Distressed M&A differs from mergers & acquisitions under normal circumstances as time is of the essence in a bankruptcy or distressed situation and numerous dynamics are at play. Investment banks with prominent financial restructuring practices are well versed with distressed M&A situations.

Distressed M&A takes place on a tight schedule versus flexibility in a normal M&A situation where the deal can fall apart without major repercussions (concluding a strategic review process with no bidders). Given the time frame and due diligence that needs to be conducted to give bidders comfort, in theory distressed M&A should garner lower prices than a normal auction process.

Opportunistic buy side firms may also use this dynamic as an avenue to purchase assets cheaply, especially if there is an information gap. An experienced financial adviser/investment bank is able to narrow this gap – however, they are also sensitive to the reality that a deal may need to happen even below initial value expectations to maximize value for stakeholders.

Where Distressed and Normal M&A is the Same

As with traditional M&A, distressed M&A involves the seller and potential bidders coming up with their perspectives on value for the business or asset. This is trickier today in the COVID-19 environment given how tricky it is to forecast EBITDA before COVID, as well as whether or not that is a relevant number on a go forward basis (because COVID never ends).

All M&A processes involve choosing the appropriate bidder universe. The investment bankers will work with the seller in identifying who the logical buyers are and whether to restrict the process to a few potential buyers or to enter negotiations with just one or two logical choices.

How a potential deal will be structured is also important – whether as a sale of equity or sale of assets and in court or out of court. Consideration for the assets or company will also need to be thought over. Understanding the legal and regulatory approvals that will need to be addressed is in the mandate of the investment banker.

Loan-to-Own in Distressed M&A

Distressed debt trades at a significant discount to the par value of the debt. This also speaks to the dynamic where if the value of the company breaks in the debt, they are essentially equity and require equity-like returns.

When a major news item comes out, debt will trade to the downside or worst case scenario (as with all assets) as investors do not know how to value the debt without sufficient information and many institutional investors are forced to sell because the creditworthiness of the debtor/bonds no longer fits their mandate (what they are or are not allowed to hold – for example a bond fund that is not allowed to hold anything in default). Some investors may sell because they do not have the expertise or manpower to evaluate a specific special situation.

This provides an opportunity for distressed credit investors who look to purchase debt cheaply and then push for debt-to-equity swaps to take control of the company. Creditors already have an inside look for companies (especially private ones with access to financials and management).

Out of Court Distressed M&A Transactions

Generally, buyers in distressed M&A prefer sales that are through court processes. However, there can be benefits to an out of court transaction if there are no overhanging litigation risks and if other stakeholders are amenable (may need to sweeten the deal). This will usually involve a partial payout or exchange offer with the noteholders while secured creditors take over the company or the assets.

If this is the case, an out of court transaction can be effected more quickly and without the onerous costs of going through a court process.

In most circumstances, distressed companies do not just suffer from a balance sheet not being right sized but may also have a litany of operational and legal issues (as well as contracts that must be honored). Additionally, shareholders and bondholders may sue if asset sales are not to their value expectations or they do not receive a sufficient payoff.

In Court Distressed M&A Transactions

Section 363 asset sales are the primary vehicle for distressed M&A transactions. When the bankruptcy court approves of a sale process and addresses or overrules any obstacles to a sale, this becomes much more reassuring for potential buyers and therefore is more likely to garner the best value for stakeholders/creditors.

Asset sales under a Section 363 process are free and clear of any liens and encumbrances to give comfort to the buyer and absolved of fraudulent conveyance and other litigation risk. There is no historical debt associated with the assets sold and therefore the transaction is unburdened. Finally, through a bankruptcy process, the courts can repudiate or reject onerous contracts such as rent or infrastructure or supply which is no longer market – leaving a healthier company best positioned to continue as a going concern.