Approach turnaround acquisitions with due care

turnaround acquisitions

Economic changes wrought by the COVID-19 pandemic and other factors drove historic global mergers and acquisitions (M&A) activity in 2021. As a result, experts expect 2022 to be another busy year for dealmaking — and turnaround acquisitions.

In many cases, M&A opportunities arise when a business adversely affected by economic circumstances decides that getting acquired by another company is the optimal — or only — way to remain viable. If you get the chance to acquire a distressed business, you might indeed be able to expand your company’s operational scope and grow its bottom line. But you’ll need to take due care before closing the deal.

Turnaround acquisitions

Although so-called “turnaround acquisitions” can yield substantial long-term rewards, acquiring a troubled target can pose more significant risks than buying a financially sound business. The keys are choosing a company with fixable problems and having a detailed plan to address them.

Look for a business with hidden value, such as untapped market opportunities, poor leadership, or high costs. Also, consider cost-saving or revenue-building synergies with other companies you already own. Then, assess whether the return on investment will likely exceed the acquisition’s immediate costs and ongoing risks.

Successful turnaround acquisitions start by understanding the target company’s core business — specifically, its profit drivers and roadblocks.

Suppose you rush into the acquisition or let emotions cloud your judgment. In that case, you could misread the company’s financial statements or misjudge its financial condition. Ultimately, you may devise an ineffective course of rehabilitative action. Hence, many successful turnarounds are conducted by buyers in the same industry as the sellers or by investors, such as private equity funds specializing in a particular sector.

Due diligence

During the due diligence phase, pinpoint the source(s) of your target’s distress. Common examples include:

  • High fixed costs
  • Lack of skilled labor
  • Decreased demand for its products or services
  • Overwhelming debt

Then determine what, if any, corrective measures you can take. Don’t be surprised to find hidden liabilities — such as pending legal actions or deferred tax liabilities — beyond those you already know about.

You also might find potential sources of value, such as tax breaks or proprietary technologies. Benchmarking the company’s performance against its industry peers can help reveal where the potential for profit lies.

Another critical step in due diligence is identifying cash flows, both in and out. Determine what products or services drive revenue and which costs hinder profitability. Does it make sense to divest the business of unprofitable products, services, subsidiaries, divisions, or real estate?

Implementing a long-term cash-management plan and developing a forecast based on receipts and disbursements is also critical. Revenue-generating and cost-cutting measures — such as eliminating excessive overtime pay, lowering utility bills, and collecting unbilled or overdue accounts receivable — can often be achieved following a thorough evaluation of accounting controls and procedures.

Reliable due diligence hinges on whether the target company’s accounting and financial reporting systems can produce the appropriate data. If these systems don’t accurately capture transactions and fully list assets and liabilities, you’ll likely encounter unpleasant surprises. Moreover, you’ll struggle to turn around the business.

Mergers and acquisitions

Parties to a business acquisition generally structure the deal as a sale of either assets or stock. Buyers typically prefer asset deals, which allow them to select the most desirable items from the target company’s balance sheet. In addition, the buyer receives a step-up in basis on the acquired assets, which lowers future tax obligations. And the buyer gets to negotiate new contracts, licenses, titles, and permits.

On the other hand, sellers typically prefer to sell stock, not assets. Selling stock simplifies the deal, and the seller’s tax obligations are usually lower. However, stock sales may be riskier for buyers because the business continues to operate uninterrupted. The buyer takes on all debts and legal obligations. The buyer also inherits the seller’s existing depreciation schedules and the tax basis in the company’s assets.

Current market conditions will likely continue to generate turnaround acquisition opportunities in many industries. We can help you conduct data-driven due diligence and develop a strategic M&A plan that minimizes potential risks and maximizes long-term value. Contact our RRBB accountants and advisors today.

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