Furthermore, because private equity firms buy only to sell, they are not seduced by the often alluring possibility of finding ways to share costs, capabilities, or customers among their businesses. Their management is lean and focused, and avoids the waste of time and money that corporate centers, when responsible for a number of loosely related businesses and wishing to justify their retention in the portfolio, often incur in a vain quest for synergy.
Finally, the relatively rapid turnover of businesses required by the limited life of a fund means that private equity firms gain know-how fast. Permira, one of the largest and most successful European private equity funds, made more than 30 substantial acquisitions and more than 20 disposals of independent businesses from 2001 to 2006. Few public companies develop this depth of experience in buying, transforming, and selling.
As private equity has gone from strength to strength, public companies have shifted their attention away from value-creation acquisitions of the sort private equity makes. They have concentrated instead on synergistic acquisitions. Conglomerates that buy unrelated businesses with potential for significant performance improvement, as ITT and Hanson did, have fallen out of fashion. As a result, private equity firms have faced few rivals for acquisitions in their sweet spot. Given the success of private equity, it is time for public companies to consider whether they might compete more directly in this space.
We see two options. The first is to adopt the buy-to-sell model. The second is to take a more flexible approach to the ownership of businesses, in which a willingness to hold on to an acquisition for the long term is balanced by a commitment to sell as soon as corporate management feels that it can no longer add further value.
GE would of course have to pay corporate capital gains taxes on frequent business disposals. We would argue that the tax constraints that discriminate against U.S. public companies in favor of private equity funds and private companies should be eliminated. Nevertheless, even in the current U.S. tax environment, there are ways for public companies to lighten this burden. For example, spinoffs, in which the owners of the parent company receive equity stakes in a newly independent entity, are not subject to the same constraints; after a spinoff, individual shareholders can sell stock in the new enterprise with no corporate capital gains tax payable.
Both public companies and investment funds manage portfolios of equity investments, but they have very different approaches to deciding which businesses belong in them and why. Public companies can learn something from considering the broad array of common equity investment strategies available.
Our expectation is that financial companies are likely to choose a buy-to-sell approach that, with faster churn of the portfolio businesses, depends more on financing and investment expertise than on operating skills. Industrial and service companies are more likely to favor flexible ownership. Companies with a strong anchor shareholder who controls a high percentage of the stock, we believe, may find it easier to communicate a flexible ownership strategy than companies with a broad shareholder base.
Many technology-based companies buy other companies that have the technologies they need to enhance their own products. They do this because they can acquire the technology more quickly than developing it themselves, avoid royalty payments on patented technologies, and keep the technology away from competitors.
Since market values can sometimes deviate from intrinsic ones, management must also beware the possibility that markets may be overvaluing a potential acquisition. Consider the stock market bubble during the late 1990s. Companies that merged with or acquired technology, media, or telecommunications businesses saw their share prices plummet when the market reverted to earlier levels. The possibility that a company might pay too much when the market is inflated deserves serious consideration, because M&A activity seems to rise following periods of strong market performance. If (and when) prices are artificially high, large improvements are necessary to justify an acquisition, even when the target can be purchased at no premium to market value.
Transworld Business Advisors is the world leader in the marketing and sales of businesses, franchises and commercial real estate. Whether you represent an acquisition-minded corporation, or are personally interested in owning your own company, Transworld offers the professional services that successfully bring buyers and sellers together.Broker of Record: Albert Fialkovich
Summary: Massachusetts-based Rockport declared Chapter 11 bankruptcy in May 2018, citing declining traffic to physical stores and a rocky separation from its previous owner, Adidas unit Reebok, as reasons. At the time of the filing, the company said it would potentially shutter all of its standalone retail stores, including 27 across the United States. Rockport agreed to sell itself to private equity firm Charlesbank Capital Partners for $150M in July. But that sale was halted when Reebok and Adidas objected to the sale, claiming $54M was owed to the shoe brands. The deal, however, was finalized in August, with Rockport agreeing to pay Adidas $8M from the proceeds of its sale. The company has since announced it will enhance its focus on its global wholesale, independent, and e-commerce businesses.
Buffett explained that he first invested in Berkshire Hathaway in 1962 when it was a failing textile company. He thought he would make a profit when more mills closed, so he loaded up on the stock. Later, the firm tried to chisel Buffett out of more money. A spiteful Buffett bought control of the company, fired the manager and tried to keep the textile business running for another 20 years. Buffett estimated that this vindictive move cost him $200 billion.
Warren Buffett's investments never include businesses he doesn't understand, which is both good and bad. Backing companies blindly is not a smart move, but shying away from them isn't wise, either. Partnering with someone whose strengths differ from yours can help you avoid missing out on great opportunities.
In his 2015 shareholders letter, Warren Buffett highlighted the depth of Berkshire's manufacturing, service and retail operations, noting that some businesses in the firm's portfolio have poor returns, and he considers those serious mistakes.
Now that we are technically out of recession, many businesses are still facing uncertainty in the face of a sluggish UK economy. However, there continues to be good opportunities for entrepreneurs to buy struggling businesses. Recently office2office plc acquired the assets and operations of the business process outsourcing (BPO) arm belonging to both The Print Factory London (1991) Limited and The DSR Group Limited, which have entered administration, for the sum of Â700,000. The business had a turnover of Â20m.
The initial increase in insolvency situations has receded somewhat, as companies have engaged in aggressive cost cutting. A total of 555 administrations were recorded for the first quarter of 2010, down from 1,028 in the same period last year. However, with government cuts on the horizon, conditions are still fragile.
So why buy a distressed business?
Only buy a struggling business if you understand exactly why it is in trouble and you know how to turn it around. Many products and services have a life cycle. If the product or service is no longer required at a level of need that enables you and your competitors to make a reasonable profit, why take on that struggling business and try to beat the odds?
Profitable investing in a distressed company is no different than investing in any other type of business. It requires selecting a business, that once stabilised, has a demonstrable demand for its product or service going forward, for at least long enough to maximise your return on investment prior to or at your intended exit.
So you must do your research, find out why the business is in trouble. Careful due diligence is absolutely critical in connection with a distressed business due to, amongst other things, the likelihood of limited or complete lack of recourse once the business has been bought.
So here are some important questions to ask:
Is the business overburdened with debt?
Are there any significant liabilities such as an adverse judgement or product liability claim?
Are any tax losses available?
Has the business lost key management?
Are its problems merely due to poor delivery or execution?
The ability to maintain the value of contracts going forward is essential. There may be restrictions on assigning contracts. Insolvency status may invalidate them and previous non-performance of contracts may incur penalties.
One of the main reasons that entrepreneurs buy businesses is the belief that they will be able to improve it. So a buyer needs to be sure that they have what it takes to achieve this. The business may have been run poorly only because management time was taken up by a problem in the recent past; so the current management are not incompetent, just distracted.
Of course, when buying a distressed business time is of the essence, so it is important that you have a full team assembled so that you can go in and get all the information that is required quickly.
An entrepreneur has two possible methods of buying distressed businesses: either he or she can buy it to prevent it going officially insolvent, or else wait until the business is declared insolvent and buy it from the insolvency practitioner. There are advantages and disadvantages of both methods. We published an article on how to buy a business out of insolvency in the September 2007 edition, which you can find on business-sale.com. Here we will look at more general aspects of buying a troubled business.
How to find a distressed business
A proportion of businesses up for sale are in some form of stress, as financial problems are often the catalyst that prompts the management to seek a sale. At the Business Sale Report, we have seen an increased number of businesses listed for sale with 500 new businesses listed in the last two months. Although these are not officially insolvent, there is a good chance that some of them are in a distressed situation. In addition to the regular listing of businesses in administration, we have started listing all businesses that have a winding-up petition issued against them. This is a precursor to the process of compulsory liquidation by the court.
In addition to these listings, you may consider contacting businesses via a trade association membership list, appropriate when a whole industry is in trouble i.e. estate agencies.
Specialist intermediaries are particularly useful if they have considerable turnaround expertise. If they know you, you will usually be treated as an important buyer prospect, particularly if you have previously demonstrated the ability to act decisively and close a transaction in an efficient and timely manner.
Investors should be prepared to sift through many bad opportunities, and also accept that for the good ones, there may well be a competitive bidding environment. If this happens, what, then, is the right price to bid? The value of a distressed company is often difficult to ascertain. The right price is going to be different for every bidder, because no two bidders:
plan to run the business in the same way
will affect a turnaround and stabilise the business in the same manner
know how the business will integrate with the other businesses they hold
have the same cost of capital structure
have the same growth plans or
share the same exit strategy
In the current climate, where lending is hard to come by and is only being offered on restrictive terms, the cost of capital is a key factor. Entrepreneurs who have large amounts of cash and do not wish to be highly leveraged are at a definite advantage at the moment. Less risk-adverse entrepreneurs are looking to finding better returns than 0.5% for cash.
So buying a distressed business can often have distinct advantages over alternatives. Start-ups always require more investment, in time and money, than is typically budgeted for. Moreover, there is often little or no track record of acceptability of the product or service. Profitable businesses have few reasons to sell other than to generate fast cash in excess of the net present value of the anticipated stream of the future cash. So entrepreneurs who are keen to rapidly expand their portfolio of business interests would be advised to take a serious look at distressed businesses.
Another opportunity that cash-rich entrepreneurs can exploit is the possibility that businesses might be divesting assets and divisions in order to improve liquidity. It is generally true that it is advantageous for the acquirer of a private company to purchase the assets and not the equity of the business for two main reasons: the tax advantages and the fact that you will not be inheriting all the liabilities of the business. However, some assets still have liabilities attached to them, such as contaminated land clean-up costs. Also, a purchaser may find him/herself exposed to intellectual property disputes on products. The entrepreneur will no doubt be under pressure from the seller to buy the entire company, but each situation is different and it is down to smart negotiation and good advice on structuring any deal.
In conclusion, if you have got what it takes to turn around a failing business, have cash in the bank or the ability to raise finance on good terms, then you are in a winning position. Cash is king. There are more failing businesses to choose from and fewer serious buyers in the market. This all leads to the prospect of rich pickings for a smart investor who is in a strong position in the market to grab market share as the economy slowly improves.
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