Buying or Selling a Struggling Business (aka the “Distressed” Business) – Part 1

Current events are having a very negative effect on many businesses, but business owners must think beyond the near term to fully assess their business prospects.  For some companies, this may be an opportunity to use accumulated cash to acquire businesses in a desired channel, market, or competitive space (Buyers). For other companies, the struggle to return to success and profitability is daunting, if not impossible, and they should think about selling their business (Sellers).

In a five part series, we will discuss some factors for both Buyers and Sellers to consider when buying or selling a struggling business.

What is a “distressed” business? 

A common definition is that the price to sell the assets of a distressed business is less than the value of those assets.  Often, a distressed business is insolvent and is or should contemplate options under federal bankruptcy and related laws (such as a Chapter 11 reorganization or an assignment for the benefit of creditors).  My colleagues in our insolvency and restructuring practice group are very experienced in this area of the law.

What is a “struggling” business?

For our purposes, we will be discussing non-bankruptcy related sales, and so using the term “struggling business” seems more appropriate than “distressed business”.  A struggling business is still able to operate and make payments on most of its obligations, however, the future prospects are dim and perhaps a significant infusion of cash is the only way the company will ultimately survive.

What are the advantages and disadvantages for a Buyer?

The obvious advantage to a Buyer acquiring the struggling company is valuation – the purchase price for the struggling business will be lower .  The other advantage is leverage – the Buyer will have more leverage to negotiate terms than the Seller, who probably needs to act quickly and thus can’t afford to negotiate at length.  The main disadvantage for a Buyer is risk – there is a higher risk of post-closing claims such as for successor liability or fraudulent transfer (which we will discuss in a future post).

What are the advantages and disadvantages for a Seller?

An advantage to a struggling Seller is that a sale may yield more purchase price for Seller’s assets than going through a bankruptcy proceeding.  Another advantage is that Seller may be able to satisfy all outstanding obligations with the right purchase price and deal structure.  And, a Seller may be able to ensure that its employees have continued employment with Buyer post-closing.  The main disadvantages to Seller are the advantages to Buyer:  Seller must sell at a lower valuation than if the company were successful, and has less leverage to negotiate terms.  Another challenge for a Seller is timing.  It is optimal to sell an operating company with revenues that is not insolvent.  Sellers should forecast their cash flow needs and act before they run out of cash.

Tips to Sellers

  1. If you are running out of cash, don’t stop paying compensation to any W-2 employees (including owners) with a promise to pay later. There are complicated tax laws and state laws regarding payment of wages and deferred compensation and violations may entail penalties. Call us for advice on wage reductions or employment termination.
  2. Be sure all payroll taxes, sales taxes, use taxes, and similar taxes are timely paid. If not, the person responsible at the company for ensuring taxes are paid may become personally liable for the unpaid taxes.

Up Next in the Series

In part 2, we will discuss the initial steps for Buyers and Sellers in buying and selling the struggling business.