What is Distressed M&A

Distressed mergers and acquisitions (M&A) involve buying or selling companies, assets, or debt when a business is in financial trouble. Buyers often get assets or shares at lower prices because the company needs help.

Distressed M&A deals can happen through private negotiations or in court under bankruptcy laws. Unlike regular M&A, distressed deals are urgent. Sellers usually need cash fast to stay afloat or pay creditors. Buyers may be able to get assets without old debts attached, or buy debt to gain control through creditor rights.

Distressed deals can take the form of asset sales, stock purchases, or debt-for-equity swaps, depending on legal, tax, and business needs. These transactions usually offer few warranties or guarantees, so buyers need to do their own careful evaluation of the business.

What are distressed businesses?

A distressed business is one that cannot meet its financial obligations or is quickly running out of cash, often needing outside help to survive. Problems can come from losing customers, high debt, poor operations, regulatory issues, or sudden shocks. Distress can be mild, like cash shortages, or severe, like insolvency. Some businesses recover with new funding and better management, but others may go bankrupt or close down.

How to value a distressed business

Valuing a distressed business is not straightforward. Standard methods like discounted cash flow (DCF) are often unreliable because the future is uncertain. Instead, buyers usually focus on asset values and consider different possible outcomes. Two common ways to value these companies are:

• Liquidation or asset value: This approach estimates how much could be recovered if the company’s assets were sold. It looks at things like real estate, equipment, inventory, and intellectual property. This sets a minimum or worst-case value.
• Going-concern value: This method estimates what the company could be worth if it continues operating after a turnaround. It involves making assumptions about changes like cost cuts or debt restructuring and then projecting future cash flow based on those changes.

A pragmatic investor should consider several possible outcomes. For example, they might estimate a low minimum value and a higher optimistic value, then add a safety margin to cover risks. Other methods include adjusting book value for asset quality or comparing the business to similar companies, though good comparisons are rare in distress. Most buyers focus on asset values and adjust earnings-based valuations for hidden costs or unusual issues. Distressed investing stresses cautiousness and testing assumptions to avoid overpaying.

Factors to consider before investing or acquiring a distressed business

Investors and buyers consider several practical and strategic factors before engaging in a distressed M&A deal.

• Urgency and timing: Distressed sales usually move quickly. Buyers who act fast and decisively have an advantage. Delays can cause deals to fall through as value drops or stronger bidders appear. It helps to have decision teams ready and to research possible targets before the sales process starts.
• Stakeholder interests: Many groups can affect the deal. Along with shareholders, secured lenders, trade creditors, employees, and unions may all have input. Knowing what each group wants helps you make a better offer. For example, lenders might accept equity or other terms to keep the business running. It’s important to address these interests in your proposal.
• Price and structure: Sellers often want cash up front to get immediate recovery. Buyers can offer creative deal structures, such as cash plus equity, earn-outs, or seller financing. However, distressed sellers usually prefer certainty, so offers that pay quickly are more likely to succeed.
• Risk tolerance: Decide how much risk you are willing to take. In distressed deals, unexpected problems like lawsuits, environmental issues, or unpaid debts can appear. Some buyers use insurance or carve-outs to manage these risks, but buyers usually take on more risk than in regular M&A. Choosing to buy assets (to avoid old liabilities) or equity (to keep tax benefits) depends on your risk comfort.
• Turnaround plan and capital: A distressed company often needs more than just new owners to recover. Investors should think about what changes are needed, such as cutting costs, bringing in new management, or adding fresh capital. Check if the buyer has enough cash, credit, or expertise to steady the business. Deals with new funding or a clear recovery plan are usually preferred by creditors and employees.
• Legal complexity: Some buyers choose out-of-court sales for simpler paperwork. Others go through bankruptcy because it can clear ownership and reduce future legal claims.

Distressed M&A process

The process for distressed M&A can vary, but most deals follow similar steps. Usually, it begins with:

Finding distressed investing opportunities

Opportunities can be found through both public and private sources. Publicly, bankruptcy filings and court calendars show companies in insolvency. Distressed debt trading platforms and special situation funds are places where debt is sold. Investment banks, turnaround experts, and restructuring advisors often run auctions and notify buyers. Trade contacts can alert you to vendors or customers in trouble. Screening public records for signs like missed filings or big revenue drops is also common. Some sectors or regions regularly have distressed deals, and experienced buyers keep an eye on these areas. Online M&A marketplaces, such as Acquire.Fi, also lists distressed Web3 businesses alongside profitable ones.

Smaller deals are often found through local accountants, lawyers, or brokers who know businesses looking to exit quickly. Larger deals are usually managed by banks and follow formal processes. Some buyers buy distressed debt instead of assets, using creditor rights to influence sales or restructurings. Building strong relationships with advisors and lenders helps you find opportunities early, before they reach the wider market.

Distressed M&A due diligence

The next step is a quick financial and legal review to decide on a bidding range. In distressed deals, due diligence focuses on urgent and important issues. Since time is short, teams prioritize risks that could ruin the deal after closing. Key areas include why the business is in trouble, how much cash it has left, major contracts, supplier and customer concentration, employee and pension obligations, secured debts, lawsuits, regulatory issues, and tax risks. Buyers also look for quick operational improvements. The scope of diligence depends on the buyer’s plan and timeline.

Distressed sellers may not have complete records, so buyers use targeted checks like calling vendors, reviewing cash flows, and doing focused legal searches. In bankruptcy sales, some risks are easier to manage, but issues like fraudulent transfer claims still need careful review. The results of due diligence shape the bid, purchase agreement, and any conditions.

Because time is tight, due diligence teams use data tools and focus on the biggest risks. Modern buyers may use analytics software to quickly review transactions or customer data. They also consult experts, like accountants or lawyers, who have experience with similar cases. A good diligence process finds the main deal-breakers and checks if the turnaround plan can work.

Deal structure and mechanics

The last step is to structure the offer and close the deal. Buyers must decide whether to buy assets or shares.

Asset sales are the most common type of distressed deal. They let buyers choose which assets to buy and avoid taking on old debts. Stock purchases are less common because there is less time to check for hidden problems. Other options include credit bidding, where a lender uses its debt to bid at auction, and pre-packaged sales that combine a restructuring plan with a sale for faster court approval. Stalking horse bidders are often protected by break fees and expense reimbursements. Buyers also negotiate warranties, indemnities, and escrow accounts to manage risks after closing.

Financing a purchase can involve cash, new loans, or equity. Some buyers provide working capital or special financing early on to keep the business running until the sale. Lenders and buyers may agree on rollovers, credit bids, or new capital, depending on creditor support and expected returns. The best structure depends on the assets, tax effects, and protections against future claims.

If the company is in bankruptcy, the sale might use a Section 363 process or be part of a reorganization plan. Buyers in these auctions usually need to provide a deposit, show proof of funds, and prove they are qualified. Buyers also need to decide whether to buy just the assets, which limits old liabilities, or to take over the whole business.

Realizing value after acquisition

Getting a good price is just the start. The real value from distressed investing comes from what you do after buying. New owners often make operations leaner, cut costs, renegotiate leases, drop unprofitable products, and work to regain customer trust. Early wins include steady cash flow, reliable suppliers, and keeping important staff. The first 100 days are crucial to show the that deal was worth it. Success means meeting key goals and moving toward profit.

In the long run, buyers might reposition products, rebuild the brand, or add assets to their existing business. Turnaround plans for distressed business acquisitions should be realistic and focus on actions that have the biggest and fastest impact, since cash is limited. Some buyers plan to sell off parts of the business once they are stable, while keeping the profitable core.

Legal concerns

Distressed M&A involves various legal issues not common in normal deals. Firstly, insolvency laws apply: courts and trustees may review transactions for “fraudulent conveyance” or preference. For example, if a sale was for less than fair value or appeared to favor certain creditors, it could be unwound. Buyers should document fair pricing and sometimes obtain a fairness opinion to shield the deal from such challenges.

Directors and officers of the target must also be mindful of their duties. In many jurisdictions, managing a company on the brink of insolvency creates obligations to protect creditors’ interests. Sales must not look like the company was stripped of assets just before its collapse. In practice, boards often get independent legal advice and document decisions carefully during a distressed sale.

Contractual protections differ, too. Sellers often limit warranties and indemnities, so buyers take on more liability. Buyers may use insurance or demand escrowed funds as safeguards. In court-driven sales, buyers frequently get a “free and clear” transfer of assets (with court-ordered vesting orders), limiting successor liability. When dealing with cross-border transactions, it’s crucial to review foreign insolvency laws, securities rules, and tax issues so the deal structure is valid everywhere.

Labor and regulatory issues can also arise. For example, in some cases, the new owner must honor employees’ existing rights or pension obligations if the business continues. Any required approvals (from competition authorities, government agencies, or counterparties to contracts) should be identified early. In short, having experienced legal counsel is vital to navigate the special rules of distressed M&A.

Risk management and mitigation

Managing risk starts before making a bid. Buyers protect themselves by valuing conservatively, making conditional offers, and using tools like escrows or indemnity limits. They share risk with sellers through warranties and sometimes use insurance. In bankruptcy, buyers get court approval to clear liens or negotiate releases for uncertain debts. They also protect operations by keeping key contracts in place with transition services or short-term guarantees. Finally, buyers plan for integration costs and prepare for a quick exit if the turnaround does not work.

In distressed investing, buyers also consider timing risk, as any delay can further lower the business’s value as it spends cash. Many buyers prefer fast, simple asset purchases so they can choose only the parts they can manage and make profitable quickly. Credit bidders use their claims to get assets without paying cash right away, and some buyers offer earnouts based on future performance to close valuation gaps.

Practical checklist for prospective buyers

A simple checklist helps buyers act quickly and avoid missing key risks in distressed business acquisitions.

• Begin with a one-page summary of why the business is in distress.
• Check how much cash the business has left and who its main creditors are.
• Identify the three biggest legal risks that could stop the deal from working.
• List the contracts that need to be kept and note which ones require approval from others.
• Decide on your highest possible bid and plan backup options, like buying only assets or using credit bidding.
• Secure your financing or proof of funds before joining any auction.
• Finally, plan what you will do right after closing to protect customers, suppliers, and employees.

What’s the difference between distressed M&A and distressed private equity investments?

Distressed M&A and distressed PE investments often involve the same kinds of troubled companies, but the buyer’s role, intent, and structure are different. Here’s a quick comparison: