This post is a follow-up piece to: Buying a Distressed Business.
Many large companies have definitely felt the pinch of COVID-19, but that’s only one part of the story. The pandemic has sent shockwaves through small businesses (defined as having less than 500 employees) that thrive in normal times. While individually these businesses are small, collectively they account for around 44% of U.S. economic activity and employ just shy of half of all American workers. Needless to say, the long-term drag on the economy from these struggles could be huge.
The disruptive nature of the COVID-19 pandemic has left some distressed owners longing to offload their burden. After what seems like a lifetime of restrictions, some business owners have been left with less of a desire to continue on. As a result, some have decided it may be time to sell their business at its current value rather than putting more money (and energy) into it.
With any level of distress comes an equal level of opportunity. While the fundamentals that we outlined in this post’s precursor still apply more than ever, let’s take a look at additional items to consider when evaluating the purchase of a distressed business.
Organize Your Financing
As touched on in the prior article, restrictions on traditional funding may apply when purchasing a struggling business. As such, you may need to seek out alternative financing sources should financing be the path you are considering.
Particularly in a distressed sale situation, a seller’s prevailing consideration will likely be: “How much time do I have to maximize value before it is too late?” As a result, in many cases, time will be of the essence in terms of getting a deal done. So it is better to have your funding in place prior to setting sail. Not only will this act as a differentiator for you compared to other buyers, but it will save you a tremendous amount of time and stress on the backend when you’re conducting due diligence and time is not on your side.
Companies that have suffered as a result of the pandemic may have taken on debt to keep their operations afloat. Many small businesses received a Paycheck Protection Program (PPP) loan- which is an SBA-backed loan designed to help businesses keep their workers employed during the COVID-19 crisis. Other forms of debt could come in the form of credit cards, private loans, etc.
To give the seller confidence that you are a serious buyer, it is important that your offer structure is clear and concise. Make it extremely easy to understand exactly what is included in the sale and what is not: the value given to each asset class, which (if any) liabilities are to be assumed and how much will be paid out, and when. This will help put you ahead of the competition from the outset. Further, the seller should be working simultaneously with their PPP lender in order to determine the protocol for forgiveness where applicable.
Look For Your Edge
When conducting your due diligence, reviewing downside risk is obviously important. Prospective purchasers need to uncover misunderstandings or errors in the company’s records and uncover any concerning trends that may not be immediately apparent. At the same time, however, purchasers should be looking for potential upsides as well. In some cases, these are upsides the seller isn’t even necessarily aware of.
In other words, you shouldn’t be chasing a deal simply for the fact of it being a bargain. Rather, you want to look for opportunities that are temporarily dormant and perhaps need a helping hand. A question to ask yourself is: how can I personally impact the outcome?
For example, a common trait among negatively impacted businesses during the pandemic is the inability to market and sell online in cases where companies are being forced to shut down over an unknown period of time.
Read the Room
All sellers, regardless of their company’s wellbeing, like to know that they are dealing with someone who genuinely cares about the business’ future. As such, your ‘north star’ as a buyer should be to establish trust with the seller as their involvement in the transitionary period will likely be your biggest asset. The absence of a transition between the buyer and the seller can seriously put the new owner in a risky situation, particularly if you have an owner that is well-liked on the way out.
It is also important to reflect on the staff as a whole. If a business is changing hands due to financial hardship (especially pandemic-driven hardship), the staff will likely be discouraged after enduring long periods of stress and uncertainty. This presents an opportunity for the new owner to step in and right the ship. Ensuring the team will receive stability and forward progress will go a long way. Doing this, however, takes strong people skills, empathy, and time commitment in order to instill confidence in your new team.
Distressed businesses can present great value- however, as a buyer, should you neglect to recognize the true reason(s) for the business’s struggles, it may cost you more than you bargained for.
While mismanaged companies definitely got hit harder in the pandemic, a lot of the damage had nothing to do with how well a company was operated. Rather, restrictions disproportionately hit companies where an in-person experience is integral to the business.
The point being, generally prospective buyers tend to be overly optimistic when purchasing a business. It is crucial to deeply understand the environment in which you are purchasing and that a decent amount of uncertainty still exists. The threat of future outbreaks is completely out of any person’s control and can drastically affect your investment. Building in a buffer and creating a worst-case scenario will allow you to project forward the risk profile of the company you’re setting out to acquire and how much runway you’ll need to weather another storm.