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June 06, 2003 02:00 AM

Research is essential when acquiring troubled companies

James M. Hill
Ira Kaplan
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    Growth for your polymer company can come in many forms. One proven method is corporate growth through the acquisition of troubled companies that may complement, or even compete with, your organization.

    However, the ongoing consolidation in the polymer and related industries in combination with a difficult economy presents both opportunities and challenges when considering such acquisitions. One must consider these issues specific to those kinds of transactions.

    In any acquisition, a crucial issue is the diligence process. One must be able to analyze the external as well as the internal challenges that may affect the potential success of the acquisition and how it can add to your financial stability. This process includes analyzing the liabilities of the acquisition target. It also involves looking at any of the senior lender's vulnerabilities, which may affect the pricing. On the operational side, you must take a hard look at whether the core business is fundamentally sound.

    You must consider any contingent liabilities. Consider purchasing assets and not stock to possibly shield your operations from the liabilities of a troubled enterprise. If you are the new deep pocket, realize that anyone can sue, and frequently they will. Take a realistic view of successor liability, both from a legal and a business standpoint.

    Next, investigate the potential environmental liabilities; they could carry over. Look carefully at what is owed to the employees because making them whole may be important in retaining value. Make sure that the company's assets are not overstated and its liabilities not understated. Consider the quality of the company's products historically.

    Remember to have an early conversation with your lenders. Some have an appetite for these kinds of deals but some never will. Your financial partners are important when entering this world. If you need additional equity, consult your advisers as to who understands how to do deals that “have some hair on them.” After the transaction closes, the right partners can add value; the wrong ones will have less patience than you would like. Consider also how your structure and lending relationship will affect your core enterprise. Are you putting your core assets at risk, and how comfortable are you with that concept? You may have no choice, but make that choice with eyes open.

    As important as it is to understand the target's relationship with its customers and suppliers, it is more important when buying a business that has been under stress. What will it take to retain the current customer base? How have they been affected by the current difficulties of the company's operations? Are any critical suppliers ready to bolt? How far out are payables, and what will it take to retain this important relationship? Can you manage the business to profitability if its customer base shrinks, and what effect should these factors have on the price?

    The condition and stability of the targeted company often makes it important to act quickly. Strategic buyers may have a leg up on financial buyers because of the potential to pull costs out of the operations and because they are able to understand the business issues better from an operational standpoint.

    Having considered all of these issues, recognize that righting a company that has been mismanaged or over-leveraged may provide a significant upside. You may be able to add volume at a reasonable price, thus enhancing the value of your existing business. You may be able to add niche products with higher margins. In summary, the current climate may bring opportunities your way. Careful planning will help ensure that you can take advantage of those opportunities.

    James M. Hill and Ira Kaplan are partners in the Corporate and Securities Practice Group of Benesch, Friedlander, Coplan & Aronoff LLP, a Cleveland law firm.

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