Buying or Selling a Struggling Business (aka the “Distressed” Business) – Part 5
In Part 1 of this series of posts, we discussed how business owners must think beyond the near term and that certain Buyers may view this as an opportune time to acquire a company while certain Sellers may be thinking that the best path forward is to sell their companies. In Part 2, we discussed some initial steps for Buyers and Sellers in preparing to buy or sell the struggling business. In Part 3, we went over due diligence and structuring the transaction. In Part 4, we outlined risks and risk mitigation. In this final post of the series, we will discuss final considerations for both Buyer and Seller in a transaction involving a struggling business.
Transaction Point to Negotiate
There are many points to negotiate in crafting an agreement between a Buyer and a Seller. With a struggling business, some of those points may be less negotiable.
Payment of Seller Debts and Obligations
Seller will presumably intend to enter into a transaction that provides enough cash to pay off all of its debts and obligations. With a struggling business, Buyer will require that Seller’s debts and obligations be paid on or around closing in order to avoid some of the risks we discussed in our prior post. Related to this point, Buyer also will seek to ensure that Seller does not file for bankruptcy after the closing, so as to avoid claims of fraudulent transfer.
Earn-Outs; Payments Over Time
A common way for a Buyer and Seller to come to an agreement on a purchase price is for Buyer to pay Seller via a post-closing earnout or in installment payments over time. Continuing to operate the Seller’s business in the same manner post-closing in order for a Seller to achieve an earn-out could be risky to a Buyer with respect to successor liability claims. In addition, a Seller will want payment up front to satisfy its debt and obligations. Thus, earn-outs may be seen less frequently in sales of struggling businesses.
Typically, Buyer will require in the purchase agreement that Seller indemnify the Buyer for claims arising post-closing that relate to the acquired assets and operation of Seller’s business pre-closing. Indemnification means that Seller reimburses Buyer for Buyer’s costs and expenses in dealing with these claims. The problem is that if Seller has no money post-closing (because all the purchase price is used to pay existing debts and obligations), there won’t be funds available to indemnify Buyer. Because of this, Buyer may conduct more lengthy and extensive due diligence pre-closing (to identify potential claims ahead of time) as well as require a large escrow or holdback of the purchase price at closing to ensure funds are available to cover indemnifiable claims.
Is This the Right Transaction for Buyer?
In contemplating the purchase of a struggling business, a Buyer will need to weigh the advantages of acting in a “buyer’s market” to acquire strategic assets versus the risks of a transaction with a struggling Seller.
Is This the Right Transaction for Seller?
The Seller of a struggling business will need to balance its current operating timeframe and cash flow needs with the timing to get a transaction completed. The Seller will also need to negotiate the appropriate terms in order to ensure that its debts and obligations will be satisfied. Finally, as we mentioned in Part 1 of this series, a Seller may want to ensure continued employment for all or some of its employees with the Buyer and Seller will need to advocate for that condition as part of the transaction.
While the current economy has severely affected many businesses, it may be an opportune time for Buyers to make strategic acquisitions at a reasonable purchase price. For some businesses, a sale may be the best of limited alternatives. In either case, Buyers and Seller of struggling businesses should consider some of the important issues that we have outlined in this series of posts.