What is a Distressed M&A?
A distressed M&A is a type of merger or acquisition (M&A) in which one company purchases another that has been weakened due to financial difficulties. The buyer typically performs a rescue because the target is not able to survive the market, and they do not necessarily want to be acquired themselves.
Fintalent’s Distressed M&A Consultants observe that in the US, distressed M&As are considered more difficult than other types of mergers as they may require approval from different regulators at both levels of government and also facilitate regulatory intervention into how companies should be operated. This definition includes deals that were initiated by private equity firms that purchase distressed targets so as to generate future returns on their investment.
Distressed companies are categorized in three major groups:
(1) “pre-distressed” (that have experienced financial difficulties but continue to operate, and whose likelihood of survival is high);
(2) “distressed” (that are not operating well and are considered on the brink of business failure, but which may be rescued due to their significant assets and prospects for rehabilitation); and
(3) “insolvent” (that exclusively operate at a loss, without the ability to generate enough cash flow to pay their debts, creditors and other obligations. Thus, these companies are typically liquidated by a third party).
Distressed M&As may be either leveraged or non-leveraged. Leveraged distressed M&As include leveraged recapitalizations and other similar transactions, in which a company borrows money to effect a merger. Conversely, non-leveraged distressed M&As typically refer to completed deals in which the two companies pay cash for the other’s own assets (directly), rather than borrowing for consolidation and reconstruction.
If a company has significant operating losses that are not easily reversed and which make it uneconomic or impossible to continue operating on current operations, then it is considered distressed. At that point, the company is considered distressed and an M&A transaction will be carried out to save the company.
Organizations that help distressed companies acquire other companies are called rescue operators. The acquisition by a rescue operator of a distressed company usually involves an “asset purchase”. Typically, if the parties involved in an M&A can agree on how much cash to pay for specific assets and liabilities of the target in order to create a financial package (usually referred to as equity or buyout) that allows the target to maintain its status as a separate legal entity with Title II tax-exempt treatment, then it is called an asset purchase. An asset purchase is different from a leveraged or non-leveraged distressed M&A.
In a leveraged distressed M&A, the seller will typically pay for all of the target’s outstanding debt, and depending on how much cash and how much debt, the buyer will pay between 0 (zero) and 75% of the target’s equity. If the seller has more debt than equity and all creditors approve, then the buyer will assume all of that debt.
In a non-leveraged distressed M&A, the buyer will typically pay cash for all of the target’s debt, and depending on how much cash, will pay between 0 (zero) and 100% of the target’s equity. If the seller has more debt than equity and all creditors approve, then the buyer will assume all of that debt.
In some cases, when a company is almost bankrupt but there is hope to regain its former standing in the market and earn profits again, there may be a private equity deal to purchase only some of a company’s assets. This would be referred to as an “asset-based” deal or “asset purchase”.
In a leveraged distressed M&A, the target will be turned into a bond or preferred stock company and its debt will be retired by the buyer. The target’s business is then destroyed, with the hope that a buyout of this lessor-related entity can be completed later.