This time last year commentators were pointing at the huge amounts of cash distressed and special situations investors had at their disposal and the comparative lack of distressed assets to spend it on.  Tradeable distressed opportunities were in short supply.  A prolonged period of expansionary monetary policy, benign economic conditions and the effect of covenant-lite loan documents were conspiring to keep the number of restructurings down.  The events of the last three months look like they are going to turn this situation on its head and investors looking to acquire distressed assets are positioning themselves to buy on the sound of Coronavirus cannons.  This series of articles will show you how to prepare and take appropriate action when the time comes to successfully deliver the acquisition of a distressed asset.

As businesses start to contemplate life in the post-Covid world, we expect sale processes to be considered by many businesses as part of their assessment of strategic options.  For reasons that could range from poor short-term trading and insufficient cashflow to damage to a valuable brand from a prolonged sale process, sellers will look to execute quickly.  These processes are also likely to be extremely competitive as a consequence of well-run auction processes and the number of well-funded bidders in the market.  Bidders are likely to find exclusivity periods hard to secure (though some kind of preferred bidder status lasting two to three weeks might at times be available).  This combination of urgency and competitive pressure means bidders need to be well prepared at the point they engage with sellers and ready to satisfy their internal conditions to transact.  Let's look at how can bidders prepare to transact quickly when required.

Efficient due diligence 

In accelerated M&A processes, due diligence will have to be highly organised and targeted to be effective.  Well prepared teams are essential before the transaction clock starts ticking.  Scoping the diligence exercise early and thoroughly will minimise wasted time, seller frustration and adviser fees.  Selective use of the right due diligence technology can also pay off and we'll examine this later in the series.

Ultimately though, bidders may have to transact on distressed assets on the basis of less thorough diligence, carried out in a shorter space of time and bidders will need to be set-up to evaluate and price risks efficiently.

Legal, financial and commercial diligence will all need to adequately address the unique risks associated with the Covid-19 pandemic and those measures the target or people connected with the target may have taken in response to it.  These might include the use of the furlough scheme, changing employment terms or practices, measures to ensure the health and safety of employees and customers, borrowing under the various emergency Covid-19 loan schemes and deferring certain tax payments or requesting a time-to-pay agreement.  Later in the series we'll consider appropriate warranties, indemnities, and warranty and indemnity insurance protection on distressed acquisitions.

One strategy for reducing the risks of an acquisition is to focus on bolt-on acquisitions for existing portfolio companies, where financial bidders and their existing management team have already assessed the particular market and its conditions.  Many business plans anticipate growth through M&A and an existing investment may already have the funding available with which to do it.  As discussed later in this article, bolt-on acquisitions can also obviate the need to invest significant time building relationships with target management teams in circumstances where it is much harder to do so. 

Availability of funding 

Bidders with committed but undrawn capital from their investors will, more than ever, need to have regard to their capital call procedures and timings in order to be successful in the bidding process.  Bidders will need to communicate these requirements early in the bidding process, especially if they don't have capital call bridging or other facilities in place at a fund level that provide more instant liquidity.  Most private equity, special situations or other funds active in the distressed investing market will have facilities in place at a fund level, so any who don't may want to investigate funds finance solutions, as  having ready access to liquidity is essential in order to compete for distressed investments.  Although the pricing of fund finance solutions has increased in 2020, they can still mean the difference between being ready to close in time and losing out to a quicker bidder.

And bidders expecting to use third party debt to fund some or all of the purchase price will have another counterparty and its advisers to contend with, which inevitably reduces the speed at which an acquisition can be closed.  Bidders can counter this by closing on an all-equity basis and bringing debt on board after closing.  This is something we see regularly in M&A and private equity transactions, but is all the more relevant in distressed situations.  That said, debt funds are generally able to move more rapidly than traditional bank lenders.  In addition, bidders can sometimes obtain short-term loans (or use fund level debt financing) in order to bridge to a refinancing with a longer term debt package within 12 months.  Covid-19 has had an effect on pricing and leverage offered by debt providers, but the leveraged finance market is still open for the right sort of deals.

Socially distanced deals shouldn't prevent relationship building

Bidders should try to get to know sellers, market intermediaries and, where possible, target management teams as early as possible in the process for two reasons:  Firstly, and most obviously, to gain their trust in the hope that it will secure them preferred bidder status.  But secondly, to make sure the seller is going to follow through with the sale.  The seller has probably been forced to consider a sale because of the asset's poor trading, short or medium term cashflow issues or a broader change in the market conditions for its goods or services and will almost certainly be facing a realisation far below its previous expectations.  If the seller is hoping that trading will improve so that it can avoid selling the asset, the bidder faces wasted deal costs if such a recovery does transpire.  If such a recovery is truly out of the question, the bidder need not worry.  A common risk if the value of the asset is less than the seller's secured debt in the asset is that the seller is prepared to make its own credit bid for the asset, so this is another reason why understanding where the value breaks and what the seller's intentions are is key.

Unless the bidder intends to bolt the asset onto an existing portfolio company or make a wholesale replacement of the target management team (which is quite unlikely), the bidder will be reliant on that team to operate the business and deliver the business plan and to help any integration with existing businesses, at least in the short and medium term.  

Building these new relationships remotely or over the top of face-masks is likely to be challenging and bidders will have little time to achieve it.  Bidders should prepare the information that management will want to see about their typical incentive arrangements, track record and portfolio history. We anticipate that the difficulty in building new relationships in the present circumstances may make bolt-on acquisitions more likely.  It may also mean more sale processes are driven by creditors, who will be less interested in the relationships involved.

If you would like to know more about how we can support you, please get in touch. 

Key Contacts

Graham Cross

Graham Cross

Partner, Corporate
London, UK

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Peter Wood

Peter Wood

Partner, Private Equity
Leeds

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Andy Bates

Andy Bates

Partner, Restructuring
Leeds, UK

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Jan Gruter

Jan Gruter

Legal Director, Investment Management
Glasgow, UK

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Tom Crill

Tom Crill

Managing Associate, Corporate Finance
London

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