When a company begins to fail, it’s bad news for all those vested in the organization, including the leadership team, suppliers and investors. However, for those who specialize in buying distressed assets, it’s good news in the form of a potential opportunity. Whether the reason for the decline is bankruptcy, excessive debt or regulatory constraints, these entities are typically priced at less than market value, meaning there’s a chance to make a profit, sometimes a significant one. That said, where do you find the best possibilities when it comes to distressed entities? And how do you assess whether they’re a true bargain or a big mistake waiting to happen? Here’s what you should know before you make a move.
Where to Find Distressed Assets
When it comes to finding troubled entities, there are plenty out there. In fact, according to JPMorgan, there was substantial distressed activity in 2015 and 2016 ended with the 5th highest yearly default total on record. In 2016, 62 companies defaulted on $59.3 billion in debt, which is a 57% higher rate than the $37.7 billion of defaults in 2015.But not all these opportunities are created equal. You want a sound investment vehicle, not hassles and headaches down the line. To find distressed entities, there are a few reliable sources you can look to. These include:
Banks: Many distressed businesses are owned by a single bank or multiple banks, or a bank will be the key stakeholder. When a bank owns the business, the process can be longer and more complicated since they’ll have different priorities than those of a corporate seller.
Attorneys: Attorneys who represent the workout lender generally know which arrangements lenders want to exit from, how quickly and how much they’re going to ask.
IRS liens: A standard listing of business liens is published quarterly in the IRS Automated Lien System database. Information includes lien ID number, TP ID number, TP name and address, and lien status.
Accounting firms: Since they work on the finances of firms, they generally know who’s in good shape, who’s not and where future opportunities are coming from.
Challenges When Buying Distressed Assets
It comes as no surprise that there are many different challenges associated with buying distressed assets. It’s certainly not for the faint of heart. However, it can be a profitable investment strategy with the right approach; this includes being aware of some of the common challenges to expect.
One of the biggest involves timing. When buying distressed assets, you have to move fairly quickly with your decision. That’s not always easy when you don’t have all the facts and financials in place; however, in most cases, the owners of the leadership team don’t have the luxury of time.
Another sizeable challenge involves the owners and/or leadership team. They often view the company as having more value than what it’s really worth, even though it’s in a state of distress. That’s why performing thorough due diligence quickly – especially in terms of the financials and legal standing of the company – is critically important. Oftentimes, facts uncovered can bring the owner back into the realm of reality, so they fully understand the situation and what’s reasonable to expect in terms of offer price.