After years of sky-high valuations, private equity funds and strategics will have ample opportunity to buy technology companies at a discount in the wake of the COVID-19 crisis. This article highlights the unique opportunities and risks associated with acquiring a distressed private technology company.
In addition to traditional sourcing outlets, buyers can access potential targets by purchasing debt and other claims from existing creditors on the secondary market. If done thoughtfully, a buyer can transform itself from a hopeful outside bidder into a creditor armed with special rights. Specifically, being a creditor may enable buyers to utilize information and inspection rights contained in credit agreements to enhance due diligence and implement special legal structures to complete an acquisition, as discussed further below.
Once a target has been selected, buyers should take care in identifying the “real” decision makers. This analysis is typically straightforward in the non-distressed context because the board, management team and key stockholders can usually negotiate and approve a deal, while creditors are simply repaid. However, in the distressed context, creditors are an additional and important stakeholder group that can dictate terms. What’s more, buyers targeting companies with tiered debt structures and syndicated loans must navigate a web of liens, covenants, remedies and intercreditor agreements to determine which creditor (or group of creditors) are needed to approve a deal.
Distressed deals can use traditional acquisition structures or creditor-driven structures outside of or through bankruptcy court (“out-of-court” versus “in-court”). As summarized below, each structure carries different levels of deal expense, execution speed and post-closing liability risk. Post-closing liability risk typically centers on fraudulent transfer claims by aggrieved creditors or a bankruptcy court’s order to recover certain payments made by a debtor before a bankruptcy filing.
Once a structure has been selected and the parties are in execution mode, buyers should take ownership of the following issues in the sprint to closing. Buyers cannot assume that a seller’s management team will be invested in the transaction or properly focused on these issues because they will likely receive sub-optimal deal consideration or just abandon a “sinking ship” altogether by resigning. Also, unlike a non-distressed deal, buyers will likely have limited or no recourse against selling securityholders for post-closing claims or liabilities. Put simply, many seller problems become buyer problems.