Business

How to Profit from Acquiring Distressed Businesses

How to Profit from Acquiring Distressed Businesses
Opinions expressed by Entrepreneur contributors are their own. Since the start of 2023, leading companies, including Vice Media, Virgin Orbit, David's Bridal, Bed Bath and Beyond and Jenny Craig, have filed for bankruptcy. More broadly, underlying economic conditions have resulted in a flurry of business failures, with a 77% increase in commercial Chapter 11 bankruptcy

Opinions expressed by Entrepreneur contributors are their own.

Since the start of 2023, leading companies, including Vice Media, Virgin Orbit, David’s Bridal, Bed Bath and Beyond and Jenny Craig, have filed for bankruptcy. More broadly, underlying economic conditions have resulted in a flurry of business failures, with a 77% increase in commercial Chapter 11 bankruptcy filings for the first quarter of 2023. Business failures across all industries have created uncertainty for investors but great opportunities for competitors and buyers.

Far from causing concern, entrepreneurs should look at this as an opportunity and follow self-made billionaire Warren Buffet’s advice to “buy when there’s blood in the streets.” Distressed companies can be acquired at a fraction of the multiples that healthy companies trade at and therefore offer entrepreneurs a unique and cost-efficient way to grow their businesses.

As CEO of a Nasdaq company, I grew by acquiring great distressed companies. The valuations were phenomenal – and each came with its unique challenges and opportunities. With a backdrop of more than 20 acquisitions, here are some lessons I learned during the journey to grow my business.

Before pursuing a distressed company, a few basic questions must be answered to ensure that the transaction makes sense.

First, is the valuation low enough and the potential upside high enough to compensate you for the risk that comes with acquiring a distressed company? The most attractive element of buying distressed companies is their price, and without a low enough valuation, the business shouldn’t be considered for purchase.

Second, does this business fall within your area of expertise? Buyers who don’t understand the business fundamentals of a market sector should be very cautious. Consider that the leadership of the distressed business presumably had more than a cursory understanding of their industry and opportunities but still failed to succeed.

Finally, what do you bring to the table that will enable you to succeed in turning around the business? You will need resources the owner didn’t have or a plan they never created or couldn’t execute to turn the business around and increase profits. Generally, the ability to turn a business around will rest less upon identifying great ideas you could bring to a company and more upon addressing the problems that caused the company’s current state of distress. You must act like a doctor and identify the cause of your patient’s symptoms before administering the cure. Generally speaking, the quality of your post-transaction team will drive your success, your ability to use technology and automation, and your ability to stabilize your customer base and exceed their expectations going forward.

Finding a business in financial distress that matches your area of expertise usually occurs through a broker specializing in distressed company transactions. However, finding failing companies through word of mouth, searching business information sites, or poring through online bankruptcy court filings in your area is also possible.

After deciding to pursue the distressed business, it makes sense to ensure you have a team that can succeed. You should consider the benefit of hiring a lawyer specializing in distressed business transactions. If the business is pursuing bankruptcy protection, you can start with a clean slate once the company is purchased and the deal finalized, but to get there, you’ll need to navigate a complex transaction with many moving parts successfully. Creditors’ concerns will need to be addressed, bankruptcy and auction time frames must be followed, and the judge overseeing the case will need to hear and approve your proposal.

Regardless of how you acquire a distressed business — through bankruptcy or a non-bankruptcy ‘firesale’ — performing thorough due diligence is critical. This will include talking with the company’s employees (so far as is legally allowed) to gain a better sense of the internal state of the company. It isn’t uncommon for employees within financially strained companies to begin looking for work elsewhere as they become anxious about the company’s future. However, you’ll need to find a way to retain the very best workers and align their interests with yours.

If the business is service-based, then speaking with customers (as permitted) and understanding their perspectives and intentions will be especially important. Customers generally can’t terminate contracts with companies during a bankruptcy proceeding, and the problems this can create for your potential customers as they wait throughout the bankruptcy process can destroy the business’s credibility with them. Customers who lose their goodwill toward the business may decide against the continued use of your service once the company resumes business under your leadership.

Acquiring distressed complementary companies can be a cost-efficient way to grow your customer base and revenues. However, buying distressed businesses comes with unique risks and rewards, so it’s important that you carefully assess the opportunities and assemble the right team to ensure success.