An M&A expert reveals the secrets to successfully buying and selling distressed accounts receivable management companies.
11/1/2019 10:00
Following is an excerpt from an article on mergers and acquisitions by Michael Lamm, managing partner at Corporate Advisory Solutions, that was published in the October issue of Collector magazine.
“Record debt levels and interest from financial buyers are driving M&A activity in the accounts receivable management industry today. In 2018, there were 30 transactions in the ARM industry valued at just over $3.4 billion. Comparatively, in the first two quarters of 2019 we saw 20 deals completed, collectively valued at over $1.1 billion.
There is a certain process that needs to be followed for companies interested in purchasing distressed ARM companies. Here, I’ll answer some questions about the steps involved and review some opportunities you might be overlooking.
What Drives ARM Companies into Distress?
While every situation is unique, here are a few common scenarios:
1. The company just lost a very profitable, big client. This could have been a first-party project or a traditional contingency client relationship that was a significant portion of its revenue, and the loss threw the business into a tailspin.
2. The company had a significant legal or compliance stumble. There have been many serious and costly issues arising from the Telephone Consumer Protection Act as well as state or regulatory actions. This could push a company into a tough position where it needs to make a deal quickly.
3. The company’s balance sheet could be upside down. A company can be overleveraged for a variety of reasons. For example, maybe it took on a lot of debt when the owners purchased the business or financed a portfolio. A financial hiccup or decline in collection performance can put the company into a tough cash flow position.
How Can Buyers Structure a Deal to Protect Themselves?
There are a few things to keep in mind when purchasing a distressed asset:
1. If the distressed company is having financial issues, there may also be compliance problems. For this reason, buyers should consider looking at an
asset rather than a stock deal. This helps to avoid any skeletons in the closet the purchaser may be walking into or inheriting. While a stock purchase may have a strategic reason, all else being equal it is advisable to buy assets in distressed situations.
2. Make sure the company is operating in trust and isn’t using client money to fund the business. This liability is an issue that will follow the purchaser after the business is sold. At the front end, assess whether the distressed asset is in trust or out of trust with any of its clients. If the answer is “yes,” hit the pause button. You might want to avoid doing a deal altogether because transferring the clients could expose you to a significant legal risk.
3. Figure out who has the client relationships. That person will be critical in transitioning the client base to the buyer. Make sure you are either locking into or assuming an employment agreement as part of the deal so clients will move over to you as part of the transaction.
4. Look at the balance sheet and liabilities. Instead of paying cash up front as part of the deal, there may be a facility lease assumption—some form of long-term debt that could be assumed by the buyer instead of paying cash up front.
5. Structure the deal in a favorable manner. Earn-outs are frequently used in distressed or turnaround deals. An earn-out in the ARM industry will typically be based on revenue rather than profitability because you will likely be consolidating the agency or debt buying operation into an existing facility. That’s why a deal based on revenue becomes much easier. Typically, revenue-based earn-outs look at one to three years of revenue, but you could go back three to five years depending on the negotiation and what is required to help close the deal. Many distressed asset deals focus on “pay for performance” and making sure the client operation can stay in place so the buyer can help turn the situation around and make a good return.”
Read more in Lamm’s article for examples of questions buyers should ask when working with a seller in the ARM industry and tips to stay focused on M&A trends. Lamm hosts the ACA Cast podcast series Leadership Fuel With Michael Lamm and can be reached at [email protected] or (202) 904-7192.
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