:quality(80))
Over the past few decades, the mergers and acquisitions (M&A) sector in Germany has undergone significant development. “Distressed M&A” refers to transactions involving companies or parts of companies in crisis situations. Given the various crises in the Eurozone, the importance of this area is expected to continue to grow. For acquirers, these transactions offer significant opportunities, such as acquiring assets at a reduced price, the opportunity to reposition the company and increase its efficiency, and access to new markets or product lines.
Timing and Transaction Structure as Key Success Factors
Corporate acquisitions arising from crisis situations have several distinctive features: On the one hand, insolvency law provisions can influence the transaction both during insolvency proceedings and immediately prior to insolvency. Second, the interests of external parties—such as banks, employees, customers, and suppliers—influence these transactions. Time pressure and a thorough understanding of the causes of the crisis play a decisive role in the success of a transaction and, consequently, in the restructuring of the target company.
In the run-up to a distressed M&A transaction, two key factors in particular must be taken into account: the timing of the transaction and the structure in which the transaction is to take place.
The transaction can take the form of either a share deal or an asset deal. In an asset deal, the business operations are sold through the transfer of all or specific assets. This allows the buyer to acquire selected assets (“cherry-picking”) while also offering the opportunity to avoid hidden risks. Additionally, tax advantages may arise from the depreciation of these assets. A disadvantage of this method, however, is the need to establish new contractual relationships or negotiate takeovers with contractual partners, which can pose a challenge given the tight timeline (e.g., with landlords and suppliers). The transfer of employment relationships should also be well prepared. A transfer of employment relationships may well meet with resistance from employees. From an economic perspective, however, a purchaser should also consider the potential consequences of a transfer of business operations (Section 613a of the German Civil Code [BGB]).
In a share deal, the shares are sold, and thus the entire company—including all legal rights and obligations—is acquired. This method simplifies the transfer and allows for the continuation of existing contracts or the retention of regulatory permits tied to the legal entity. However, in a share deal, the buyer also assumes all of the company’s existing liabilities, including hidden risks. The assumption of existing liabilities represents a significant disadvantage, particularly when purchasing a company in crisis situations, which is why this transaction structure is used much less frequently. In the context of insolvency proceedings, this disadvantage can be mitigated under certain conditions in a share deal by the insolvency administrator or debtor submitting an insolvency plan. One possible approach, for example, is a capital reduction followed by a capital increase, so that the investor then acquires the newly created shares.
In addition to the structure, distressed M&A places a particular focus on the timing of the transaction. Various time points may be considered for the transaction and significantly influence its framework:
pre-insolvency, i.e., during an economic crisis before an insolvency petition is filed;
during insolvency proceedings;
after the commencement of insolvency proceedings.
In the run-up to filing for insolvency, the transaction is subject to the provisions of general civil and corporate law. At this stage, the company often still has a functioning supply chain and an unencumbered customer base. Furthermore, the company is not yet associated with the headline of insolvency. A potential drawback is that risks in this phase may not be fully identified, and the existence of grounds for insolvency may be overlooked. In the event of subsequent insolvency, there is then a particular risk that the insolvency administrator will challenge the business purchase agreement (Sections 129 et seq. InsO), which in the worst-case scenario could lead to the return of the assets involved in the transaction; in such a case, the purchaser would have no recourse other than to file a claim for the purchase price in the insolvency schedule.
If the transaction has not been fully completed at the time of a subsequent insolvency, there is a risk that the insolvency administrator will exercise his or her discretion under § 103(1) InsO and refuse further performance of the contract. In this case as well, the purchaser can only file a claim for repayment or damages with the insolvency schedule. In addition, various non-insolvency-specific liability provisions outside of insolvency proceedings must be taken into account, which are linked to the acquisition of companies or parts thereof. In particular, the risks of liability for tax matters (Section 75 of the German Fiscal Code (AO)) and the liability of the company (Section 25 of the German Commercial Code (HGB)) must be weighed against the advantages of the acquisition outside of insolvency proceedings. If a share deal is being pursued, the risks associated with so-called change-of-control clauses—which allow a contracting party to terminate the agreement prematurely due to a change in ownership—should also be taken into account.
Between the filing of an insolvency petition and the opening of insolvency proceedings
(“insolvency petition proceedings”), company sales generally do not take place. During this period, the provisional insolvency administrator will explore and prepare options for the liquidation of the debtor company’s assets. It is not uncommon for an orderly investor process to be initiated during this period, though it is not finalized until after the commencement of insolvency proceedings.
Once insolvency proceedings are opened, the risks for a purchaser are significantly reduced; in particular, the risks of avoidance actions are eliminated, and there are special provisions regarding the company’s liability and tax matters. This can present an opportunity, particularly for strategic buyers with a viable restructuring plan, to establish a foothold in competitive markets or to acquire interesting technologies. In this context, restructuring goals—for example, those related to insolvency labor law—can be implemented more easily through special provisions. One example is the termination of unfavorable contracts. However, even when acquiring a company from insolvency, the risk of a transfer of operations under Section 613a of the German Civil Code (BGB) cannot be completely ruled out.
The Insolvency Trustee as Seller
As with any other business transaction, it makes sense to understand your business partner’s motivation. In insolvency proceedings, the insolvency administrator is responsible for achieving the best possible realization of the insolvent company’s assets in order to maximize creditor satisfaction. If business operations are ongoing, the insolvency administrator assumes management of the company during the insolvency proceedings and, at the same time, negotiates with prospective buyers. Ultimately, however, the insolvency administrator acts less as a seller in the traditional sense and more as a facilitator between the various stakeholders involved in the transaction. He coordinates their interests in light of his mandate to maximize creditor satisfaction. In cases of asset deals, he must also take into account the security interests attached to the assets.
Particular challenges arise from the time pressure inherent in (preliminary) insolvency proceedings and the limited information available to the insolvency administrator. This makes it difficult for acquirers to conduct due diligence and, consequently, to identify and assess risks.
Unlike traditional M&A deals, the sale by the insolvency administrator typically takes place at a fixed price without the possibility of subsequent purchase price adjustments. The insolvency administrator will generally refrain from providing guarantees for risks that he cannot fully assess and will seek to limit his liability to the minimum extent possible.
When valuing the company or part of the company to be acquired and determining the purchase price, prospective buyers must factor in identified and potential risks in advance. The offer will generally have to exceed, at a minimum, the value derived from a pure break-up scenario. The successful completion of a distressed M&A deal requires the insolvency administrator to possess not only expertise and negotiating skills but also a keen sensitivity to the complex requirements of these specialized transactions. In doing so, the administrator always pursues the goal of maximizing the value of the company in the best interests of the creditors.
Process of a Distressed M&A Deal
Certainly, every distressed M&A transaction has its own specific characteristics. In practice, however, a typical process for selling a company in crisis situations has emerged. This process is usually divided into three phases: preparation, marketing, and negotiation/closing. This process generally spans a period of six to twelve weeks.
During the preparation phase, an information memorandum is typically prepared while the search for potential investors is conducted simultaneously. The information memorandum serves as the primary source of information for interested parties. It includes a description of the company, its markets, strategic direction, and financial position. Particular attention is paid to describing the crisis situation and the company’s potential unique selling proposition (USP). In parallel with the preparation of the memorandum, a “long list” of potential investors is compiled, comprising both strategic and financial players who might be interested in an acquisition. Especially in times of crisis, a comprehensive approach to the market is crucial for quickly finding a suitable buyer.
The marketing phase of the company follows directly after the preparatory phase. A central and potentially decisive step in this phase is the “management presentation” for prospective buyers whose initial indicative offer is deemed promising. For the prospective buyer, this presentation—as part of the M&A process—offers the first opportunity to meet key personnel within the company and gain a comprehensive understanding of the management and operational processes.
The due diligence phase allows the buyer to thoroughly examine the company’s economic, legal, and financial circumstances and to finalize their offer. In situations characterized by financial distress, the review focuses not only on historical data but primarily on future prospects and opportunities for operational value creation. Key points of review should include:
Analysis of the business model—opportunities and risks
Understanding the causes of the crisis
Analysis of financing and restructuring potential
Analysis of the liquidity situation and liquidity planning: Determination of financing needs for investments and working capital, liquidity planning
Analysis of supplier and customer relationships, key contractual arrangements, and financing agreements
Development of a new business plan
Presentation of the proposed transaction structure
Based on the binding offers submitted, and taking into account the results of the due diligence and the price expectations of both parties, negotiations on the purchase price and the terms of the agreement take place. In crisis situations, a high degree of speed and flexibility is often required to successfully steer the company out of the crisis. The closing marks the formal completion of the M&A transaction. In this decisive phase, the agreed-upon terms are implemented, and ownership rights are transferred to the buyer.
Conclusion and Recommendations
For acquirers, distressed M&A transactions present both significant opportunities and risks that should not be underestimated. The challenges are diverse and range from the complexity of insolvency laws to the need to consider the interests of external parties and the necessity of conducting due diligence that is both swift and comprehensive.
The benefits include the opportunity to gain value-creation and process expertise by increasing operational efficiencies and improving organizational performance through the integration of the target company’s best practices. Expanding the product portfolio can lead to diversification and a strengthening of the acquirer’s market presence. Furthermore, distressed M&A opens up opportunities to gain market share in existing markets as well as to tap into new markets and distribution channels. Last but not least, reducing competitive intensity through the acquisition of a competitor can strengthen the acquirer’s market position and lead to improved margins.
The successful execution of distressed M&A deals requires careful preparation, the identification and appropriate assessment of potential risks and opportunities, as well as a strategic approach to the transaction structure and timing. The willingness to invest in the necessary due diligence and the ability to react quickly and flexibly to changes are essential in this regard. A prerequisite for success is a comprehensive understanding of the specific challenges that such transactions entail, as well as smart and forward-looking planning and execution of the acquisition. It is therefore often advisable to engage consultants specializing in crisis situations for such a transaction.
