Understanding and managing the risks of an insolvent acquisition
OPPORTUNITY ARISES OUT OF ADVERSITY
The recent global financial crisis has seen consumers tighten their belts and the retail industry as a whole has faced increasing pressure. Profits warnings have peppered the financial pages and fashion retailers, in both the budget and luxury sectors, have been subject to formal insolvency processes.
However, for those fortunate enough to be in the position of buyer, the current climate can give rise to considerable opportunities, including:
- the ability to cherry-pick the business’ best assets without having to acquire its liabilities; for example the acquisition of prime retail sites and the ability to leave failing stores behind
- cost effective market growth
- the acquisition of direct competitors and key parts of their supply and distribution networks; for example, the acquisition of JJB Sports by Sports Direct
- the consolidation of an existing business in the sector
- the diversification of brands and
- the development of a multi-channel offering; for example, by acquiring an online or catalogue function.
Knowing your industry, your competitors and their financial position is key to being able to capitalise on any opportunities which present themselves. An appropriately structured offer by a purchaser with an established link to or knowledge of the retail sector and an ability to move swiftly can prove attractive to any insolvency practitioner appointed to deal with the sale of the distressed business.
UNDERSTANDING THE PITFALLS
While the acquisition of a distressed business can present numerous opportunities and the ability to bolster an existing offering at an attractive price, any purchaser should proceed with a certain element of caution and make sure that they understand the nature of a distressed acquisition to avoid any pitfalls.
Some of the key practical issues which should be considered by any prospective purchaser are set out below:
- Time is of the essence – Often any potential purchaser will be required to enter into a non-disclosure agreement when commencing negotiations in an acquisition. A distressed acquisition will often be completed in a matter of days (typically 1-2 weeks) from the point at which the non-disclosure agreement is signed.
- Cash is king – Administrators will favour a party who is able to demonstrate ready funds and an ability to pay cash as opposed to reliance on bank or third party funding.
- Due diligence – In order to structure an offer at the right level, you will need to understand the state of the business and what is on offer. However, the nature of a distressed sale means a limit on the amount of detailed and reliable current information available both in respect of the assets and the financial status of the business and a limit on the time available to review it. The lack of information and consequently, the increased risk for the purchaser, will typically enable you to negotiate a reduced price.
- Warranty/indemnity protection – A purchaser cannot expect the administrators to provide any warranties or representations (backed by indemnities or otherwise) in relation to the business or assetsbeing sold, nor will an administrator incur any personal liability in relation to the sale. The administrators are under a duty not to knowingly mislead or provide false or inaccurate information. The buyer will, nonetheless, be obliged to pay the full purchase price without deduction or ability to claim for losses where difficulties present themselves post-completion.
- Non-transferable assets – Some of the assets of the business, for example, intellectual property and operating licences, may be non-transferrable in their entirety or require the consent of any relevant counterparty. The purchaser should therefore consider carefully the value to the insolvent business of such assets and whether or not its existing business would be able to operate without them. The need to negotiate with any third parties will inevitably impact timing and could delay completion.
KEY STAKEHOLDERS – WHAT IS NEEDED TO RUN THE BUSINESS EFFECTIVELY?
It is imperative that any purchaser has a clear understanding of the main key assets required to run the business effectively following an acquisition. It may not be possible for the vendor and its administrators to sell and/ or grant access to such assets and a purchaser will invariably need to liaise with various stakeholders in this regard.
Two of the key stakeholders are:
- Landlords – The premises from which a fashion retailer operates are often key to the business and any purchaser may wish to retain the ability to operate from wellestablished, landmark stores. Such premises are not always owned by the insolvent company and are often occupied pursuant to the terms of a lease. Such a right of occupation is invariably non-transferrable without the consent of the landlord. While a landlord would usually be entitled to object to the occupation of the premises by a purchaser of the business, landlords are often willing not to enforce their strict legal rights on the basis that the rent for any period of occupation is paid, and they are often keen to secure occupation of the premises by a solvent tenant.
- Suppliers – A company’s suppliers can be critical to the day–to-day functioning of the business. When a company goes into insolvency, suppliers’ terms and conditions of business often permit them to take steps to protect their position, for example, terminating the supply contract. Suppliers are often in a strong bargaining position visà- vis the insolvent company and any potential purchaser. While the possibility of termination of critical supplies can be a great concern to a prospective purchaser, particularly, for example, if the supplier supplies branded goods critical to the business or an alternative source of supply is unavailable, there are a number of steps which a purchaser can take to secure the continuation of supply, for example:
- A transitional services agreement could be entered into for a short time post-completion of the acquisition. Under this agreement, the vendor and the administrators agree to provide or procure the provision to the purchaser of the service in question (this could include stock management systems, electronic point of sale systems etc.). This mechanism provides a purchaser with time to make its own arrangements inrespect of the relevant supply or negotiate its own terms with the supplier.
- The purchaser could agree to make settlement payments equal in whole (or in part) to any outstanding sums owed by the insolvent company to a supplier in return for the continuation of supply of goods or services, or the release of goods by the supplier to the purchaser. This may be an attractive proposition to a supplier as otherwise it would simply rank alongside other creditors of the company and would likely only receive a small “pence in the pound” return from the insolvency process.
- If time permits prior to completion of the acquisition and a supplier is willing to cooperate, the purchaser could seek to enter into a novation of the relevant supply contract. However, a purchaser will often wish to negotiate its own terms with the supplier so may not feel that this is the most appropriate course of action.
While there are a number of pitfalls for the imprudent purchaser of a distressed business, those savvy and well advised will be able to capitalise on the opportunities offered in this arena.