You can find distressed businesses in every industry. Some can be great opportunities, especially if they can be bought for a low price and infused with capital and managerial know-how to create better outcomes. Others should be avoided at all costs. In this article, we’ll help you make an informed decision about whether you should invest in these risky business opportunities.
What causes a business to become distressed?
There are lots of reasons businesses go into distress. Sometimes, it’s that they’re poorly managed. Others are up against poor market conditions or changing buyer preferences. They may be overburdened by debt or need capital to market, redesign their products, or update their systems or machines.
For prospective buyers, the reason matters a great deal. Some causes may be difficult to overcome; some impossible. But you could find some where it won't take much time, energy, effort, or capital to start generating cash.
How can I tell if a distressed business has value?
Due diligence will help you decide whether a distressed business is worth the time, energy, and resources you’ll put into it. Through the due diligence process, you’ll look for signs of value—and vitality—you can develop to bring life back to the business. Often, these signs include a loyal and diverse customer base, high-caliber employees, or capabilities that other firms don’t have.
And, as we mentioned above, you’ll also need to learn why the business is distressed. To do this, you'll look beyond the obvious symptoms the business is experiencing and find the source of its biggest issues. You might achieve this by pouring through the business’s financial documents. And, often, talking with the managers, employees, customers, and others can help you get more clarity.
Once you find the root of the problem, you might spot ways to restore the business’s financial, legal, or reputational health. Still, the purchase is only a smart move if the solutions meet these criteria:
- They're reasonable and attainable.
- They're financially sound.
- They have favorable odds of success.
- They can help you to address the core problem.
|Want to invest in a distressed business but the problems seem too big to take on? Consider another tactic. Look into buying the business's high-value assets, including its customer lists, intellectual property, or a profitable division, rather than the entirety of a business. |
This smart move can help you avoid assuming the business’s unwanted liabilities. It can also introduce some tax concerns that you’ll need to weigh before proceeding. A tax attorney can help you to understand the risks and benefits.
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How do I find a distressed business to invest in?
Few businesses will announce their distress, but there are some strategies that can help you find businesses worth investigating:
- Pay attention to changes in industry trends, costs of inputs, legislation, tariffs, licensing requirements, and prevailing ideas, and identify businesses that may be suffering because of them.
- Talk to lenders, customers, suppliers, competitors, and others in your target industry to keep up to date on who’s performing well and who’s struggling to stay afloat.
- If you already own a business, talk to your vendors and suppliers. Some may be facing insurmountable problems in parts of their business and be open to an acquisition. Consider any option that could be valuable to your operations, save your business money, or boost your business’s performance.
Guidance for moving forward
It can be risky to invest in a distressed business. Be sure to speak with an attorney who can help you understand the liabilities, judgments, and recourses of a distressed business and work through the complex process of acquisition, which might include negotiating with the business and its creditors, equity holders, bondholders, landlords, and others.
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An accountant will be an important ally to have you on side as you consider whether to invest in a distressed business. Lean on this pro's expertise to evaluate the business’s debt and taxation issues, examine revenue streams, and help you to determine the right offer price for the business.
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Is there anything else I should know before I invest in a distressed business?
It's more complicated to finance a distressed business than one that’s solvent. Traditional means of funding, including bank loans and SBA loans, may not be available to you. However, you might arrange seller financing or an earnout scenario that’ll help you reduce your upfront costs. You can work with your attorney or accountant to model these scenarios and find the option that’ll work best for you. Learn more about these options here:
Whether you choose to invest in a distressed business or purchase one that’s financially solvent, you’ll need to follow a specific series of steps to make your purchase a success. We can help you with every part of this process. Log into your owner’s portal for a free step-by-step guide to source and analyze businesses, negotiate terms, and complete your acquisition.