trouble, you carry expertise in how to turn it around, and you also have an exit strategy. Here is a short list of factors to consider to increase the probability of success when buying a struggling or distressed business.
Assessing the risk factor. It’s essential to understand why the targeted business is failing, and more importantly, the potential for change. A lender will require a detailed and thorough assessment and will always be on the lookout for red flags, including inadequate business planning, debt repayment, unrealistic expectations and undercapitalization.
Understand who you are buying from. Many distressed businesses, or their assets, are partially or wholly owned by banks, which can be a different process than buying from a sole owner. Be clear about whom the seller is and their priorities.
Consider your fundraising options. Raising capital for a distressed asset can be more complex than for one that has clear and straightforward value. The key is what is available to you. Having secured funding in place adds credibility and creates certainty for sellers. You will need more than just the purchase price – the cost of implementing a turnaround plan and covering debt or losses can be substantial.
Positioning your offer. There may be other interested buyers, so pitch your offer appropriately to be appealing to the seller. The information available is never complete, so agree on a period for due diligence to adjust your value assessment. It’s not always about the highest offer.
Know what you are purchasing. Have a solid picture of the assets that create value, but also how they fit and create synergies with your current assets. Do your due diligence in considering what parts of a business will add value, and consider “cherry picking” assets or part of a company – such as a side business – that are potentially profitable.
Understand the company’s situation. Make an immediate assessment of the company’s predicament and how long it can survive. Is the company overburdened by debt? Has it lost key management and are problems related solely to poor execution? Companies get themselves into distressed situations for a variety of reasons, so it’s essential to genuinely understand those reasons and have the right fix.
Ensure you have a turnaround plan. Every entrepreneur believes that they will be able to run the business better. Make an assessment and put serious consideration into how you can resolve the issues before purchasing. Assess, plan and forecast to be sure you have what it takes to achieve this.
Avoid costly and common management mistakes. One of the biggest risk areas surrounds management, where the impact of changes and relationships can be fundamental to value. If you seek to replace a management team, ensure that the removal of the existing team is appropriately handled and that redundancy terms and costs are clearly dealt with in your offer.