Insolvency group KSA provides tactical advice to those thinking of expanding by buying a troubled business at a knock down price.
Be prepared to lose all your money. Yes, all of it. Buying a business out of administration or liquidation is a high-risk game. Of course, if you get it right then you can reap great rewards. But turning around a business is very different from growing an already successful business. A successful growing business has many features that can be nurtured by a cleaver entrepreneur. A failed business is a different prospect. There are often deeply entrenched problems that need to be fixed - and be especially wary if the company has been in difficulty more than once. It is not uncommon for investors to get burnt in this process so don’t even embark upon this journey if you’re not a risk taker.
What is the deal?
Firstly, the sale of an insolvent business is handled by an insolvency practitioner (IP), which will have been appointed either by the courts or by company creditor(s). Find out on what basis the insolvency practitioner has been appointed. Legal requirements and procedures vary depending on whether the business is in administration, administrative receivership or liquidation and you will need to research the differences between these states. Of the three options, administrative receivership is the more complex, but due to changes to the Enterprise Act in September 2003 these are becoming less common. However, in most cases, the business sale will be handled by a qualified chartered surveyor who is instructed by the IP to value the assets and achieve a quick but fair sale for the creditors. The IP is not an expert at selling businesses so this is best handled by specialist firms.
Find out what is included
As previously mentioned, when buying an insolvent company, it is often possible to pick and choose the parts of the business you want. The downside of this is that it is not always clear what is included in the sale. Some assets, such as office machinery or equipment, may be subject to hire purchase or leasing agreements, which can be terminated when the IP is appointed. Likewise, computer software licenses supplied by third parties may well have ended when the company entered insolvency, and suppliers can reclaim stock. If the business premises is included, and if this is leasehold, you will need to check whether the landlord is prepared to offer you a new lease and on what terms. Retaining book debts will enable you to continue relationships with customers, but these may have already been assigned through factoring or invoice discounting.
What’s in a name?
If you want to purchase the goodwill of the business, make sure you are legally entitled to use the company name. Under section 216 of the 1986 Insolvency Act (restriction of re-use of company name), it is an offence for any director or shadow director to be involved in the company if any of its trade names are re-used. So if you retain senior staff, you need to know the procedures for complying with these regulations.
Assess the human cost
A second important piece of legislation to be aware of is the Transfer of Undertakings (Protection of Employment) 2006. This relates to the employees of the business, whom you will automatically assume when buying from an IP. Although there are certain legal loopholes where you can make redundancies if they are in the interests of the survival of the business, you need to prepare for the possibility that you may need to make substantial payouts in this situation. On the other hand, make sure you have not paid a high price for staff who will walk away as soon as a better opportunity comes along. You need to assess whether the human assets of the business will really remain committed to it, otherwise you are wasting your money.
Prepare to move quickly
Sales of insolvent businesses move very quickly, with most selling within a month of the appointment of administrators and a great many in a matter of weeks or days. To increase your chances of finding a suitable business, it is a good idea to write to all the main insolvency practitioners stating your acquisition criteria, the funds you have available, and that you are ready to move on suitable opportunities. This way, you may be contacted directly as soon as the administrators are appointed, giving you a valuable head start on buyers relying on announcements in the press.
Have proof of funds
It is important to have proof of your ability to fund the acquisition. Insolvency practitioners are frequently asked by people who have no funds to buy businesses. They have more optimism than money and you need both!
A high-speed sale also puts extra pressure on the due diligence phase of the deal, so it is sensible to have an advisory team in place so that when the ideal opportunity appears you are in a position to act on it. You need to examine exactly what went wrong with the business you plan to buy, and do your calculations for how much capital you will need to invest to turn the company around once you have bought the assets.
The following checklist should help:
• What, or more likely, who was the cause of the business failure?
• Has the cause been addressed?
• What is the market for its products?
• Is there a profitable niche within the market place for the company?
• Can it be viable if sales are lower and costs are reduced?
• Is it within easy travelling time for you?
• Is the existing management capable of running the company if you are not there constantly? If not, who will?
• What were the business’s objectives and do they match yours (for example can it be rebuilt and make good returns)?
Be emotionally drained
Use your head not your heart. Look at realistic forecasts for the business. Be sure that you can meld the two businesses together. Remember that the insolvency practitioner is not liable for any oversights during due diligence - once you have bought the business, any claims over stock ownership, etc. are your responsibility.
Clear the decks
Finally, when negotiating the price of the business with the IP, be aware that you may be competing with the existing management team, which is often approached first once the business has entered insolvency. To avoid a bidding war, try and negotiate a period of exclusivity to allow you to conclude the deal. On the other hand, remember that the IP wants a quick sale which he or she can justify to the creditors.