With so many companies struggling these days, buyout shops who in the past haven’t considered turnaround situations may find themselves mulling over the possibility. One scenario that could provide entry is a previous target ending up in bankruptcy protection. In such cases, the due diligence that put the brakes on a deal during the boom can position a firm to capitalize on the bust.
Goodwin Procter LLP issued a client alert on April 28 detailing the nuances of acquisitions taking place under Section 363 of the Federal Bankruptcy Code, which usually involves presenting a negotiated deal to the supervising court wherein the acquiror, commonly referred to as the “stalking horse,” has already set a bottom for the ensuing auction process. The 363 sale allows a debtor in bankruptcy to sell assets under court supervision with the purchaser able to acquire the assets “free and clear of most creditors’ claims, with the ability to pick and choose which of the debtor’s contracts to assume and often the leverage to renegotiate deals with suppliers and customers in the process,” according to the alert.
Sounds good but it’s not as easy as that. The 363 sale has its share of quirks and conditions, not the least of which is the challenge of a strict time element. This is where that prior due diligence can come in handy. Goodwin Procter stresses the need for buyout professionals to “react in real time” as the process unfolds, noting the target’s financial condition, already uncertain, is especially vulnerable, as “vendors and customers may withdraw their business and employees may jump ship.”
Timing is also important when it comes to expressing interest in a potential deal. The earlier a buyout shop gets involved, the more it’s likely to find out about the target’s capital requirements, the expectations of the debtors, and the actual health of the business. This is where the pros and cons of assuming “stalking horse” status should be weighed. On the one hand, the shop that goes this route gets to negotiate some terms of the auction’s procedures, like the dates of key milestones; is usually entitled to payment of a breakup fee and/or expense reimbursement; and determines the form of the consideration to the paid for the assets in question, according Goodwin Procter’s alert. The potential downside is taking the lead in the bidding from the outset, and possibly overestimating outside interest. Again, having done the homework ahead of time will be a distinct advantage.
Ultimately, the 363 sale option has to be evaluated on a case-by-case basis. But it can prove a valuable tool, especially in cases where the firm has added insight from previous due diligence which, as Goodwin Procter points out, can allow it to speedily analyze the challenges in the target’s evolving capital structure, the prospects for business to improve, the ability of the existing management team, and even what kind of funding will be needed to get the target back on its feet.