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Thread: Taking over a bankrupt business.

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    Default Taking over a bankrupt business.

    Well, this goes in this category but not sure which of the three forum to post it. I guess this one's as good as the others.

    I am considering acquiring an existing but bankrupt business. The business is still in operation and, as long as the cash flow is positive, this bankrupt company could continue indefinately, I suppose - at least as long as the creditors allow it to.

    What are my options with regard acquiring it? Being bankrupt simply means that liabilities exceed assets. So, if I buy it, what am I paying for? I am buying a debt - doesn't seem very logical! Could the owners just sign the business over to me so that I assume their debt and they are relieved of the obligation? Might they actually pay me to take over their obligations?

    I've never dealt with a bankrupt business before so invite observations and suggestions.

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    Frederick,
    By bankrupt, I am assuming that you are referring to a chapter 13 bankruptcy where the debt was reorganized to allow for repayment. If that is true, was are the repayment terms?

    What are you hoping to get out of acquiring this business; the customer base, the business name, etc.?

    If the business truly has more debts than assets, would it be cheaper to start from scratch?

    If you do acquire this business, be sure that your personnel assets are protected. I would talk with a lawyer about your obligation and if your personnel assets are at risk.
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    Echoing a bit on what Nealrm touched on, if it's a situation of "Debt > Assets" then the biz is 'insolvent'. 'Bankruptcy' is a distinct legal concept, although the two are kissing cousins. The distinction is important, though, because in a bankruptcy proceeding the matter of which assets go to which claimant can be complex.

    There's money in distressed asset investing, but it's analogous to successfully tiptoeing past all the buried landmines to reach the pot of gold situated in the middle of the minefield. (First, of course, you've got to see that it's indeed a pot of gold sitting there, and not a basket of rocks. Distressed asset investors say they make as much money on the deals they walk away from, as on the deals they take on.)

    Very generally, most of the value in DA deals comes from a combination of ...
    1. Determining that the collection of assets is worth more alive (as an ongoing biz) than dead (sold at auction). Roughly, that the present value of the expected future cash flows exceeds the assets' liquidation value. And then...
    2. ...convincing the existing creditors to take a haircut. "If I take over the biz and run it, I'll pay off your debt to the tune of 70 cents on the dollar. Otherwise, you can have the assets, sell 'em, and you'll be lucky to get 30 cents on the dollar."


    It's hard to generalize the advice since the best answers have to be very situation-specific, but there is one common thread that's almost always true...you've got to find out everything you can about the existing debts, the creditors, the loan agreements (including lease agreements), and contingent--but not yet materialized--obligations. If possible, you (and/or your advisor) should become such an expert on the existing debt architecture that you know more about it than the other parties themselves. A number of reasons you'll wanna do that...

    For one, you've got to have a razor-sharp picture of how the assets would be divvied under various bankruptcy or workout scenarios. You don't want any nasty surprises here, after you've invested your coin.

    For another, you might spot an opportunity to purchase some of the debt at an attractive discount. In itself, that leads to a couple of possibilities. First, you'll buy yourself a seat at the creditor's table. From that pulpit your arguments might have more weight when you're convincing the other debtholders that it's in their best interests to let you run the business. Separately, and depending on the terms of the debt you buy, you might be able to convert your debt paper into direct ownership of the assets via (a) foreclosure; or (b) conversion of the debt into equity. A lot of companies have been taken over via this indirect "loan to own" dance.

    A by-product of this due diligence on the existing debt arrangements is an answer to one of your questions; namely, it's critical to see exactly where the existing owners stand under the current debt. Personal guarantees; exactly how much they're on the hook for; etc. You can't effectively negotiate with the owners until you know those answers.

    Sorry to ramble, Frederick. It's just a big topic, and hard to stop when you start chasing a thought . One final thing, though...if you determine that you or someone in your employ can run the show better than the incumbent ownership, it's certainly something worth looking into. Best of luck!

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    Frederick, I'll try to expand a bit later but as ArcSine said, it's a big topic.

    If the value of the going business exceeds the liquidation value of the individual assets, but the debts exceed the value of the business, there are ways that a buyer can purchase the assets without taking on liabilities:

    1. A formal bankruptcy proceeding
    2. An assignment for the benefit of creditors
    3. A UCC sale (if there is a secured creditor)
    4. An asset purchase

    All have their pros, cons and limitations, and have various legal issues. Also there are practical questions apart from the legal questions. You may be able to buy the assets without becoming liable to the creditors, but if the creditors who get burned are essential to the business (such as a key vendor whose product cannot be readily substituted), you may be under pressure to pay debts that you are not legally obligated to pay, in order to preserve the business.

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    Thank you for your responses. Yes, I'm realising this is a big subject. Here are a few pointers to explain where I am coming from--

    1. I am not looking to avoid the liabilities. I see the liabilities as part of the purchase price. viz, If the assets are $1 million and I purchase the assets, it costs me $1 million. And I would own a shell of a business. But if I accept the liabilities, I would buy the assets and liabilities together for $100,000, say. Now I would own an ongoing business.

    2. I am not looking to oust the present owners. They have experience and longevity in the business which would be useful in turning the business round. I would be happy for this process to help them get back on their feet.

    3. I am not seeking to shortchange the creditors. We will need them to continue the business and prosper. There is enough future business for us all to benefit from a change of direction.

    I am not your hardnosed "shark" investor, I am more of a magnanimous "rescue" investor. Zig Ziglar said it best: You can have anything you want in life if you just help enough other people get what they want.

    I know that to be true.

    How does that affect your thoughts?

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    1) On taking on the liabilities - Since you are taking on someone else's problems $100,000 in liability shouldn't equal just $100,000 in purchase reduction. You are taking a risk, and that risk needs to be addressed. Also, you want to make sure that these acquired liabilities do not jeopardize your current assets.

    2) It's good that you are considering keeping the current owners. However, the company is bankrupt and they were the ones in charge. For some reason this company failed while others didn't. You need to determine how much the owners are responsible for that failure.

    3) As stated above, make sure you know more about the debt than the owners themselves. Make sure that any repayment terms allow the company to grow.

    Last - Sometime help is an out reached hand and sometimes it's a kick in the butt out the door. The hard part is knowing which to use.
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    The updates are helpful, in terms of getting better focus....thanx.

    Re (1), you've got a good perspective on what existing debt actually represents. It can be an attractive method of financing the purchase. If you tried to buy the biz for cash, sans its current liabilities, the terms of the new acquisition debt that you'd need might be more onerous than simply taking on the existing debt as part of the purchase price (assuming you could get new financing in the first place). Especially if you can negotiate for more favorable terms (longer maturities; lower rate), which the existing creditors might be motivated to provide, if it means a better debt recovery potential for them over the long term, vis-a-vis liquidation.

    Re (3), first make a distinction between 'strategic' creditors (e.g., key vendors) and 'financing' creditors (bank loans, say). The vendors are probably a key component in any turnaround plan, and you gotta keep 'em happy. (OTOH, if the biz represents a large percentage of some vendor's revenue, you'll have some leverage there. And don't just assume that the existing vendor base represents the very best supplier set for the biz--it's likely, but you can't say for sure until you vet it.)

    With respect to the banks, et. al., getting them to accept (say) 65 cents on the dollar isn't shortchanging anybody, IF your takeover means the difference between them getting back 65% of the face of the debt, versus settling for 30 cents in liquidation. It's just typical in these situations that if the debtholders refuse to take any haircut at all, the numbers tend to show that there's not enough profit potential for the deal to make sense from where you sit. If you're gonna get them 65 cents instead of 30, they've got to make it worth your while.

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