There is no denying that distressed mergers and acquisitions are a great opportunity for making significant profits, however, unless planned and executed with caution, they also have the potential to cause significant losses. However, there are ways to manage and mitigate these risks.

Identifying reasons for distress: Identifying root cause of distress is important to arrive at a fair valuation and it enables investors to analyze the cost of investment and the corrective measures required to turn around the target. It is also important to identify and differentiate between a permanent and a temporary distress while turnaround strategies. An investor would need to arrive at a valuation that is conservative enough to accommodate multiple risk scenarios, costs involved in the deal as well as the taxability of the transaction.

Selecting the right process: Investment in distressed assets can be either through a complete buyout, or of specific assets in isolation. In both these cases, it can be through negotiations with the company before default, a bankruptcy sale, or through a creditor-initiated sale. In Videocon’s case, for example, we will see a group sale of all distressed NPA companies either as a package or separately to different buyers, by the same resolution professional. When acquisition of the asset is agreed upon prior to the default, the structuring would be as if the entity was not in distress and the counterparties would be limited to the investee company and/or existing shareholders.

However, in the case of a bankruptcy sale or a creditor-initiated sale, there would be multiple counterparties including trade creditors, senior secured creditors, unsecured creditors and the decision of the insolvency tribunal, all with a differ­ent agenda. There could also be a hostile promoter or shareholders in the case of a creditor-initiated sale, which could further hinder the price discovery process.

Efficient due diligence: A distressed sale is often done on tight deadlines, so it is important to focus on the critical aspects of the transaction. Key contracts have to be reviewed to ensure there are no breach of terms, focus on the assets, including charges and facilities taken by the target. The due diligence should also cover purchase risks such as material adverse changes and change of control provisions. A distressed sale usually means indemnities, warranties and repre­sentations are fewer and narrowly tailored. It would be good to negotiate a hold back escrow. It is also advisable for the buyer to factor in transaction risks into the price.

Timing the deal: It is important to mini­mize risks in an acquisition and to identify and acquire assets before it is in default. This can ensure that the assets acquired are bankruptcy remote and not at risk of being clawed back by any subsequent cred­itor process. However, this is rarely feasible in a distressed sale through the National Company Law Tribunal.

Investing in a defaulting entity prior to start of insolvency proceedings, although a much more complex process that involves negotiations with creditors, is also an option. In comparison, investing in a company after initiation of insolvency proceedings carries fewer risks and provides clarity on the clear title of the asset as well as provide maximum leverage on valuation.

Strategizing multi-party negotiations: In a distressed deal, the buyer is often required to negotiate with multiple stakeholders including bankers, creditors, lien holders, customers, service providers, and asset reconstruction companies to understand the risks and arrive at an appropriate valuation.

This is much better handled in a corpo­rate insolvency resolution process under the Insolvency and Bankruptcy Code, 2016.

Read Less-