Tips for Acquiring a Distressed Business

One thing this rough economy has done is made strong companies stronger and weak companies weaker. We probably all know competitors that are struggling or businesses whose owners are ready to call it quits. Now if you're one of the strong companies considering buying a distressed company, there are a few things you should consider. Since there are plenty of opportunities in the market right now, having a game plan before you proceed can help you focus your efforts and get the best match in your acquisition.

Recently I visited with Benjamin Alexander, a corporate attorney with law firm Rutter Hobbs & Davidoff. He's been involved in many mergers and acquisitions. Unlike most attorneys, Alexander is trained as an engineer specializing in digital design, programming, and systems integration. Alexander has many good M&A stories to tell and a few stories of disappointment. Here are some of his tips:

1. Don’t get “auction fever.” People get excited and want to win. This creates a time pressure that makes the process more difficult.
2. Do your homework. Third-party due diligence is extremely important and can help you maximize your purchase.
3. Have a clear plan on how to make the assets work for you and to answer the question, “Why is it going to be different when you own it?” When you can articulate a good plan for how you're going to succeed with an acquisition, you're more likely to be happy with the end results.
4. Decide ahead of time how much you're going to spend. It's easy to overpay for a company that looks good at first blush.

Alexander believes you need to do as much due diligence as possible before any money changes hands. Even then he advises his clients to structure the purchase terms so that there are post-closing adjustments for diligence items that can't be addressed before the close (for example, often customers can't be contacted in a distressed sale until after the sale). In effect, some of the purchase price is paid as a long-term earnout. Alexander says one transaction he was involved in had a five-year earnout.

I asked Alexander if there were any trends in the M&A market that business owners and executives should know. He says buyers are being extremely cautious about acquisitions without thorough due diligence, regardless of the type of purchase. He frequently sees companies make a successful asset purchase to pay trade creditors to keep goods and services flowing. A little money paid to valuable vendors goes a long way to rebuilding goodwill.

One company that successfully acquired another that was going through tough times is Martinizing Dry Cleaning. Martinizing is a 60-year-old franchisor that targets upscale customers. Currently more than 160 franchisees operate over 550 stores in the United States and eight foreign countries.

Two years ago, Dry Cleaning Station approached Martinizing about an asset purchase. Both companies are franchisors. The acquisition by an affiliated company has worked well for Martinizing -- but there were a few differences in the way the two do business. Martinizing decided at the beginning to allow each franchisee to decide whether they changed their name. Most of the Dry Cleaning Station locations kept their current brand identity. Jerald Laesser, vice president of marketing and franchise development at Martinizing, tells me that his company is privately owned, too, and recognized that it "didn’t want to use the big stick approach.”

Laesser agrees with Alexander that due diligence is key to any successful acquisition, especially those involving distressed companies. In Martinizing’s case, they spent five weeks on due diligence. Laesser says he and the company’s chief executive officer, George Strike, sat down with Dry Cleaning Station's franchisees individually and listened carefully to each franchisee’s concerns.

Although Dry Cleaning Station is now owned by one of Martinizing’s affiliated companies, the businesses continue to operate their brands separately.

Sam Thacker is a partner in Austin Texas based Business Finance Solutions.

You may contact Sam directly at: sam@lesliethacker.com

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