What is Accelerated M&A?

Selling in distress - Accelerated M&A 

When a company gets into financial difficulty and creditor pressure grows its strategic options narrow very rapidly. With a clear eye to the interests of the creditors, it’s important that the directors try to maintain the value of the business before stakeholders take matters into their own hands and stop the company from trading either by commercial (eg refusal to supply) or legal means.

This note looks at some of the advantages and pitfalls of organising a sale of a business from a position of financial distress.

Accelerated M&A is a generic term referring to any sale of a business (or, less commonly, company) where time is short and the future of the company is in peril. Such sales can either be undertaken by the directors, or more commonly (because such sales involve risk for the directors and may raise conflicts of interest), organised by the directors but completed by a subsequent administrator. These are called pre-pack sales. We cover pre-pack specific considerations in this piece, but the principles discussed apply to all accelerated M&A sales.

Directors' duties and their strategic options when the company is distressed

The directors of a solvent, profitable company owe their fiduciary duty primarily to the shareholders, but when there is a downturn in fortunes the focus of that duty flips to the creditors, as the likelihood of any return to the shareholders diminishes. The directors then need to take action to protect the interests of the creditors so far as they can.

The strategic options for a failing business tend to fall into the following categories, broadly in descending order of turnaround potential: 

·       New Investment and/or compromise with creditors and trade out

·       Accelerated M&A

·       Administration followed by a brief period of trading in an administration with a view to a sale out of administration

·       Cessation of trade and liquidation

In this note we consider only the Accelerated M&A option but would be happy to debate the viability and pros and cons of each option with clients. 

First things first... is there a business to sell?

A business is any commercial activity which has the capacity to generate a profit. A business will have a value that is derived from its expected future profits which in most cases is greater than the value of the assets that the company owns (such as intellectual property, plant, stock etc).

So the first question is whether the business has made money in the past (and if so how much) and/or can it do so in the future and if so what needs to change?

The directors also need to consider what damage has been done by the financial distress.  All businesses need customers, contracts, suppliers, employees, know-how and management as well as physical assets. However if the company has not paid its suppliers, or has let its customers down, or lost its staff or know-how then, unless those things can be replaced, it may well have little or no value (and no prospect of finding a purchaser).

If this is a company with project or long term complex contracts (as is often the case with construction companies), those contracts will need to be novated or assigned on sale. This requires the formal agreement of the customer which needs to be negotiated before the sale takes place.

How distressed is the company?

If the distress is recent and creditors, while stretched, have taken no action either to repossess assets or to wind the company up, things are relatively straightforward. The difficulty comes when creditor actions need to be unravelled in order to achieve a sale. In extreme cases where a petition to wind the company up has been presented, a sale of the business, or any assets, may need to be validated by the Court before the sale can be completed. Unless an administrator is appointed to complete the sale.

At the time of writing, this is not such a problem in the light of the 2020 Covid legislation to prevent enforcement by landlords and petitions for winding up. It is unlikely however that these changes will last indefinitely.

What assets (and liabilities) are included in business sale?

It is the business and assets of the company we are talking about here, not the shares in the company. 

Typically, the assets will include the name, trademarks, intellectual property, contracts, fixed assets (plant and machinery, real estate, vehicles etc), and current assets necessary for the continuation of the business such as stock and work in progress. Debtors are sometimes included in the sale if there is a reason that it would be advantageous to do so (such as ongoing relationships with customers), but often belong to third parties under factoring or invoice discounting arrangements, which can complicate things.

The vendor may also be looking for a payment for goodwill, which is the additional value (if any) over and above the bare value of the assets being transferred reflecting the business’ ability to generate profit in the future.

There may be challenges to the ownership of assets because, for example, of the application of Retention of Title clauses by suppliers, and charges over assets securing loans which will need to be considered and dealt with in the sale process.

By and large liabilities remain with the old company to be dealt with in a subsequent insolvency process. There are some liabilities though which the purchaser will need to deal with either by law (eg redundancy and other employment liabilities which may have to be met by the purchaser under the TUPE rules) or because of commercial pressure (eg payments to key suppliers, arrears of lease rentals etc) .

Regulation of pre-packs

All accelerated M&A is sensitive and controversial particularly where the existing directors or the management team are the purchasers. In the case of pre-packs, the administrator may refuse to complete the transaction or at the least require further work which could result in the deal failing if time is of the essence.

Insolvency practitioners are obliged to comply with a range of Statements of Insolvency Practice (SIP’s). These include SIP16 which covers “Pre-Packaged Sales in Administrations” (pre-packs). The point of this regulation is to ensure as far as possible that the deal struck is in the interests of the creditors. There are certain processes that need to be completed and on which the administrator must report to creditors within seven calendar days of the transaction. It is important therefore that the company has its house in order when an administrator is appointed. 

The administrator’s report needs to cover the following ground:

·       Why the sale was undertaken, the alternatives considered and why the outcome achieved was the best available outcome in the circumstances

·       Marketing of the business undertaken

·       Details of the assets involved

·       A summary of the main terms and the date of the deal. This will specify the consideration and the terms surrounding the payment of the consideration, including any security for deferred consideration

·       The identity of the purchaser and connections with the management team

·       Independent valuation advice received and from whom

·       Efforts made to consult with major or representative creditors

Although the regulation stipulating these considerations only apply to pre-packs, ie sales completed by administrators, directors should bear them in mind in any accelerated M&A transaction.

Sales to connected parties e.g. directors or their associates

If the sale is to a connected party the administrator may decide to seek a view from the “Pre-Pack Pool”, a group of experienced and independent businesspeople as to the value of the business on which they will report.

Finally, connected parties should produce a viability review stating how the purchasing entity will survive for at least 12 months after acquisition. This should include an explanation of what the new company will do differently to minimize the risk of the business failing again. One of the most powerful arguments would be the introduction of new capital and/or a successful and strong corporate purchaser.

Conclusion

Accelerated M&A can be a very valuable tool in any turnaround because it has potential to:

·       Maximise recoveries for creditors;

·       Minimise creditor claims;

·       Offer continuity of supply to customers;

·       Maximise employment ;

·       Enable directors to fulfil their fiduciary duty to the company.

But it is complex, technically challenging and time consuming requiring a wide range of technical, commercial and legal knowledge and experience. We strongly recommend that if this is one your options that you seek professional advice at the earliest opportunity.