Buying A Distressed Tucson Business (Before It Goes Bankrupt)
In the Distressed Businesses page within our Listings on this website, we discuss some of the characteristics of distressed businesses, and lay out a number of reasons why buying a distressed business in Tucson could prove to be a sound investment strategy for you to consider. Businesses can become distressed for many reasons, and if some relief and resolution is not found for the underlying problem, once possible outcome is that they could end up in bankruptcy. In this article, we are going to talk about taking advantage of buying a distressed business before it gets to bankruptcy.
1. Perform Extra Thorough Due Diligence. Whether a business is distressed or not, performing a thorough due diligence is a central component of any aquisition from the buyer’s perspective. In the case of a distressed business, it takes on heightened importance because it is less likely you as the buyer will have any recourse against the seller should things not go as planned after the closing. That makes it essential for you to dig in deep to understand the reasons why the business in questino is distressed in the first place. Is it overloaded with debt? Did it lose several key players who took large pieces of business with them? Has it failed to execute on its targets due to incompetence, or because they were unrealistic? Without knowing the causes of the business’ failure, it will be nearly impossible to develop a comprehensive post acquisition game plan. If the business is totally hopeless, you may conclude that you’d only be interested in a post bankruptcy scenario. A qualifed business broker can assist you in this assessment.
2. Buy The Business Assets Only, But Not Stock (Equity). Whenever your’e considering buying a distressed business, it’s going to be important to have access to competent advisors, including those who can advise you on the tax implications of the different ways you might approach the transaction. In most instances, when you’re buying a distressed Tucson business, you will first want to look at the possibility of doing a deal that only involves the purchase of the business’ assets. There are several reasons why for this: (a) you could obtain an accelerated tax basis for the acquired assets; and (b) it may minimize your need to acquire unwanted liabilities of the distressed business for sale.
That said, if the business for sale is very distressed, there may not be any tax benefits to an asset deal. Nevertheless, it is prudent to pursue this angle of inquiry as far as you can until the seller pushes back. Of course, it is to be expected that the seller will push back strenuously and try to get you to acquire the entire company, problems and all. If you are able to do an assets only purchase, it is your surest safeguard in terms of risk and liabliity that you willl be able to avoid unknown or undisclosed liabilities of the business that derive from the stressed circumstances it finds itself in, including unpaid taxes, pending lawsuits, and ongoing fraud or negligence in the operation.
3. Do Your Best To Avoid A Fraudulent Transfer Challenge.
If you try to buy the assets from a distressed business prior to it eventually filing for Chapter 11, you need to be aware that you may face the risk of a fraudulent transfer challenge. There are several classes of fraudulent transfer challenges covered by federal law, state law and/or the Bankruptcy Code. The first is called “actual fraud,” and can be claimed when dissatisfied creditors or a bankruptcy trustee can show that the sale of assets (to you) was conducted in order to hinder, delay or defraud the seller’s creditors. The second, which can be easier to claim, is known as “constructive fraud,” in which case the creditors will try to show that you acquired the assets for less than fair market value or reasonably equivalent value and that the seller was either insolvent at the time of the sale, or made insolvent by the sale. or sale was made for less than fair consideration or reasonably equivalent value and the target was insolvent at the time of, or rendered insolvent by, the sale. Indeed, Section 544 of the Bankruptcy Code empowers bankruptcy trustees to utilize applicable state law to void such asset transfers for “reach-back” periods of six years or more.
So, how can you protect yourself from a transfer fraud challenge if you’re the one buying a distressed Tucson business? First, do everything possible to get a third party validation (from a bank or business valuation expert) to show that you paid “fair consideration” or “reasonably equivalent value for the distressed business’ assets. Second, structure your purchase so that the terms of the deal specify that the proceeds of the sale stay within the Seller’s company as opposed to being distributed to shareholders or partners and insist that arrangements be in place that ensure the Seller’s creditors will be paid off.
4. Don’t Allow For Time Between Signing And Closing.
If you’re considering buying a distressed Tucson business, and go so far as to sign a contract to buy one, then you need to close on it immediately. Do not allow for months or even weeks to transpire before closing, because the Seller could conceivably file for Chapter 11 during this interim period. If that were to occur, the Seller could reject the purchase agreement leaving you, the Buyer, with little more than an unsecured pre-petition for claim for damages that would likely be worth pennies on the dollar, if that.
The Seller, on the other hand, would still retain the right to “assume” the purchase agreement, thereby locking you into a deal that might suddenly not look so good if weeks or months have passed and the business may not look so good after weeks/months of the deterioration of the target’s business. Eliminate the risk of any of this happening by insisting that signing and closing occur simultaneously.
5. “Hold-back” or Escrow a Significant Portion of the Purchase Price.
In the event that the Seller of a distressed Tucson business files for bankruptcy after you have closed on the purchase of their assets, if you seek an adjustment to the purchase price, or indemnification of the entire sale itself, your claim will again be treated as an unsecured, pre-petition claim. In some cases, claims for indemnification can be completely disallowed if they are contingent at the end of a Chapter 11 process. Unless you have a guarantee from a creditworthy affiliate or stockholder of the Seller to make good on the deal, then the best way you as a buyer can protect yourself from this risk is to hold-back or escrow a significant portion of the purchase price. Escrow/ holdbacks are frequently used as part of deals, including deals involving healthy companies. By putting in place an escrow/holdback as part of your deal you are protecting yourself. In normal circumstances, 10-15% is the usual amount held back. But, if the company is distressed, the buyer should consider a greater amount, up to perhaps 25% or more.
We hope this information about buying a distressed business will be helpful to your efforts to buy a Tucson business. Give us a call at 502-909-8242 or contact us if you’re interested in further exploring the possibility of buying a distressed business. And, of course, keep an eye out for updates to our Listings page, which includes a link to distressed business listings that we may have from time to time.
If you’d like more information on this subject, please Contact Us.