5 Tips On Buying Distressed Businesses
Published 9:34 am 28 Aug 2019
Recent changes to the law make it possible for you to buy a distressed business and make it profitable. In this article, DG Institute founder and CEO Dominique Grubisa explains what you need to consider when doing this.
Failing startup businesses litter the road to business ownership.
That’s because it’s incredibly difficult to get a start-up off the ground and build some momentum. In many cases, entrepreneurs find themselves so stifled by debt that they just give up.
This has had an effect on the start-up founding rate in Australia, as Business Insider reports:
“The number of early-stage start-ups in Australia has fallen for the first time in five years.
According to the annual Startup Muster report, released yesterday, 12.5% fewer start-ups were active in 2018 than in 2017.”
This clearly shows that the idea of business ownership has become a frightening prospect for many people. When up to 90% of start-ups fail, why would anybody take the risk on a new venture?
The good news is that you don’t have to take that risk. Instead, you can buy a distressed business and turn it around to make it profitable. This allows you to use that business’ momentum to create something that benefits you.
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The Conundrum of Small Businesses in Australia
Australia’s small and medium-sized enterprises are the true backbone of its economy. They’re the reason why the country has a low unemployment rate of just 4.9%.
The government examined the contribution of these businesses. In October 2018, it published a paper on the Parliament of Australia website.
As of the end of June 2017, small businesses accounted for 44% of all employed people in the country. Medium-sized businesses accounted for 24%.
That’s 68% of the country’s total employed population.
The issue that these businesses face is that so many people aren’t spending the money that they earn on their services. This means the country has no inflation or growth.
The markets also play to larger businesses. This leaves small and medium enterprises as the forgotten ones in our economy.
What’s Happening in the Australian Economy?
The result of this issue is that there’s been a 20% spike in the winding up of companies and businesses in the current economy. Many become insolvent due to the conundrum mentioned above. Despite employing the majority of the workforce, they’re unable to maintain profitability.
This leads to businesses becoming insolvent.
Of course, insolvency isn’t the only reason why a business might wind up. In many cases, the owners have reached the stage where they’re ready to retire and move on. However, they struggle to find someone to take over the business.
This can result in them closing the doors to a solvent business.
Either way, this means that there are a huge number of viable businesses shutting down shop in the country. Even struggling businesses still have some momentum.
A Unique Business Opportunity In Australia
This increase in the supply of failing businesses available for takeover creates a business opportunity for you.
In July 2018, the government introduced new laws related to insolvency.
Previously, an insolvent business would have to throw up the white flag and cease trading. Even if they only had a temporary cash flow issue, it was enough to send them into liquidation or administration.
These new laws change that. If the business has a plan in place, it may be able to continue trading even when distressed to the point of insolvency.
That’s where you can come in.
Buying distressed businesses with the goal of turning it around and making it profitable is now possible.
These are the five tips that will help you to do it.
Tip #1 – Take Advantage of the new Safe Harbour Laws
The new legislation essentially creates a “safe harbour” arrangement for distressed businesses. This means that they protect directors, assuming that they have a plan of action in place.
The opportunity here is that this plan could be either direct or indirect. It may involve the director making changes to their own company. Or, it may involve them giving control to somebody else who can create a plan for the business.
The key is that they’re making a change. Take advantage of this to position yourself as the instrument of that change.
Enter the business as a turnaround expert and you will be able to take control of it.
Tip #2 – Pump the Brakes: Negotiate with creditors and keep the business flow going
Once you take control of a distressed business, it’s time to pump the brakes.
What this means is that you’re going to speak to the company’s creditors. You will tell them that you’ve taken over the business and will need some time to create a new structure. Those creditors will see you as somebody who could help them to get the money that they’ve chased the previous owner for.
As a result, they give you time to implement your plan.
During all of this, the business continues to operate. So, you’re pumping the brakes on the outgoings without stopping the flow of business.
This allows you to build some momentum and make some money. From there, you can negotiate new terms with each lender based on your control of the business, rather than the previous owner’s.
Tip #3 – Remember That This Business Opportunity applies to all types of registered businesses
You don’t have to limit your search when looking for a distressed business to buy.
This new legislation applies to any business that’s registered with ASIC and has an Australian Business Number (ABN).
However, it also applies to businesses operated under a sole trader structure that don’t have an ABN. This may be the case if the business has a GST turnover of below $75,000.
The point is that you’re not limited to certain types of businesses. You can acquire a sole trader’s business and evolve it into something larger, if that’s your strategy.
Tip #4 – Check for both types of Business Liabilities: undisclosed and undiscovered liabilities
In an ideal world, the previous business owner will disclose all potential issues to you during the sale.
However, that’s not always going to happen. This is why you must always keep the premise of caveat emptor in mind. This is a Latin phrase that roughly translates to ‘buyer beware’.
As a buyer, you need to inform yourself as much as possible before entering into a transaction. This is where your due diligence plays an important role. The onus is on you to learn as much as possible about the business before you buy it.
The key here is that you minimise the risk that you face before any purchase. In some cases, you’ll create a special purpose vehicle instead of stepping in and taking over directly.
Consider how you can structure the arrangement so that you face as few problems as possible.
Tip #5 – Maintain the Momentum of the Business
When you’re coming into someone else’s business, you have the chance to see what works and what doesn’t.
The important thing to remember here is that a body in motion stays in motion. You’re not looking to grind everything to a standstill so that you can reinvent the wheel.
Instead, take what works and build upon it.
Don’t treat this like you’re launching your own start-up. Maintain the momentum that the business has while working on improving its structure elsewhere.
Important questions to ask before you buy a distressed business
Is the distressed business overburdened with debt?
When looking at a distressed business for sale, the first thing you need to assess is the level of debt. When you take on a distressed business in many cases you are also taking on the debt in various forms. The definition of a distressed business is one that can’t pay its creditors as they fall due. So you will need to have a plan of how you could make the business work when you see a distressed business for sale. A distressed business for sale might be cheap, but it might not be good value.
Are any tax losses available to the distressed businesses?
While a distressed business might be overburdened by debt, if you have a plan to turn it around, sometimes these losses can work in your favour. Before you buy a distressed business for sale, seek out professional advice on if any of those losses can be carried forward for tax purposes in the future. That might give you another means by which to turn the distressed business around.
Has the distressed business lost key management?
Buying distressed businesses takes a degree of skill and one of the key things you need to consider is why is the business not profitable. If they lost a key manager who was holding the business together, then before you buy the distressed business, you need a plan in place to replace or improve those processes the business lost.
Are the distressed company’s problems due to poor delivery or execution?
Again this comes back to how the business became distressed in the first place. Many businesses are based on good ideas but become distressed by executing their strategy poorly and wracking up debt in a bid to make more sales. Be sure to assess the way in which the distressed business generates its revenues. If the business is distressed and burning cash, then you’ll need to have a plan as to how to execute more effectively than the previous owner or management.
Learn More About Distressed Businesses
The changes in the law have created some amazing opportunities for budding business owners.
You now have the chance to take control of a distressed business so that you can turn it around. However, there are some risks involved, particularly in regards to your due diligence.
Use the advice in this article to protect yourself as much as possible.
Lawyer, Asset Protection Specialist and Property Educator
Dominique Grubisa is a practising legal practitioner with over 22 years of legal and commercial experience. She is a property investor and developer, an entrepreneur with businesses in Australia and Southeast Asia, a speaker, educator, writer and published author. You may contact Dominique at firstname.lastname@example.org
This column has been written for general information purposes only. It is not intended as legal, financial or investment advice and should not be construed or relied on as such.