As inflation and rising interest rates start to bite, companies which may already be reeling from the effects of the pandemic are facing yet more stress. Many good businesses are struggling to weather a downturn as supply and debt costs grow.
Market conditions are increasingly throwing up opportunities for private equity funds and other buyers, meaning that mergers and acquisitions ("M&A") activity involving businesses in financial distress has ramped up in recent months. It looks likely that this trend will continue in the short term at least.
With this backdrop, we look at some key features of a 'distressed' M&A transaction.
Time will often be of the essence on a distressed deal. There may be suppliers and lenders at the door, giving very little time to complete the transaction and limited scope for negotiation. A seller will need to act quickly to realise remaining value and potentially save the business and its employees' jobs. Pressure on a buyer will be exacerbated if the situation is competitive and there are multiple bidders circling.
An opportunistic buyer attracted by low pricing will often be willing to accept more risk and move quickly to 'bag a bargain'. This might include doing limited due diligence, accepting limited (or no) warranty or indemnity protection from the seller and typically making full payment on completion. A buyer requiring more protection may be able to obtain warranty and indemnity insurance, if time allows.
Distressed deals can take a number of forms including:
- Share sale: The simplest option may be for the shareholders of a distressed business to sell some or all of their shares to a buyer. This approach allows for a complete, quick exit by shareholders and minimal disruption to the business, but may not be favoured by a buyer who is reluctant to acquire a challenged business and its liabilities 'warts and all'.
- Asset sale: An asset deal allows a buyer to cherry-pick attractive assets and, where possible, leave behind liabilities. This is likely to be the buyer's preferred option in a distressed situation, particularly if more bargaining power lies on the buy-side and there is limited time for due diligence. However, an asset deal can be more complex, and is more likely to require the consent or agreement of customers and suppliers.
Some element of debt and/or equity restructuring is often needed. The buyer might be happy to restructure after making the acquisition, or alternatively might insist that any problematic existing debt (or other liability) is paid down, refinanced or perhaps converted to equity as part of the deal.
In practice, there may be multiple deals running in parallel with different buyers acquiring different parts of an affected business. The situation is likely to be complicated by parallel negotiations with lenders (who often lead the process) and suppliers who may be forced to accept a discount or 'haircut' on sums due to them, or who agree to take shares or assets in settlement of their debt. Directors of a company in distress will be doing their best to avoid personal liability and consultations with employees may be underway. Depending on the circumstances, an insolvency practitioner may be involved. In all cases, there are likely to be multiple stakeholders with competing interests who need to be carefully managed – and appointing the right advisers at an early stage will inevitably be critical.
As a leading offshore legal adviser, Bedell Cristin acts for buyers, sellers, management and lenders across a range of sectors on both conventional and distressed M&A deals, and specialises in complex debt and equity restructuring involving offshore vehicles. If you would like any further information, please get in touch with Guy Westmacott or one of the contacts listed.