Gold Rush-Buying Pieces of Distressed Companies

The Daily Deal

October 23, 2002
by Alan J. Bernstein and Mark Finkel

In the chaotic aftermath of the late 1990's acquisition boom lies the opportunity for smart buyers to cherry-pick great technologies at next-to-nothing prices.

Chasing delusions of synergy, dozens of companies in the tech sector purchased private companies in the hope of bulking up for the IPO. Now, desperate executives are figuring out what their core business actually is — and rushing to get their noncore assets off the books yesterday.

The road to success for entrepreneurs seeking to capitalize on these opportunities is simple: Buy smart, operate smart and sell smart. The key is execution, and that will rest naturally on the quality of the team doing the deal.

First, buy smart. In sourcing deal flow, identify executives who may be sellers through industry conferences, personal networking and industry-focused research. Use your advisers to locate opportunities. Tell your lawyer to send an e-mail to the corporate department at the company to be on the lookout for the type of deal you seek. Your accountants should do this, too.

Buyers must be prepared to establish their own credibility. Sellers want to move fast and need to deal only with qualified leads who have substantial operating experience and demonstrable financial capability. They will know that an inexperienced buyer, or one lacking industry knowledge, will be more likely to tank the company, which will reflect poorly on the seller.

How do you avoid jumping at a deal too soon without missing the golden opportunity? One way is to state your criteria in advance. What is your price range? What distribution model and target market are you looking for? How cash-dependent are you, and what are your sensitivities?

As in any acquisition, understand why the business is being sold. Good answer: It's great technology, but it's a noncore asset and we need to focus. Bad answer: Few customers are buying, or it's obsolete.

Separate, divisional financial statements are a must. Do not accept excuses from the seller that he only has them for the entire company. If you don't have historicals, you will not be able to prepare meaningful projections, which means you will be flying blind.

The ability to determine projected cash flow is pivotal. If you can't readily do this, find another target. Understand the metrics of the sales pipeline: How many leads turn into qualified leads? How many of those turn into sales?

Financial due diligence should start with sales. Evaluate customer concentration, deal sizes, geography and channel. An interesting question is what percentage of quarterly sales is in the third month. If the answer is "a lot," the seller may be desperately stretching to make the numbers on the quarter, leaving the first month of the next quarter dry with attendant cash flow problems.

Determine early on if there are any dual assets — rights or technologies that will be needed post-closing by both the buyer and seller. In some cases a sublicense or separate agreement may be negotiated. If this is impossible, determine before closing if a quick technical fix is possible or if the asset can be independently sourced at a reasonable price.

Then operate smart. The first job is to make sure you have the right operating team. Know backgrounds, talent and responsibilities. In every organization there is a small subset of people who actually make the entity work. Identify and incentivize them. Find the crucial gaps in the team and fill them.

Execute on short-term revenue opportunities by identifying the low-hanging fruit. With vendors and channel partners, set up personal meetings soon after closing. Encourage frank feedback and find out what they liked best about your predecessor. Check back two or three months later to see if your fix was effective.

For the transition period, the buyer may want to negotiate a short sublease with the seller until suitable offices are rented and equipped. The new Web page should be ready to go live at closing. Work out arrangements with seller on notifying customers and transferring receivables to the buyer. The buyer's fulfillment obligations begin the moment after closing, so be ready.

You also need to sell smart. Since the public capital markets are virtually closed for the foreseeable future, a buyer needs to understand if the business will throw off distributable cash from operations or if the liquidity event comes by selling the company (or both). If the purchase is a revenue play, you don't need to worry about positioning the company for a trade sale.

If you might sell the company, take care to remember today's partners are tomorrow's acquirers. Early on in the game, think about who might want your intellectual property, brand, distribution capability or installed base. Make your decision on how to grow the company accordingly to facilitate the ultimate sale process.

For the smart buyer who can understand the technology and opportunities, focus and execution can lead to success.

Alan Bernstein ( is a partner in the corporate department of Carter, Ledyard & Milburn. Mark Finkel is chairman of LLC, which purchased the content division of ServiceWare Inc., a public corporation.

This article is reprinted with permission from the October 22, 2002 issue of The Daily Deal, LLC. © 2002 NLP IP Company.

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