Buying a distressed business can be an ideal option for clever entrepreneurs. However, it may also represent great risks and some potential issues since what you are buying is a financially troubled business. These problems almost never come when you buy a financially stable business, nevertheless, it is often worth the shot given the fact that you can buy a great business and business idea at bargain prices.

There are two possible scenarios for buying a distressed business. In the first scenario, the company has already filed the Chapter 11 and has already gone bankrupt. In the second scenario, the company hasn’t gone bankrupt yet but is struggling with its financial situation. In this article, Suzzanne Uhland will talk about buying a distressed business after it has filed the Chapter 11 because that could give the buyer some benefits in a short period of time, once the company has made it to the Section 363.

Related: Buying a Distressed Business: Ten Tips for Entrepreneurs

Section 363

When a sale is done under the Section 363, things may work better for the buyer. A company that filed the Chapter 11 has two options to sell its assets: selling the company as a part of a reorganization plan or selling it as a Section 363 sale. The first option is always going to be highly expensive since it involves a series of procedures within the company’s structure. The second option is the most commonly used one. It is faster and cheaper.

Some of the reasons that make a Section 363 sale so attractive for entrepreneurs are listed below:

Court Approval: In most cases, the court accepts the sale of every single asset without any difficulty. The sale is free and good to go, without having to deal with liens and liabilities. The only thing that is always clarified is that the buyer will need to assume all responsibilities that may be claimed by the company.

Fraud Protection: Once the bankruptcy court gives the green light, any possible fraudulent behavior will be barred.

Cherry Pick: The buyer will have the opportunity to choose which assets and contracts want to take from the debtor. This means it won’t have to “clean” overdue contracts and obligations. It will have the right to assume whatever it wants to assume from the company.

Speed Up the Process: In most cases, transfer takes places immediately and you don’t need to wait for shareholder approval or other laws.

Image courtesy of Eden, Janine and Jim at Flickr.com

“Stalk” the Bankruptcy Court

Under the Section 363, an auction is generally conducted in order to set the highest and best price for the company that is being sold and is able to repay some of its debts. This auction is conducted under the supervision of the bankruptcy court and the buyer will need to be a both a stalker and a bidder. This way, it will be able to know the terms of the bankruptcy approved by the court and will decide whether or not it wants to make a higher bid.

If you are “stalking” the court, you will have more chances of conducting a proper investigation during the diligence. Also, you will choose the price you want to pay and will be allowed to negotiate it under your own terms and conditions. However, the risk of being the so-called stalker is that you may bid too high with a number that may not look good during the auction.

You Shall Negotiate

When the company hasn’t filed the Chapter 11, the buyer simply needs to negotiate with the owner or board members to determine the terms, conditions, and price to acquire the struggling business. Nevertheless, if you choose to buy a company that has already gone bankrupt, you will need to deal with all sorts of creditors, landlords, trustees, holders, and many other characters.

The buyer will need to understand how the capital structure of the company works, and which are its dynamics and variations throughout every process. It is very likely that during the process you will need to deal with creditors, as they need to give their approval to the Section 363 selling process, making sure that they will get their money back in no time.

The Bidding Process and The Purchase Agreement

Let’s say that the buyer was actually a stalker and did its research about the company. Then, the buyer should have proposed a purchase agreement that needs to be approved by the bankruptcy court over other documents given to the court by other bidders.

It is recommended to keep the purchase agreement as simple as possible and negotiate with the court every single detail of it. This way, the buyer should pay attention to the auction day, the bid deadline, the needed criteria for the bid, the matching rights, bidding rules to avoid overbidding, and be aware of the bidding fees and expenses.

* Featured Image courtesy of M C Morgan at Flickr.com