3 Risks and Rewards of Distressed M&A Opportunities

Distressed mergers and acquisitions (M&A) present a unique set of challenges and opportunities. For businesses and investors willing to navigate the complexities of acquiring financially troubled companies, distressed M&A opportunities offer the potential for high rewards at significantly lower acquisition costs. However, these opportunities come with inherent risks that require careful consideration and strategic planning. Continue reading to explore the risks and rewards associated with distressed M&A to decide if it’s right for you.

3 Potential Risks of Distressed M&A Opportunities

Before investing in a distressed business, consider the top three risks that you may face along the way.

1. Hidden Liabilities

One of the greatest risks in a distressed M&A deal is the presence of hidden liabilities. These can include:

• Pending Lawsuits: A company in financial distress may face legal challenges, such as unresolved lawsuits or regulatory penalties. Failing to account for these could result in significant financial and reputation damage post-acquisition.
• Environmental Risks: Distressed companies, particularly those in manufacturing, energy, or heavy industries, may have unresolved environmental issues. Clean-up costs or legal penalties related to environmental violations can be costly and unpredictable.
• Debt and Vendor Obligations: In addition to obvious financial liabilities, there may be hidden debts owed to vendors, employees, or other third parties that surface after the acquisition.

2. Integration Challenges

Once the acquisition is complete, integrating the distressed company into the buyer’s organization poses significant challenges. Key areas to consider include:

• Retaining Key Talent: A distressed company may already suffer from low morale or an exodus of key employees. Post-acquisition, retaining experienced talent to manage day-to-day operations or lead a turnaround can be difficult.
• Operational Restructuring: Often, a distressed business requires a complete operational overhaul, which may involve restructuring internal processes, cutting costs, and streamlining production. These changes can be disruptive and difficult to implement successfully.
• Cultural Integration: Merging two company cultures, especially when one is coming from a position of distress, can create friction. A lack of cultural alignment may lead to further employee turnover, reduced productivity, and poor communication.

3. Market Instability

Market volatility is another key risk in distressed M&A. A struggling company may be operating in an unstable or declining industry, which poses additional challenges for recovery.

• Industry Downturns: If the sector in which the distressed company operates is in decline, even an acquisition at a low cost may not be able to overcome the macroeconomic forces at play.
• Competitive Threats: Acquiring a distressed company in a competitive market may leave the buyer vulnerable to rivals capitalizing on the acquisition’s weaknesses or prolonged integration periods.

3 Potential Rewards of Distressed M&A

On the flip side, there are several incredibly appealing rewards associated with buying distressed companies including:

1. Acquiring Assets at a Discount

One of the primary attractions of distressed M&A is the ability to acquire valuable assets at a significant discount. When a company is in financial trouble, its market value is often depressed, creating opportunities for buyers to acquire valuable resources for a fraction of their normal cost.

• Asset Liquidation: Distressed companies may be selling off assets to stay afloat, offering buyers the chance to purchase high-value real estate, intellectual property, or equipment at bargain prices.
• Negotiation Leverage: Buyers typically have stronger bargaining power in distressed M&A deals. Sellers are often highly motivated to close the deal quickly to avoid further financial losses, giving buyers the upper hand in negotiations.

2. Market Share Expansion

Distressed M&A can also be a strategic move for companies looking to expand their market share or enter new markets.

• Eliminating Competition: Acquiring a distressed competitor can be an effective way to increase market share without the risks of organic growth or direct competition.
• New Customer Base: Acquiring a distressed company may give the buyer access to new customers or geographical markets that would otherwise be difficult or expensive to reach.

3. Opportunity for a Turnaround and High Returns

For investors and businesses with the right expertise, distressed M&A offers the potential for significant financial gains through successful turnarounds.

• Operational Improvements: By identifying inefficiencies and implementing better management practices, a distressed company can be revitalized, leading to a surge in profitability.
• Strategic Realignment: Turning around a distressed company may involve repositioning its products or services to better meet market demands, resulting in higher revenue and market share.
• High ROI: For companies able to execute a successful turnaround, distressed M&A deals can deliver high returns on investment, often far exceeding the initial acquisition cost.

Is Buying a Distressed Business Right for You?

Distressed M&A presents a high-risk, high-reward opportunity for companies and investors willing to take on the challenges. The potential to acquire assets at a discount and expand market share is enticing, but hidden liabilities, integration difficulties, and market instability require thorough due diligence and strategic planning.

To mitigate these risks, buyers must conduct exhaustive due diligence, carefully evaluate the distressed company’s financials, and assess potential legal and operational liabilities. For those who can successfully navigate the complexities of distressed M&A, the rewards can be substantial, offering the chance for both growth and high returns.

Ready to navigate the complexities of buying a distressed business for the purposes of expansion or value creation? Contact the team at SBB Capital Partners. Our experienced M&A advisors are here to help answer any of your questions and guide you.