A distressed asset sale involves a business selling an asset at a depreciated value in a quick transaction. It typically occurs when a business needs cash immediately. A business may need cash immediately to help with cash flow problems or to pay off a debt and avoid the appointment of an administrator. A distressed asset sale allows businesses to increase their available funds quickly and purchasers to buy assets cheaply. However, a distressed asset sale comes with risks for both the seller andpurchaser. This article outlines key considerations for sellers and purchasers in a distressed asset sale.
Considering a Distressed Asset Sale
In the event of a distressed asset sale, the seller prioritises time and cash flow over return on investment. When businesses sell assets at a higher price, purchasers have the luxury to take their time and may be less inclined to purchase the assets quickly. A distressed sale, on the other hand, emphasises speed and encourages a quick purchase. However, a cheap sale may invoke fear in purchasers who wonder why a business is selling their assets at such a low value. Therefore, sellers should consider the potential reaction from purchasers and appropriately market the sale. Further, despite the need for speed, it is important to ensure the sale goes smoothly.
Sellers should consider the possibility that their finances may improve. If you are a seller, carefully consider whether it is worth having a distressed asset sale. Once you advertise assets at a low price, it is unlikely that a purchaser will accept a higher price for the same assets in the future. Further, when panicking about making ends meet and sourcing cash, you should be wary of selling valuable assets for low prices. If you sell a core business asset, your business may be limited from growing in the future. Selling key business assets is a commercial decision you should not take lightly.
Purchasing a Distressed Asset
A key benefit for a purchaser is the reduction in the purchase price of a distressed asset. A distressed asset sale sometimes gives purchasers the opportunity to acquire an asset that:
- may not have been available previously; or
- they may not otherwise be able to afford.
Purchasers should, however, be wary of rushing into a sale without undertaking basic due diligence. Some businesses may falsely advertise asset sales as ‘distressed’. Therefore, if you are a purchaser, you should ensure that the assets meet your expectations.
You should also consider the solvency of the company. If you do not, the business may go into administration after you pay a deposit and before you receive the assets. The interests of stakeholders vary widely, making it difficult for an insolvent business to come to a decision. Further, it is possible for a stakeholder to reverse a decision of another stakeholder. For example, a stakeholder may reverse the decision (of another stakeholder) to sell distressed assets to you. You should, therefore, avoid buying distressed assets from an insolvent business to minimise any risks.
Asset Sale Contract
It is important to have a formal asset sale contract in place for the transfer of assets. The speedy nature of the sale may mean that essential steps are skipped, which can cause problems later. A contract formally records key terms of the sale, including:
- who owns the asset;
- the date of the transfer;
- who has authority to sell;
- the representations made; and
- the price.
As purchasers often pay a substantially lower price in a distressed sale, they may need different warranties and indemnities to those used in a traditional asset sale. A purchaser should expect a reduction in warranties and indemnities, along with the low purchase price.
However, a purchaser should be very clear on basic warranties that are non-negotiable. A purchaser should also undertake due diligence, as any warranties may have a limited effect if the company providing the warranties is no longer around to follow through with them. It is best practice to ensure a lawyer drafts or reviews the terms of the contract to ensure you understand what they mean and what you should negotiate.
Due to the risks associated with a distressed asset sale, purchasers should ensure they undertake due diligence. Purchasers should also focus on the key elements that verify the value of an asset.
As a distressed asset sale favours speed for a lower purchase price, purchasers may not adequately undertake due diligence and, therefore, may not identify certain key issues. A purchaser should be clear on:
- who actually owns the assets;
- whether there are any encumbrances (claims) on the assets, for example, if another entity has a secured interest in the asset;
- if there are any third parties involved; and
- how the value of the asset was established.
Basic due diligence is even more crucial in a distressed sale because there may be a reduction in warranties (or they may be non-existent). Further, the seller (and proceeds from the sale) may not be around after completion of the sale should issues arise with the asset.
A distressed asset sale has advantages for both sellers and purchasers. Sellers have a chance to:
- use the proceeds from the sale to pay off debt;
- comply with debt covenants; or
- increase their cash flow to deploy in other, more successful ventures.
Purchasers have an opportunity to purchase an asset that may not have otherwise been available at a substantially cheaper price. However, the speed of the sale also brings about risks for both parties. Therefore, it is important for both parties to be clear on the process and key terms of the sale. Ideally, the parties should enter into a formal asset sale contract to minimise the possibility of a dispute arising.
If you have any questions or need assistance with a distressed asset sale, get in touch with LegalVision’s business lawyers on 1300 544 755 or fill out the form on this page.
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