Buying a business out of administration and turning it around quickly and effectively is an attractive prospect to many entrepreneurs. There’s a lot to be said for this approach to buying businesses and a lot to gain for those who are able to make a good job of a turnaround project. However, buying a business out of administration does, of course, come with many potential risks.

Let’s take a look at some of the main risks involved with buying a distressed business and the measures you can take to minimise them.

WHAT ARE THE RISKS INVOLVED WITH BUYING AN INSOLVENT BUSINESS?

1. INFORMATION IS NOT GUARANTEED

This is perhaps the main risk involved with buying a business from an administrator. It’s also where buying a distressed business differs from buying a solvent business. During both processes, you may be presented with sales information about the company, including its financial situations, its assets, its liabilities etc. However, when purchasing a distressed, this information business is not guaranteed.

This means that you could complete a purchase only to have a major asset claimed by a leasing company a week after. In this situation, a buyer has no recourse to the administrator, and it will be too late to make changes to the paid price.

When a business is sold by its owner – in a normal solvent situation – various indemnities and warranties are offered, in order to assure the buyer that they are getting exactly what they expect. However, when buying from an administrator, no such assurances are offered.

HOW DO I MINIMISE THIS RISK?

Two words: Due diligence.

Although timing is of the essence when buying an insolvent business, it is essential that buyers carry out as thorough a due diligence process as possible, to protect themselves against as-yet-unknown challenges. The idea is that problems can be identified in advance of a deal being completed for the price paid for the distressed business to reflect the true state affairs.

Another way to minimise the exposure to unforeseen risks and the lack of assurances is to gather a great team of legal experts to help advise the purchase, as well as help with the entire deal-making process.

2. THE PRICE MIGHT NOT BE RIGHT

Although not all insolvent businesses that are purchased out of administration are bargains, great value deals do still exist for those who have their finger on the pulse. Of course, the true value of a business can only really be judged a year or two after sale, when it has become more evident as to whether or not the buyer has managed to turn the business around.

Due to the lack of details and time available when buying an insolvent business, it can be easy to pay too much.

HOW DO I MINIMISE THIS RISK?

As stated above, carrying out the right level of due diligence and having the right people around you, when buying a business in administration, can help you pay a fair price for a business or its assets. Spending time asking the right questions and establishing as much as there is to establish about the business, is recommended.

Find out about retained contracts, the staffing situation, whether there is stock and equipment included, as well as machinery and premises, and of course, whether there are any legal issues outstanding against the business.

It also pays to obtain as much financial information about the business as possible, such as details of the outstanding debts and liabilities. The price can then be renegotiated with accurate information in mind, if necessary.

3. THERE MAY BE PROBLEMS WITH EMPLOYEES 

The problems buyers can inherit regarding employees, and particularly litigation brought about by them, can be a major risk factor when buying an insolvent business. It’s important to make sure you have a clear view of any outstanding employment law cases against the business. In some cases, they may be so severe or numerous that it may not be worth going ahead with the purchase.

Usually, when buying a business out of administration, you are unburdened by the pre-existing liabilities, as these are settled as part of the deal. However, this if often not the case for costs related to employee rights. The ‘Transfer of Undertakings (Protection of Employment) Regulations 2006’ or TUPE legislation means that any new employers are responsible for the protection of employee rights after purchase. This can extend to employee tribunal awards, for example, which can financially cripple a new owner, if not considered at the purchasing stage.

HOW DO I MINIMISE THIS RISK?

Again, it’s all about surrounding yourself with the right experts who have full awareness of the TUPE legislation and how it could impact you after purchase. Also, remember that the staff you inherit as part of a sale can be the best asset you have, as well as being a major risk area. If you retain the right staff and management, they can be the key to turning the business around after insolvency.

4. SUBSIDIARY COMPANIES CAN BE ATTRACTIVE BUT ARE OFTEN AN UNKNOWN QUANTITY 

You may find, when looking to buy a distressed business that the firm you are interested in has subsidiary businesses that are still solvent. Although purchasing these businesses can sometimes be sensible, they can also present risks, as the administrators in charge of the main business are unlikely to have any awareness of the subsidiaries’ circumstances.

HOW DO I MINIMISE THIS RISK?

If you are interested in taking on some subsidiary businesses as part of the purchase of a distressed business, carefully check any prospective liabilities these could have, or any that could come about as a result of the parent company changing hands. For example, does the subsidiary business have legal cases outstanding against it that the administrator is not aware of?

As highlighted above, areas like employment law, including environmental and contractual laws need to be checked, to ensure they are not in violation of any regulations.

It’s clear that buying a business from administrators can present some risks. However, providing you go into the purchasing process with your eyes open to these risks, and with the right legal team behind you, you can prevent any major problems coming your way. After all, no purchase is completely free of challenges and the payoff for those who can turnaround a failing business is often worth a slightly elevated level of risk.