Amid the current situation, I find it essential to discuss a fascinating yet complex niche “application” of our business: distressed M&A.
You should not be misled by the straightforward definition of distressed M&A. The mechanics and dynamics, causes and effects, as well as the valuation and process particularities, are rather hard to grasp. In essence, distressed M&A is an overarching term referring to the process of taking over a target that has high illiquidity, a considerable over-indebtedness risk or finds itself in an insolvency or bankruptcy proceeding. In short, the target is financially distressed.
So, what brings about financial distress for companies? As a company’s financial health is closely linked to numerous factors, it’s worth looking at some of the important causes of financial distress. Harbingers of distress can be general macroeconomic dynamics, such as an economic slowdown, an economic downturn or market saturation; geopolitical conflicts, such as the trade war between US and China or the armed confrontation between Russia and Ukraine; or once-in-a-lifetime humanitarian crises, such as the Covid-19 pandemic. However, distress can also be brought about by microeconomic factors, which are equally relevant when analyzing causes of financial distress. Bad managerial strategic decisions, the incapacity to adapt to technological disruptions on the market, moral hazards by key management, or far-reaching principal-agent conflicts are sometimes precursors of financial distress.
As the company’s value decreases substantially, you will probably wonder, why invest in an asset in financial distress? Well, this is the beauty of distressed M&A. In terms of basic risk-reward dynamics, such a high-risk investment represents an immense opportunity for a fruitful return over a short period of time. Now let’s continue the thought process: who would invest in a company in financial distress? Investment funds or hedge funds focused on distressed investments and strategic investors with an opportunistic mindset are all excellent candidates for buy-side distressed M&A. All of them are usually equipped with a unique set of qualities inherent to such a process closely resembling a rollercoaster ride. Their in-house capabilities are in seamless harmony with the wide range of skillsets of a task force of financial, legal, or tax advisors. Only a handful of highly specialized investors and advisors can successfully pull off a takeover of a distressed target.
We now have a clearer view of the actors in distressed M&A. To connect the pieces of the puzzle, let us immerse ourselves in the particularities of the process. We are looking at a fast-paced, complex sales process filled with intricacies and tight deadlines. While a typical M&A process is expected to last for several months, often in distressed situations, a target needs to be divested within a couple of weeks. The process is essentially a race against the clock to salvage as much value as possible, even save countless job positions or avoid painful factory closures. The due diligence process can also vary considerably. Time is short and the breadth of information available and access to management may be very limited. As a result, experience is pivotal as investors strive to identify the most relevant key issues, red flags, and deal-breakers. Additionally, a solid legal background is essential to protect investors from “acquiring” legacy legal liabilities.
Finally, what happens after the sale is completed and how does an investor create value? The acquirer will start a tedious process of bringing the company back on track. This can happen through an insolvency procedure and a closely formulated and implemented restructuring plan. Very often, the acquirer makes use of its creditworthiness to negotiate with lenders and restructure the company’s debt. Such actions coupled with stringent measures to improve operational efficiency can ultimately help a company get back on track towards sustainable financial health.
Evidence is piling up that distressed M&A will surely be a trend in the coming years. You should expect and be prepared for an increase in distressed M&A activity in an environment where the world economy is currently experiencing a sluggish performance after a long period of bullish growth. As the leading mid-market M&A advisory to the manufacturing industry, we have an impressive track record of successful deals in highly challenging situations. We can help you navigate the turbulent waters of distressed investing by tightly controlling both buy-side and sell-side processes and attentively coordinating professional teams to operate like clockwork. Let’s get your deal done!