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Current Situation
Small and medium-sized enterprises in Germany are currently facing an escalating crisis that can no longer be resolved through isolated adjustments, restructuring of loss-making business units, or targeted changes to processes alone. Stakeholders—particularly external lenders and regulatory bodies—are demanding an assessment of the company’s status in accordance with IDW S6, combined with comprehensive restructuring planning and reporting, as well as a professional and targeted implementation of restructuring measures, supported by experienced crisis and interim managers.
During this difficult phase, owners of family-run companies often decide to sell the business. Potential buyers are typically strategic investors or private equity firms; an experienced M&A advisory firm is engaged to handle the search and the entire sale process.
Alarming Signs of Crisis vs. Strong Financials in the Data Room
Typical crisis indicators—which usually occur simultaneously and threaten the company’s survival—include: significant capital depletion—negative equity; strained liquidity—high levels of (past-due) liabilities; weak management with no experience in crises, a deteriorating market position with weak product demand, and a sales force overwhelmed by new requirements for high-margin orders and new market share—and lacking a strategy.
In the course of substantial loan disbursements, (all) valuable collateral has already been transferred to the debt financiers. Release of this collateral can only occur through repayment of the secured loans; if applicable, this collateral secures all such loans.
In contrast, the M&A advisor is putting together a teaser (as well as the data room) for potential investors, presenting the company as a valuable investment with growth potential and a strong USP. The figures are often adjusted for or put into perspective by highlighting “adverse but one-time effects,” so that the core business continues to appear profitable and stable. The strict restructuring—which is actually mandated by stakeholders and taking place in parallel—is rarely mentioned or discussed in detail.
Diverging Interests
The M&A advisor’s primary focus is ensuring that the sale of the shares or the company proceeds quickly and smoothly, that the sales commission is earned, and that the significant effort involved in the M&A process pays off.
The owners are interested in divesting themselves as quickly as possible of the high business risks, as well as any liability risks that have arisen.
Employees and executives —usually under the professional guidance of an interim manager experienced in crisis management—devote all their energy and time to supporting the planning and implementation of the restructuring that has begun. Their jobs are at risk—a major motivator in this process.
The supervisory body is usually caught between a rock and a hard place: on the one hand, it must represent the owners’ interests (a successful sale); on the other hand, it must oversee and advise management, including with regard to the implementation of the strict restructuring measures.
The providers of debt capital (usually banks or insurance companies acting as guarantors) focus on avoiding loan defaults; they feel obligated to demand that the restructuring—as mandated by law—be initiated and implemented, on the other hand, they view the fastest way to avoid loan defaults as the repayment of the loan by a new investor.
The investor is interested in a sensible and fairly priced acquisition of the company. Incentives for the purchase can vary widely, and this is factored into the investor’s due diligence assessment. Thus, while the investor may well recognize the risks, they may view them as non-threatening by integrating the company into their existing business operations, or they may prioritize their past entrepreneurial success over the identified, necessary restructuring measures of the company to be acquired.
The M&A Process Between Signing and Closing—This Phase Is Critical
The greatest risk of failure—and thus the company’s entry into insolvency—lies in the phase between the signing and closing of the purchase agreement.
Euphoria over a successful sale has grown on all sides; the actual restructuring is—despite strong intervention by the interim manager—often neglected and is no longer demanded or supported by the supervisory body.
Communication between the buyer and the debt financiers is initiated, but it is ineffective due to misaligned expectations on both sides.
The funds provided by the buyer (purchase price + working capital for the company) are often insufficient to adequately serve both parties. The lenders’ demand for (full) repayment is very forceful and characterized by a refusal to release the collateral. However, this release of collateral is almost always necessary and a condition of the purchase agreement, since upon closing the purchase, the buyer must settle its liabilities (debts to third parties) and, for this purpose (or for its own acquisition financing), requires the assets that were previously pledged as collateral for these liabilities. The purchase agreement is in danger of falling through.
The powerful tool of negotiating a waiver of claims with creditors is rarely used. Preparing such a waiver is also time-consuming, as it must ensure that creditors are not disadvantaged (Section 133 of the Insolvency Code [InsO]).
SideNote: To this end, companies are increasingly utilizing the established insolvency proceedings under self-administration pursuant to § 270a InsO, as an InsO plan developed in advance is submitted directly during the opening phase, and the proceedings can be concluded after approximately 6–8 months by a resolution of the creditors’ meeting. The balance sheet of the company in question is then restructured.
However, the buyer wishes to satisfy the financiers’ claims and repays the (secured) loans, often at the expense of the free cash flow that was intended for the company. Risk: this cash flow is then no longer available for new loans.
The company is unable to reduce its (overdue) liabilities, or at least not to the extent required, because the expected free cash flow is not flowing into the company in sufficient quantities. The acquirer did not inquire sufficiently or in detail about this prior to signing the agreement and is therefore unaware of the resulting threat under insolvency law (illiquidity requiring a petition under Section 17(2) of the German Insolvency Code [InsO] that extends beyond the statutory three-week period for a suspension of payments).
Even if the closing is successful thanks to the consent of the lenders, the company’s future is not secure. The strict restructuring (which may have been neglected in the meantime) is, at a minimum, the key factor in determining whether the actual causes of the crisis can be professionally addressed and eliminated after the closing. Only then can the company succeed in returning to sustainable profitability—much to the delight of the new owner.
