When to Consider Acquiring a Distressed Company
In this short, three-part video series, Greenberg Glusker Partners Andrew Apfelberg and Brian Davidoff discuss important financial considerations for health, beauty and wellness companies in the wake of a pandemic. Part three looks at when to consider acquiring a distressed company, including the options on the table, the risks, and the rewards.
Andrew: Brian, in the wake of this pandemic we find ourselves in, companies in the health, beauty, and wellness industry are understanding now that they need to enhance their capabilities. One of the quickest ways to do that would be to acquire a company and, as counterintuitive as it sounds, acquiring a distressed company could present an incredible opportunity if done right. I know you’ve handled a lot of those sorts of thing in this industry, so I was hoping to ask you a few questions about that today. I guess the first question is, how do I do it?
Brian: There are a number of established ways of acquiring the assets of a distressed company and, depending upon the approach that you take it, may increase in complexity, it may increase in cost, but along with that also comes a certain benefit to the buyer of an assurance of not taking on the liabilities of the seller.
The most basic way of acquiring assets of a distressed business is through an asset sale – a regular purchase and sale agreement for the sale of assets. It’s rarely done through a stock transaction because, as you well know, in a stock transaction, along with the company comes the assets and the liabilities, so typically a buyer does not want to take on the liabilities of a distressed transaction. An asset sale supposedly does include only the assets without the liabilities, but many buyers are concerned in a distressed transaction that they may get tagged for the liabilities of the seller, so usually a buyer will want some other form of transaction that protects the buyer from the liabilities of the seller, and there are a few alternative ways of approaching this.
One of the ways of approaching this is if the seller has a secured lender creditor, who maybe is foreclosing on the assets of the borrower, that they conduct a private or a public foreclosure as it’s called, and you buy the assets of the company through this foreclosure. Normally, it takes the cooperation of the lender to do so, and often lenders are reluctant to get involved in those kinds of transactions because of their concern that there might be subsequent litigation. But if you can acquire assets as a buyer through a secured creditor foreclosure, that can be a relatively inexpensive, quick, and efficient way of acquiring assets with a significant amount of protection from a legal point of view.
The other alternatives would include, for example, an ABC, which is an assignment for benefit of creditors. An ABC is essentially the state law equivalent of a bankruptcy, and ABCs exist in most but not all states in the United States. In some states, such as in California, you do not need court involvement for the commencement of an ABC. In other states, you do need court involvement. But the way an ABC transaction works is that instead of – as you would have in a normal transaction of seller and buyer – here you have the third-party assignee involved. What happens is that you negotiate the transaction between the assignee and the buyer, and then once your terms are resolved, the assets of the seller are assigned by the signing of an assignment agreement, which is normally really just a 2 or 3-page agreement. Legally, the assets are transferred to the assignee and then, at the same time, as soon as the assignee has received those assets, the assignee executes their pre-negotiated sale agreement that the assignee has with the buyer. The buyer pays the purchase price to the assignee. The assignee then acts similar to a trustee in bankruptcy, and it takes the proceeds from the assets sale and uses those proceeds to distribute to the creditors of the seller. Doing it that way gives the buyer a significant level of protection.
The third alternative is doing it through a so-called Section 363 sale – Section 363 of the bankruptcy code. That does require that the seller files a bankruptcy and that the assets are sold through this process called a Section 363 Sale where it goes through a court process and there is the opportunity for other people to bid on the assets. If you are the successful buyer in a 363 transaction, you get significant protections under that court order.
Those are basically the ways in which a buyer can acquire the assets of a distressed company.
Andrew: It’s good to know that there are so many options, so you can fit the one to the situation that you have at hand, but I think a lot of clients will consider this from a risk and reward point of view. First, I’d like to ask you about the risks. What are the risks of acquiring a distressed company?
Brian: As I mentioned before, depending upon the nature of the transaction, you can work to mitigate those risks. Typically, the biggest risk that a buyer is concerned about is taking on the liabilities inadvertently of the seller. And so, if you do a regular purchase and sale agreement without any sort of legal oversight, whether an ABC, foreclosure, or Section 363 Sale, there is always concern by a buyer that they are going to get tagged with the liabilities of the seller. But, again, as you go up the chain of the nature of the transaction, you can mitigate that risk. But independent of that risk there are other risks that a buyer of distressed assets runs into. First of all, there are typically very limited warranties that are available from distressed sellers. You will typically get only the basic reps in warranties of a formation that the contract is properly executed, that the officers are duly authorized, but you will not get the host of representations for warranties that you would get in a regular purchase and sale agreement, so that’s something that the buyer needs to take into account. And then there’s the issue of the ability to do diligence. Typically, a distressed transaction is done usually in a pretty quick hurry. You don’t have the amount time that you would under normal circumstances of doing diligence. And so sometimes you simply have to shortcut that as part of the acquisition of assets of a distressed company.
Andrew: So, why do it? What are the benefits? Why is this good for me?
Brian: First and foremost, you’re typically getting these assets at a bargain basement price. So, if you are looking to add onto your business, if you’re looking to get into an industry that Is new to you, but this represents an opportunity to do that, you usually will be acquiring an entryway at a price substantially less than you would in a normal transaction. That probably is the biggest benefit to a buyer, which is the ability to acquire an entryway or an add-on to their business at substantially lower prices.
Andrew: Brian, I want to thank you. As I’m talking with my clients in the industry, I think we’re all expecting a fair amount of consolidation. Some of that will be companies that don’t make it. Some of it will be companies that get acquired. But it sounds like, from what you’re saying, if some of our clients can be the acquirer, they can wind up having some really incredible opportunities for growth to both help them manage this pandemic, But also to really excel on the other side of it, so thank you for giving us such practical advice, and we appreciate your time.