Troubled times for some companies may present an extraordinary opportunity for liquid, profitable companies. In 2009, almost 90,000 U.S. businesses filed for bankruptcy, a 38 percent jump over the previous year, and the number is unlikely to drop in 2010.

With numbers like those, companies interested in synergistic growth should explore the possibilities and pursue deals that make sense. Simply buying a distressed company at a “good” price won’t work. A successful acquisition requires finding the best opportunities, analyzing and investigating both the benefits and challenges, and selecting the best process to close the deal.

Identify the Opportunity

Limit your search to industries and, where possible, to companies you know well. There are two basic reasons for this. First, you are less likely to make a mistake, and second, you will probably be able to quantify the value of the acquisition to your existing business. Make it known throughout your industry contacts, especially suppliers who often hear and spread rumors that you are in an active search for companies that are in or near bankruptcy.

Due Diligence

This is less of a problem in an acquisition of a company in bankruptcy than in a traditional one. Assets purchased through bankruptcy are free and clear of hidden contingencies such as environmental liabilities, unpaid federal payroll taxes or warranty claims. The buyers are also free of cumbersome contracts such as pension liabilities, over-market leases and labor agreements. You also have more leeway in structuring the deal. For example, you may be able to buy only customer lists, useable inventory, only machinery that your company can use and favorable contracts.

Challenges

Although normal due diligence won’t take place, that doesn’t mean you don’t have to check things out. Remember, since they are selling under distress, “buyer beware” has more relevance than in a traditional acquisition. This is really where your industry knowledge comes into play. Rely on your connections and existing public databases, such as public court records involving the bankruptcy proceedings. You should already know the advantages to your company, but you should be prepared to learn about things you might not know that could be deal breakers. Was the bankruptcy caused by inadequate financing, bad management or industry contraction, items that could make it a great opportunity for you? Or was it caused by important customers leaving, a product flaw that you were unaware of and can’t correct or an inability to retain needed employees, things that might make the deal undesirable.

Finalize the Decision

With all the information gathered about the target, figure out whether this acquisition still makes sense for your company. Do not underestimate the cost of integrating new operations. There are different scenarios where the acquired expertise maintains its existing site than if it is to be consolidated with an existing facility. Relocation and disruption of personnel, new infrastructure costs, overestimated economies of scale and underestimates of contribution to gross margin are common to these transactions. You should make sure that the sum of all those issues and others do not outweigh the benefits you expect from the acquisition.

Once you’ve determined the acquisition is the right strategy, tactical steps to acquire the assets should be taken. In many situations, the best results can be obtained by convincing the bankrupt company to prefer you to be its favored bidder, commonly called a “stalking horse.” The stalking horse makes the first bid on the purchase price. Other bidders must go significantly higher to beat the “stalking horse” because if that bidder is not selected, the selling company must pay it a break-up fee. Thus, the incentive is great to sell to the stalking horse.

Even though much has to go right for all this to happen, the risk/reward ratio makes it worth the effort.

For additional information, contact Tom Bechtel at 800-229-1099 or email at tbechtel@cohenflorida.com