Hunting for opportunities in difficult times

Buyers looking to acquire a distressed business or assets therein need to be careful of making costly mistakes.

Few sectors have been left unscathed by the Covid-19 pandemic, and although it may affect the appetite for new business transactions, it will provide significant opportunities for ‘fast-moving’ buyers who have done their homework and are looking to acquire a distressed business or assets.

“We are already seeing buyers with strong market positions or balance sheets who want to capitalise on the opportunities available in the most challenged sectors, as well as in those who have performed well,” says Marc Yudaken, partner at law firm Baker McKenzie in Johannesburg.

But buying a distressed business or asset in times like this carries huge risks, as owners may want to sell before the buyer realises they are, in fact, boarding a sinking ship. There are, however, those owners with good businesses who have simply lost their nerve and want out.

Although there are no hard and fast rules,“good businesses” are generally the ones that have maintained sound records and financial controls, have no claims against them and carry little inherent risks. It is also important to consider the financial statements of the last three years. A badly-managed business usually has outstanding tax returns (see box). However, if they are fairly up to date, it is a good sign.

Generally, corporate advisers, accountants, lawyers, business brokers and business rescue practitioners are the best go-to-people to assist with finding the right deal.

According to Tobie Jordaan, director and business rescue specialist at Cliffe Dekker Hofmeyr, a riskier business to buy may be one that is locked into onerous or long-term contracts, has claims against it, or is a party to a dispute.“One would need to measure the price against the value of the business – both present and potential future value – and the risks associated with the investment,” he says.

Madelein Burger, partner at Webber Wentzel, says it is important to focus on buying good assets rather than an entire business. When buying the entire legal entity, it comes with “warts and all”. If possible, it is better to “cherry-pick”.

“Even in good times, our advice will be to buy assets and some of the liabilities rather than the entire legal entity.”

Do the work

Buyers will need the right support in this time of unprecedented uncertainty, says Yudaken. “Due diligence investigations have always been essential to assess business vulnerabilities, but they will be crucial post-Covid-19,” he stresses.

It will be important to identify which Covid- 19-related questions could be relevant in the due diligence.

For example: Will the company remain capable of complying with existing contracts? Can any third parties terminate their contracts as a result of the pandemic?

The legal and financial investigations must include detailed reviews of a seller’s supply chains, an understanding of the geographic scope of operations, dependencies and business risks and legal rights.

Cliffe Dekker Hofmeyr director Rachel Kelly adds that a proper due diligence upfront can save considerable time and money for the buyer. The process typically starts with a checklist of questions covering corporate governance, assets, liabilities, funding, litigation, tax, employment and regulatory compliance.

The due diligence report should contain a description of the business and material risks for the transaction or the business, as well as recommendations on how these risks can be managed or mitigated, she says.

Burger says it is vital to consider the profit margins, the assets and historic values. In terms of the legaldue diligence, the buyer should consider all the contracts, bank loans, employee contracts and even environmental issues. “The aim is to identify the risks ... Do not be penny-wise and pound-foolish by saving on the right advisers at this time.”

Kelly agrees. 

While obtaining professional assistance will add to the overall transaction cost, it can also save buyers from making costly mistakes in the long run.
 Yudaken points out that a distressed sale is characterised by a compressed timetable, limited available information and invariably limited contractual protection for buyers. “Buyers need to be well-prepared, with experienced advisers, and they must be ready to act quickly. The success of the transaction depends on having real knowledge instead of relying on market perception.”

Deep discounts

Lara Kahn, turnaround specialist at Webber Wentzel, says more businesses are entering into business rescue. The upside for buyers is that they are buying at deep discounts. However, the risks include the absence of warranties and the speed at which the sale should be made (very little time for due diligence investigations).

She expects an uptick in transactions quite soon and companies with cash will find it a good time to buy. A successful business rescue process can rid the company of the “warts and all”, but it is quite expensive. “In most instances it is not suitable or affordable for smaller companies that are already in trouble,” says Kahn.

Stefan Steyn, senior business rescue practitioner at Business Rescue Partner, says the best buys are family-owned businesses. In most instances they are the easiest to turn around. It may be necessary to invest in the turnaround of the business. “It will be best to understand the industry in which you want to invest to ensure you are not being sold a lemon.”

He adds that a frequent mistake buyers make is not understanding the cash conversion cycle of the business, and then the business is undercapitalised. “You need a full parachute when jumping from the plane. It does not help if it only lasts three quarters of the way. It is the same as having no parachute.”

Read more
This article originally appeared in the 16 July edition of finweek. To read the full story, you can buy and download the magazine here.
finweel, july, 2020

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