The Anatomy of a Distressed Company Sale

Thanks to the economy, a growing number of mergers and acquisitions in the accounts receivable management industry are distressed deals. The sale of a distressed company offers the owner a chance to salvage the business or walk away from it with minimal or no liabilities, and a buyer may see a distressed company as an affordable way to grow through acquisition.  However, anyone considering the purchase or sale of a distressed company should understand the unique characteristics of this type of transaction.

These companies are not valued the same way as a company in good financial health.  The structure of these types of deals is also different, as is the timeframe to complete the transaction.

Valuing a Distressed Agency
Agencies that are profitable and experiencing sustainable top and bottom line growth are typically valued as going concerns based on a multiple of adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization – then normalized for any non-recurring or excess expenses). However, agencies that are distressed are usually experiencing a consistent decline in revenue (net fees) and profit, are generating negative cash flow and have insufficient working capital. This may cause them to violate bank loan covenants and/or not be able to cover payroll, rent, or other critical expenses. Agencies in these situations are not valued as going concerns but rather, they are valued based on either their existing assets, the perceived value of their existing client relationships, or a combination of the two.

When valuing a distressed agency, a buyer needs to take a hard look at the agency’s balance sheet, the book of client business, the existing client relationships, and the staff that are managing them.  The buyer will also need to obtain the fixed asset listing – the desks, the chairs, the workstations and the technology that comes along with it. Licensing can be a value driver if the buyer needs to be nationally licensed and the distressed agency has these licenses in place and is in good standing. An assessment of all of these elements will be used to derive the value of the business.

Components of the Deal
The structure of a distressed deal is generally comprised of one or two components; 1) a cash component and/or 2) deal structure, usually in the form of retained equity or an earn out. The cash component is normally calculated as the discounted value of the assets and the licenses in place, however, distressed transactions tend to offer very little cash at closing for the owners.  The buyer may need to assume certain liabilities, such as facility or technology leases, or legal fees associated with current and pending lawsuits. These liabilities may replace the upfront cash component completely. 

The second component is value derived from future performance, which is provided to the seller in the form of retained equity or an earn out.  Typically, earn outs are limited to the future revenue or profit derived from the existing book of business, and are established for a one-to three-year period of time.  In some cases, the buyer might keep the owner on staff as a sales executive.  In this case, the former owner may get an employment agreement with a defined base salary, a commission structure for new business, and potentially some company benefits (healthcare, 401k, etc.) as well.  This helps a buyer to ensure a smooth transition and also enables the seller to have some participation in achieving the earn out.

Issues to Keep in Mind
If you are considering a distressed company acquisition or sale, be ready to move quickly! These deals have to get done in a very short period of time, often in less than 90 days. In some cases, the seller has literally two to three weeks before the agency runs out of money and is not able to make payroll.  While this puts buyers in a position of strength, a deal can only get done if the buyer is capable of completing due diligence quickly and working with the seller to resolve any legal and financial issues that may exist.

For buyers and sellers, it is important to work together to understand each other’s needs and expectations.  A buyer needs to understand all of the outstanding liabilities and potential red flags of a deal – including outstanding and pending legal issues – and the seller needs to be up front and willing to share this information with the buyer. A buyer also needs to have a plan to turn the company around or integrate the client business into another agency before consummating a transaction. As a buyer, ask yourself; what can you do with this company?  Is it a matter of cleaning up the Balance Sheet? Is it a matter of consolidating the operations and turning the owner into a sales executive to manage the book of business? If you wait until after a deal is done to figure out the answers to these questions, you will be taking on a lot more risk and having a much harder time making the acquisition work for you.

Michael Lamm advises owners on their growth and exit strategies for Kaulkin Ginsberg’s Strategic Advisory team. You can also read his other blogs/articles on insideARM.com.  Michael can be reached directly at 240-499-3808,  by email, or on LinkedIn.