Judging from the recent spate of new entrants into the US turnaround market, more and more cash-flush investors are eyeing turnaround opportunities. But investors need to know exactly what they’re buying into, making thorough, timely due diligence a core component of any distressed deal.
Collin Beecroft, a partner at Boston-based law firm Ropes & Gray, warns that
Here, Beecroft notes some of the main issues to keep in mind when looking at a turnaround investment:
Timing: time, or rather the lack of it, is an important consideration in due diligence on any private equity deal. But when dealing with troubled companies, the stakes are even higher. “The companies don’t have much runway,” Beecroft says. “They’re already halfway down the runway, that’s why they’re distressed.”
For this reason, investors need a good, realistic idea about what is wrong with a company and what their turnaround strategy will be. Is it a simple matter of a liquidity crunch or are there serious structural problems with the business model? Can management be fine-tuned or are wholesale executive team changes needed? As Beecroft points out, as these companies are already in some degree of trouble, investors may not have years to implement their corrective measures.
The legals: the legal issues involved with a distressed deal are subject to the same time constraints as the rest of the due diligence process, but remain exceptionally important. Many issues that are essential to a turnaround strategy – particularly regarding pensions, real estate, contracts with management and workers – can, if not properly understood, destroy even the best-laid turnaround plan. For instance, can issues involving the company’s retirement plan and plant location be changed without going through bankruptcy court? Beecroft notes: “There is a lot of pressure on figuring out how quick these things can be changed.”
Business cycle: many experienced distressed investors are approaching the current market with caution –and being driven away by high prices: some take this as a sign that it might not be the best time in the cycle to make a distressed investment, another point raised by Beecroft. He says the key question here is this: “Part of the diligence process has to be, ‘when is it time to play and when is it time to pull back?’”
It goes without saying that due diligence is an important part of any transaction. But in the current market, a quality examination of a distressed asset pre-acquisition can mean the difference between owning tomorrow’s success story or something that will quickly deteriorate into becoming a distressed investment opportunity for someone else.