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Buying and selling companies or business units is common practice both during and after a crisis, serving, for example, to generate cash or restructure portfolios. After a period of many years during which corporate insolvencies steadily declined, they suddenly rose again in 2022, as did the number of companies in crisis. This shift was primarily fuelled by inflation-driven, cross-sectoral demand disruptions, as well as an economy severely weakened by the pandemic and fragile supply chains. The challenges of acquiring or divesting a business are fundamentally different once a crisis affects the transaction.
Companies are most likely to turn to distressed M&A following a liquidity crisis and the start of active restructuring. At this stage, it is important to accurately gauge the impacts of the crisis on the company, and often necessary to resolve or counter broadly divergent stakeholder interests. In many cases, companies have already resorted to debt repayment-related measures such as deferments, standstill agreements or working capital adjustments, representing the senior management team’s initial efforts to preserve liquidity in the midst of the crisis.
In view of the time pressure involved, anyone selling or acquiring companies engaged in crisis or insolvency proceedings must keep a cool head and constantly manage the various stakeholder interests involved, as well as any stabilisation measures already in place. It is also vital to pay close attention to the peculiarities characterising each phase of the crisis. Thus the pre-insolvency M&A process differs somewhat from the M&A process once a company actually becomes insolvent. As a rule, company owners engaged in pre-insolvency proceedings are actively seeking solutions, whereas a company that has become insolvent is primarily concerned with satisfying creditors. This is why, in the event of insolvency, all potential investors should be involved in the process.
A company’s cash reserves are critical to assessing its value and determining how best to manage the whole process – as are potential stabilisation measures that could buy time or provide a rationale for speeding up the process. Where companies have substantial cash reserves, the use of adjustments or normalisation procedures may make it possible to apply market price-based valuation methods, but frequently investors will instead apply liquidation values, i.e. insist on applying sale prices. Likewise, it is also important to carefully examine the ownership structure, because as a rule, certain fixed assets are not actually owned by the company (e.g. IP/retention of title). This issue often represents a significant challenge in insolvency cases. It is also important to note that many companies in crisis are characterised by poor-quality data and an inefficient controlling function, and are thus unable to address the above-mentioned issues.
By acquiring insolvent companies, investors can swiftly eliminate the causes of the crisis. To do so, however, they must first create a solid basis for future planning, and rapidly carry out a full audit of the company’s data. This is done by drawing up a restructuring schedule and identifying key information that may impact the company’s valuation and any resulting transaction. They may also have to identify the relevant financing requirements, while keeping in mind the fact that many companies in crisis experience a brain drain, as well as the probability that access to both management and workforce may be limited.
These issues must be addressed systematically by advisers with insolvency experience, as part of the due diligence process. Confidence among employees and potential investors must be restored by drawing up a resilient action plan. The insolvency toolbox makes it possible to mitigate any hidden risks which the buyer may uncover. To realise any commercial benefits that may be gained from a transaction, the investor must focus on such factors as licences, permits and customer contracts when selecting a suitable transaction structure. The next step is to choose the most appropriate structure for the acquisition, for example in the form of an asset deal, share deal (if an insolvency plan is in place), or the application of suitable restructuring measures. In the case of an asset deal, for instance, all liabilities are retained by the insolvent legal entity, i.e. not transferred to the buyer, whereas a planned insolvency process would include the purchase of the legal entity plus all related contractual relationships, licences and permits.
Whereas pre-insolvency workforce restructuring can be costly, many special rights apply once insolvency proceedings commence, including the special termination and option rights stipulated in employment contracts. The insolvency administrator can take advantage of these rights. One of the key aspects of an asset deal is the transfer of going-concern operations with the primary objective of protecting employees, which purposefully overrides the purchaser’s own business interests. In Germany, one way to avoid the risks associated with such a going-concern transfer is to engage a placement and upskilling company (Beschäftigungs- und Qualifizierungsgesellschaft, BQG), with the aim of devising a solution that is as socially acceptable as possible.
While a crisis represents an opportunity to acquire target companies at attractive prices and without legacy issues or liabilities, it does require a high degree of stakeholder management. Although there are generally no guarantees and warranties in insolvency scenarios, those parts of the business which are most at risk are generally not transferred but ring-fenced. Similarly, “political” reputational risks, e.g. as a result of restructuring allegedly at the taxpayer’s expense, as well as potential damage to the company’s corporate image or reputation among customers and suppliers, all play an important role in valuation, and can be addressed by, for example, an appropriate communication strategy. One key criterion for a successful transaction is a combination of rapid action with a pragmatic approach that aims to avoid time and resource bottlenecks on both sides. As far as the insolvency administrator is concerned, ideally a solution should be found by the time insolvency proceedings are opened and any insolvency relief payments come to an end.
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