Buying distressed: microcap? Small businesses?
It is fairly common for the unsecured debt holders to end up controlling the equity as part of a restructuring.
- Does this ever happen with small companies? Can EBITDA companies access the unsecured credit market to begin with? Do small, local businesses get bought out of bankruptcy?
Another, separate question is,
2. Why do vulture investors tend to be financial buyers, rather than strategic buyers?
-Just to clarify distressed companies by nature of being 'distressed' will typically have relatively low or even negative EBITDA so the classification of EBITDA doesn't necessarily make sense in deciding what is small and what is not.... But to answer your question their is a thriving market for all types of PE shops that specialize in buying companies of all sizes... this forum puts in your head that only KKR or TPG matter when there is a very active middle and lower market space that buys private 'local' businesses
-If you're referring to issuing some type of high yield instrument i.e. 'junk bond' I'm fairly certain that cannot do this due to fact that there is a minimum size requirement for the bond issue... I have seen a lower middle market firm obtain some mezzanine financing, but I think this case might be atypical
-To give you an idea distressed companies that I have seen CIM's for that are typically 'lower middle market' will usually only have some type of senior revolver credit facility, some term or a shitload depending on when they got it ('07 let the good times roll), no sub debt and no mezz.... but this is anecdotal
Is there an upcoming trend in PE shops that buy small distressed companies as well? I'm going to start an internship in this kind of area (corporate recovery) soon.
There will always be financial players at the lower end of the mid-market/small-cap space, but there's a reason that most firms stick to true MM or large-cap buyouts. It's not twice as hard to buy a $50mm company as a $25mm company, and if you can raise a $500mm fund it's silly to use your time investing in 50 $5-10mm EV companies instead of larger buyouts. Small companies also come with their own headaches and risks such as non-professional management, difficulty in finding leverage, less likely to have franchise value, etc.
yeah but it'll be small enough so you can buy the revolver off the hapless senior prior to default and loan-to-own or if was originally a private placement and the holder doesn't want to deal with bankruptcy, same thing the key there is being able to recap quickly and make some operational headway before re-levering (if you can)
Small businesses generally won't have unsecured debt just due to their small size. Debt is typically just bank loans and any mortgages on the properties.
The same distressed debt investing idea applies though: buy the debt at a significant discount to market, so that if 1) the debt pays off as planned, you make a good return because of the discount you bought at, or 2) the debt defaults, you use your secured standing as a way to kick out the owners and take control of the business yourself.
Buying a distressed asset (Originally Posted: 09/12/2017)
When buying a distressed asset under liquidation, do you pay the creditors and take the property or do you make some kind of offer based on the assets value?
Thanks to both of you for the answers.
Could either of you explain the collateral/recourse in cases like this? The first poster mentioned revolving debt, but what would that debt be secured by? Mortgages on properties I understand, but then you're just left with an empty building if you foreclose. If it's inventory or equipment, then you're left with a machine and some inventory but nobody to sell it to. Don't you want the customer list? Until you take control of the LLC then they can walk away with the customer list and leave you with excess capacity and nowhere to utilize it.
Of course if these are dumb questions please tell me where I could find an explanation.
Bump
Downtown is right that small-cap companies rarely have unsecured DEBT but they often have unsecured liabilities, ie trade claims.
The number 1 cause of financial distress for small-cap companies in my experience is a lack of liquidity, and frequently small companies stretch their payment terms with their suppliers as a de facto form of financing.
Revolving debt to small companies can either be cash flow (ie no specific collateral package) or it can be secured by assets or inventory etc. Usually there's a borrowing base that governs how much the company can have outstanding, ie 50% of inventory.
It is possible for unsecured claims (trade creditors) to take control of a company, but it's not very common for a few reasons: 1) Small cap companies often end up liquidating rather than reorganizing: You make a case for there being "value" in a company with $1mm EBITDA due to customer lists, etc but companies operating in this space are often undifferentiated and can be quickly replaced by their clients, especially once there's a whiff of distress. Very few large or middle-market companies ever go into Chapter 7 but small companies do all the time. A lot of companies in this space are just shit companies that aren't worth anything.
2) Trade creditors are often disorganized and not prepared to act as rational investors in a workout: Unlike distressed debt investors, trade creditors usually just want to get paid and have little or no interest in trying to take the keys to the company.
3) Senior debt is often impaired, so any equity value goes to secured lenders. As noted, mortgages, bank revolvers and equipment loans are the most common forms of formal financing for small companies. However, an equipment loan from a specialty finance company to pay for a rapidly depreciating piece of machinery is often-times "impaired" as soon as it's underwritten, just like a car loan (as soon as it's off the lot, you can't recover your principal by seizing the car and reselling it). There's rarely much, if any value left for the trade payables.
Small companies do get "rescued" from distress by financiers, but often times this comes as a "recap," ie I come in and take out the existing debt, pay off the payables, and take over the company, rather than via a purchase of debt in the secondary market.
It's an interesting space because often times none of the stake-holders (for example a commercial bank and vendors) have any interest in owning the company, and unlike large, liquid issuance there's not much of a mechanism for an opportunistic investor to come in.
On your second question, re vultures: Imagine an industry where two companies sell one indistinguishable product, with a fairly inelastic demand structure. Due to mismanagement, one of these companies is in distress. If I'm the manager of the second company, the only reason I would have any interest in buying the distressed company is if I need their assets in order to produce enough supply to meet their share of the market's demand. Otherwise, I'm better off letting them go under and taking their market share organically. That's an oversimplification, and there are other factors (such as the challenge of integration, the headaches that come with dealing with a company that's been in distress, potential regulatory delays versus a financial buyer in a situation where time is of the essence, etc etc). Even with those factors, it does happen-for example a media conglomerate just bought MySpace, which is a distressed subsidiary, because they saw potential synergies for some dumbass reason.
Another note on trade claims: they're increasingly important in distressed situations. They're interesting because they can be a better deal than traditional unsecured notes for a number of reasons: the vendor may be a motivated seller, or they may be structurally senior to other unsecured claims (opco payables vs holdco unsecured notes)
Here's a pretty good blog post about that: http://www.distressed-debt-investing.com/2010/10/trade-claims-primer_26…
I'm no expert and actually just an intern at a distressed/turnaround PE shop, but from talking with the guys at this firm and given the current economic environment they see the volume of financially distressed companies continuing... not that it dies off there is just a lot more activity right now for obvious reasons
anyone have any insight how to find these companies? meaning as an individual investor, I would consider buying a company either in Chapter 7 or 11 for
[quote=dondraper85]anyone have any insight how to find these companies? meaning as an individual investor, I would consider buying a company either in Chapter 7 or 11 for
I can't say I've seen a bank sell an individual small-cap C&I loans, and if they do, it would be on a relationship basis.
In my experience financial buyers in the micro-cap space are much more likely to come in pre-bankruptcy and do a recapitalization than to buy debt and take a company through a workout. As mentioned before, the value of the companies is too low and any franchise/sustainable earnings power they may have are too fragile or too tied up in the owner's know-how to afford the cost associated with bankruptcy or survive an uncooperative change in control, and too often the creditors (including regional banks) aren't rational financial actors willing to work together. When this happens, it's usually because a capital provider was put in touch with the business BEFORE things got to the point of bankruptcy proceedings (though often the company is insolvent and has been kicking the can down the road).
Two good resources are local/regional CPA or law firms, who often serve as catch-all consultants to small business owners, and factoring companies, who lend against a company's AR. As mentioned, a major cause of distress for small businesses is liquidity and working capital constraints, and small-cap companies frequently turn to factors to accelerate their cashflow. Factors are often eager to get permanent capital in place with their customers as it reduces their collection risk, and usually have a wide network in the small-business world.
Kenny excellent point.
I work for a CA firm in Canada doing bankruptcy work. I agree 100% that by the time they get to us they are too far gone and the banks are uncooperative.
The question is how do I find the before.
As an aside, some of the smaller deals we see at my firm are relationship driven i.e. buddy from XYZ calling someone here and saying they saw XYZ deal; they're not interested, but we might be..
Some businesses have their own database where you can find the amount of bankruptcies during a certain time frame and the total amount. The firm in interning at this summer has build such a database. Where I live there are about 40 bankruptcies a week.
send it!
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