What to consider when buying distressed assets

The global tax trends survey by Ernst & Young recently revealed that 53 per cent of companies had admitted that they would consider snapping up a distressed asset deal if the appropriate opportunity presented itself. But what do these deals mean for companies, and how do you avoid any pitfalls?

Despite a raging market for distressed assets in 2010 - which saw financial investors and strategic acquirers clamour in hot pursuit of them - there are significant limits to the opportunities they present, not least of all that they are called distressed for a reason.

A company that has been suffering financial distress for any amount of time can often be found to be suffering from 'chronic ailments' that may well span a range of problems. A frequent problem stems from the company failing to keep up with the funding of its pension liabilities. This may leave the purchasers of the assets liable for filling in these gaps and becoming responsible for other items, including fulfilling employment contracts. These issues can, however, be negated by insolvency, leaving a valuable asset open to whichever potential purchaser is quickest off the mark.

Falling product quality, stemming from the cashflow problems in the run up to insolvency, as well as regulatory issues, can also present problems for acquirers. To this end, a full and comprehensive due diligence process is of paramount importance when looking at distressed assets. A professional with experience in due diligence should be taken on to examine facilities, supply chains, reputation, existing contracts and everything else that could possibly have contributed to the distressed state, and find out how they would affect the existing business of a purchaser.

Buyers who have the confidence that they can overcome these pitfalls will then be thrown into the frenzied scramble that precedes a sale in the invariably short period the assets are on the market. The closing of such deals often happens within 30 days and, as such, anyone wishing to stand a chance must be fully prepared and unafraid of moving very fast. Everything will move quickly: the identification of opportunities, the consideration of the staff, the decision making process. Anyone unable to move quickly enough will swiftly lose a deal to a more determined and organised buyer.

A buyer who has done research on a company that they suspect may soon be facing administration could even attempt to negotiate 'pre-event' terms which, although often resulting in a price that's not quite rock bottom, will get a savvy buyer in there before the masses descend.

As with every business deal and transaction, tax issues are often the most problematic. It is often difficulty with tax that has caused the distressed state in the first place, whether the company is behind on its filings or has judgements out against it for other reasons. It is for these reasons that buyers commonly turn to purchasing the individual, unattached assets themselves, rather than taking ownership of a company or its shares, as this allows them to acquire assets without assuming responsibility for the company's tax liabilities.

The post-recession recovery of the appetite for risk has had the effect of raising prices on would-be bargains. The biggest difficulty in buying distressed assets is still finding the right assets in the first place.

Individuals and companies with experience in buying distressed assets will have the right degree of fortitude to pull off a good deal. It is encouraging to know that lenders, such as banks and private investors, are increasingly willing to support this type of investment.

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