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20 November, 2018
In situations when financing is tight, such as during recessions, corporations face difficulty refinancing existing debt or capitalising their businesses.
When faced with such realities, distressed corporations often turn to M&A transactions as a means of generating capital and exiting from non-performing businesses. In such situations, M&A transactions typically take the form of asset salesrather than mergers or share sales.
Asset sales are effective at helping sellers recover value from its assets, while allowing purchasers to buy over just the assets (which can still operate and create value) separate from the distressed seller. Buyers of such assets typically enjoy a price discount, arising from pressure on the seller to make the sale.
Assets sales by distressed sellers also give rise to some complexity in executing the transaction, but these are not unsurmountable with the right advice.
Despite some complexity, distressed M&A is often a worthwhile transaction for both the buyer and seller:
The buyer may benefit from gaining a performing business line (after alignment with its existing group), gaining market share by taking over operations of a competitor, or even just enjoying good value from purchasing discounted assets.
For the Seller, this may be the way to access funds to repay loans and forge a path back to growth.
Carefully Packaging the Asset Sale
Given that the sale would typically be at a discount, it is important for sellers to bundle the assets subject to the sale carefully. For example, it may not make sense to sell off an inventory of warehouse equipment without assigning the lease for the warehouse as part of the same package.
On the other hand, the buyer will be looking to maximise value, and it might wish to take over the workforce associated with the assets in order to gain a new business line rather than just purchasing the fixed inputs. For example, a buyer might want the warehouse staff as well as the warehouse equipment and lease.
Yes, asset sales can and should include an assignment of contracts associated with the asset and can include assignment of employment agreements as well.
Potential buyers and sellers should be aware and carefully package the deal to get the best value for both sides.
Dealing with Existing Encumbrances on Assets
Singapore does not have bankruptcy sale provisions similar to that available in the US Bankruptcy Code. This means that if any assets were pledged or given by the distressed seller as security for loans, these assets cannot be sold in liquidation. This is because the distressed company it is no longer beneficially entitled to such assets once it enters liquidation.
It is therefore crucial for distressed sellers to quickly work with creditors before a company is in the liquidation stage to identify and put valuable assets or business lines up for sale. This could be conditional on the creditor discharging the relevant assets from charges or other encumbrances. Typically, such creditors impose the condition that the sale proceeds of the asset sale will be used to discharge their outstanding debts.
If the distressed company is under judicial management, the judicial manager may also sell encumbered assets while being obligated to ensure that creditors are repaid from sale proceeds.
Limited Protection and Fast-track Due Diligence
Understandably, in a distressed situation there is not enough time for buyers to conduct complete and deep due diligence on the target assets. Therefore, it is important for buyers to work with advisers to ascertain and target key areas for due diligence. Much depends on the type of asset being purchased and the business in which it operates. Fundamentally, the performance of the asset or business should be carefully evaluated to assess whether it would be a worthwhile investment.
Unlike typical M&A, distressed assets would often be sold with limited warranties and indemnities, and often no escrow purchase price holdback. This is because the distressed seller is pressured to sell the asset to repay loans, and may not be in a position to provide extensive warranties or willing to chance that there may be an indemnity claim. As the funds are also immediately required to repay loans, an escrow holdback of the purchase price would not be workable.
Funding Distressed Asset Purchases
Debt funding for the purchase of distressed assets are not widely available, but there are several options available:
- Cash-flow financing from the purchaser's own account are the most typical option, particularly if the asset purchased are mainly intangible.
- Working with lenders to finance the transaction by using the purchased assets as security.
- Working with existing creditors of the distressed company to come to a financing package deal as such creditors are incentivised to recover value from such assets via a sale rather than continue to seek repayment from the non-performing seller.
Conclusion
It has been several years since the last recession, and many—from economists to soothsayers—are predicting that the next recession is due in 2019/2020.
In the event a recession hits, parties in a strong financial position may be able to go bargain hunting to come out of the recession with better market share, new product lines or an equipment refresh.
Distressed sellers should also be encouraged that there is potential to recover funds via an asset sale, which may provide much needed relief from economic duress and a possible return to a better financial position.
For further information, please contact:
Sandra Seah, Partner, Bird & Bird
sandra.seah@twobirds.com
