How to make a successful distressed acquisition

Amid soaring inflation, supply chain problems and the withdrawal of COVID-related support schemes, business distress is on the rise in the UK. In Q1 2022, business insolvencies were more than double their Q1 2021 figures, while County Court Judgements (CCJs) rose 157 per cent over the same period.

This trend offers a wealth of opportunities to acquisitive parties looking to snap up distressed businesses and implement turnaround strategies to return them to profitability. In the current climate, distressed acquisitions can also offer businesses a perfect alternative to organic growth.

A core part of making distressed acquisitions is for the buyer to determine in advance the profile of business they will seek to acquire. Considerations such as what sector to target, the size of business and the specific location or region will help to develop a detailed profile and streamline search efforts.

Securing funding in advance will also be vital. Distressed acquisitions, by their very nature, move quickly, with administrators and insolvency practitioners under time pressure to close a deal. If proof of funding is not forthcoming from the off, administrators will quickly move on to other parties.

Once a profile has been established and funding secured, buyers can begin looking for potential distressed acquisitions. In an environment where distress is so rife, there will be ample opportunities, but also a strong degree of competition. For that reason, it will be worthwhile to spot early warning signs that a business is in distress.

Common early indicators of distress and potential insolvency include cash flow problems, which may lead to a struggle to pay rent or meet payroll, with the business having negative working capital. Creditor action is another warning sign, with an increase in creditor or debtor days and, potentially, the issuing of CCJs.

Creditor action will often lead to falling margins, at which point the business will need to either sharply raise prices, or see its profits begin to fall. Distress also takes a toll on the human side of the business, with the strain potentially leading to employees leaving.

The time constraints of distressed M&A also mean there is a huge need for due diligence processes to be performed quickly. Buyers, therefore, will need to prepare to ask the right questions in order to gain a comprehensive overview quickly, rather than relying on a more thorough, drawn-out process.

Important questions to ask will be: how or why did the firm enter its distressed state? What are its prospects post-acquisition? Are its problems internal, external or both? And can these problems be solved or are they likely to persist?

Asking these questions will also be vital to instituting a turnaround strategy if a buyer decides to go ahead. Identifying key internal and external issues and getting an overview of the firm’s financial state will enable buyers to outline the steps they need to take to improve how the business operates and, ultimately, return it to profitability.

Read more in our in-depth insight on the key steps to making successful distressed acquisitions, featuring a close-up look at United Capital's successful turnaround of building services giant McGill & Co.

Click here to view the UK's latest distressed businesses.

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