Stressed-Deal Doing

There are many reasons why a professional investor would shy away from investing into troubled businesses. For example, if you need 12 or more weeks to do your due diligence, forget it. Stress normally requires moving faster than that. And if you want to be a remote minority investor, trusting prior management to deliver the turnaround results you need, then you will probably be disappointed with your investment returns.

Investing into stressed or distressed companies isn’t rocket science, but it’s a completely different planet to the “vanilla” world of traditional MBO transactions.

So what’s good about it?

In theory – if you can move quickly and do more challenging deals, secure in the knowledge that you have the right plan and the means to implement it – the pricing of stressed investment opportunities is very interesting.

The more aggressive the deal, the better the potential outcome on a price to value basis. For example, if pre-packs or other forms of insolvency mechanisms are involved in the transaction then a great many investors will rightly be frightened away. Even experienced specialist investors can come unstuck by, for example, underestimating the scale of retention of title claims, wrongly estimating continuing credit support from suppliers, getting stuck with deposit requirements from HMR&C, and so on.

Bad times push operators to the fore in place of intellectual, hands-off transaction engineers. Existing management in stressed businesses are very probably doing things wrong. And even if they are just plain unlucky to find themselves in trouble, their experience is unlikely to include the kind of robust approach to operational change and stakeholder negotiations that is required in this arena. The 100 day plan in such transactions is not merely a profit bridge, including a few strategic, operational and relationship tweeks. Far from it – you are very likely to see items such as closing factories, replacing a majority of the directors, fundamental changes to cost structures and product design and renogotiation of external commercial relationships. Decision making has to be done in real time and plans abandoned and rewritten when assumptions prove false – which is all the more likely when the deal has to be done in weeks rather than months.

Stressed deals normally allow controlling stakes to be obtained. Without such control, investor confidence that management will implement the kind of radical changes required will probably be inadequate to pursuade them to invest.

Clearly, this is not a territory for the inexperienced and poorly advised. But get it right and you can gain control of a profitable business with a good brand and/or product for a fraction of its subsequent value.

What’s the problem?

There are a few problems in accessing the good deals.

There is a lot of junk out there

Identify yourself as an investor into stress and you will be sent a lot of stuff by those organisations that take a shine to you. The problem is that most of it will be utterly useless and time-consuming to process.

“I know XYZ LLP”

Well maybe you don’t? You may know a couple of partners in a large firm of accountants, but each of those individuals is a micro-market with his own deals and favourite investors. Even his colleagues in London won’t send you any deals, let alone his chaps in Frome and Whitley Bay.

Reciprocity

Specialist investors tend to do most or all of their due diligence and not to use business consultants, simply because they have a lot of the skills in-house and are more used to using professional turnaround managers. So, when a great deal comes along, how memorable are these investors to the advising accountant? How much effort will he or she put into maintaining that contact?

The world and its mother

“If in doubt, send it to everyone”. This isn’t a bad rule of thumb for an advisor looking to avoid subsequent criticism of the completeness of his marketing the opportunity. The problem is that by the time you get your hands on the deal it may already have been flogged around the market for a week or two and someone is well ahead of you. This is probably more true with larger, higher profile transactions.

Dying on the vine

A corporate finance advisor tends to work on the basis of an instruction from the vendor. If he is not confident that the vendor will be in control at the time of a successful transaction or he thinks that there isn’t enough time to find a buyer, then that isn’t a transaction he will want to be involved in. This means asking for a big up-front payment - which a stressed business probably doesn’t have - or rejecting the instruction altogether.

The deal proposal may have been put together when there was still plenty of time for the production and circulation of a fat information memorandum, and where there was still a reasonable expectation that shares had a value. Months pass, no investor steps forward and the business gets close to a cashflow cliff. Often there is no mechanism to put such a deal back out to the kind of investors who would want it. The advisor has tried his best and failed – and that may be the end of the road.

The point is that while advisors will often be imaginative and fast on their feet, they have a living to make and a job to do. Like anyone else they will focus on the most profitable and lower risk work.

Because of this, certain perfectly decent opportunities (for specialist investors) never even make it onto the market.

The solution

What’s needed is a better market place so that opportunities can find their way to the right investors, without burying them in spam, and in a way that doesn’t cost advisors dearly in accessing, understanding and maintaining contact with the entire investment community. It’s a big and growing population - I personally know over 100 specialist investors of this kind – and that’s just professional investment organisations, excluding trade investors and individuals. I couldn’t even guess how many individual advisors are sitting out there in all the accountancy firms and corporate finance boutiques....

Well, watch this space because a little bird tells me that something interesting will be happening to this end in the very near future