Is It Worth Investing In A Distressed Business?
In an already difficult economy, many businesses were facing a challenging 2020 even before the COVID-19 pandemic struck. This means that even if they have navigated the furlough scheme and have managed to re-open their business post-lockdown, the same problems still have to be faced.
However, a distressed business might still have some very attractive qualities, due to location, personnel or the product or service. Circumstances may have simply dealt them a bad hand, and therefore, investing in or completely buying-out a distressed company post-COVID can potentially appear to be an appealing opportunity. But you should approach this with caution and take good advice. So let’s start with answering a few questions.
What should I consider when looking at the health of a business post-COVID?
There are many different factors that you need to look at in order to consider whether the business is a sensible investment, or whether COVID is merely masking some deeper-rooted issues.
Try and obtain the management accounts for the 12 months prior to the pandemic to establish the real health of the business. This should tell you whether the business is struggling for other reasons, such as Brexit for example. Whilst on the subject of finance, has the business taken out some short term loans to navigate the pandemic? Such as bounce back loans or CBILS loans.
What is the potential cost of their return to work? Is the furlough scheme still in place? Will you need to deal with a raft of redundancies? This won’t be a pleasant start to your ownership and could be very costly, so establish the true position.
What is the general state of the industry? Could COVID have affected this industry more than others? If the business is in the hospitality sector or the arts, then the chances are that yes it has.
Are the premises leased or owned? When does the lease come up for renewal? In the new trading climate, would it make sense to downsize premises if leased?
Many cost savings can be made by streamlining processes and freeing up money tied up in assets, if they are being under-utilised. This would be a good place to start on efficiencies, rather than immediately looking at redundancies.
Should I buy all or part of the business?
There is no right or wrong answer on this, it really depends on your available cash, your circumstances and your ambitions. Purchasing a business outright might make sense if you can acquire it cheaply due to the existing circumstances, but you will become immediately liable for financially supporting the business.
Alternatively, you can avoid liabilities by acquiring only part of the share capital, as long as this agreement protects your investment by giving you the control you want. You could also invest in assets held by the company which carry a decent value.
Could I just loan money to the business?
Yes you can, but it needs to be worth the risk. So agree a decent interest rate to ensure you get a return on your investment and include a form of security to protect yourself. If you are lending money to a limited company, this security can be in the form of a personal guarantee or a debenture on the company.
Could I purchase the business premises only?
Again, yes you can, but you need to protect yourself. You can purchase the property – if the business owns the freehold – and lease the premises back to the business, ie. you become the landlord. This benefits the business as they get a cash injection, and benefits you because you get regular income and security from the lease agreement.
Can I just buy the company name and not the liabilities?
When a business is facing liquidation, it is possible to negotiate the purchase of certain assets, such as the trading name, the brand, the website or other assets, without incurring the liabilities. Naturally, this needs to be done right, so you avoid taking on huge debts.
Overall, there are many different ways you can consider investing in a distressed business. But there are plenty of pitfalls too, so always do your homework and always take professional advice.
Simple advice from Yorkshire Powerhouse
Have you any questions?
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