The number of Accounts Receivable Management (ARM) industry companies struggling to compete is, unfortunately, growing. But a certain process needs to be followed for companies interested in purchasing distressed ARM companies. We here break down the process and talk about opportunities for parties looking to purchase distressed ARM companies.
Which key themes or attributes are driving Account Receivables Management companies to go into distress?
- The company just lost a very profitable big client. This could have been a first-party project or a traditional contingency client relationship that was a significant portion of their revenue, and the loss threw the business into a tailspin.
- Legal or compliance issues. There have been many issues around TCPA as well as state or regulatory action. This could push a company into a tough position where it needs to do a deal
- The company’s balance sheet could be upside down. Several companies have been overleveraged for a variety of reasons. For example, they took on a lot of debt when they bought the business or were financing a portfolio. As a result, when they had a hiccup or their collection performance was down it threw them into a tough cash flow
How can you structure a deal to protect a buyer when pursuing a distressed asset?
- If the distressed company is having issues it is likely there are other problems going on with the company from a compliance perspective. Companies buying a distressed situation should consider looking at an asset rather than a stock deal. This helps to avoid any “skeletons in the closet” the purchaser may be walking into or inheriting. While a stock purchase may have a strategic reason, all else being equal it is advisable to buy assets in distressed situations.
- Make sure the company is operating in trust and isn’t using client money to fund the business. That liability is an issue that will follow the purchaser after the business is sold. Make sure to assess at the front end whether the distressed asset is in trust or out of trust with any of its clients. If the answer is “yes” hit the pause button. Avoid doing a deal because transferring the clients could pose a significant legal exposure to you as a buyer.
- Figure out who has the client relationships. That person or persons will be critical in transitioning the client base to the buyer. Make sure you are either looking into or assuming an employment agreement as part of the deal to make sure clients will move over to you as part of the
- Look at the balance sheet and specifically the liabilities. Instead of paying cash upfront as part of the deal there may be a facility lease assumption; some form of long term debt that could be assumed by the buyer instead of paying cash up
- Structure the deal in a favorable manner. Earnouts are frequently used when doing a distressed or turnaround deal. Typically an earn-out in the ARM industry will be done on revenue rather than profitability, because you will likely be consolidating the agency or debt buying operation into an existing facility. As a result, doing it on revenue becomes much easier. 1 – 3 years as a form of a revenue-based earn-out are typical, but it could go 3 – 5 years depending on the negotiation and what is required to help get the deal done. Many distressed scenarios are deals where it will be “pay for performance” and making sure the client operation can stay in place, so the buyer can help to turnaround the situation and make a good
A distressed acquisition might be appealing if a collection agency is doing well and looking at expanding or growth opportunities. What questions should the purchaser ask about this distressed agency? What are key data points?
With a distressed situation usually a number of things are at play – a client loss, a legal issue, key people have left, the balance sheet is upside down. The key is to figure out and determine as quickly as you can if you can help to solve the problem in a timeline that is going to work for everybody.
Distressed situations come up quickly. When they do the selling shareholders are looking to move as quickly as possible. As a result, the due diligence timeline and process is condensed. This is where things can get missed.
The more you can evaluate upfront with a distressed situation, the better off you are. Does the company have good financial controls in place? Are clients who continue to place business salvageable? If it is a debt buyer is there more runway in the portfolio to collect out what they think will be there as a part of the estimated remaining collections analysis.
The more the purchaser can determine what the pain points are upfront and whether you can solve them, the better off the company will be after closing the deal and asking why did I buy this? Hopefully the purchaser isn’t saying this for too long. Hopefully it can correct some of these issues right after closing on it.
Are distressed assets a long term or short term trend?
Every year there tend to be several events for a variety of reasons discussed above. This isn’t a one-off. It will be a consistent theme once this market has a “correction.” This will be especially true with some of the smaller and mid-sized ARM companies. They are usually at risk because they are on the bubble inside of a large agency network for a big creditor and they get downsized as part of the consolidation of a network.
When we eventually have a market correction some of these companies will get a large amount of placement volume that is less collectible. As a result staffing and operational structure will be off balance.
The trend will be consistent that every quarter there will be distressed situations. In the past 2 – 3 years distressed situations have been in financial services. That should be changing, as we see more companies struggle in other markets. They may be overleveraged or their balance sheet is filled with a lot of debt they aren’t able to service it because the collection environment changes.
Do your due diligence when purchasing distressed ARM companies. Don’t let the fact you have to do something quickly prevent you from doing your due diligence on the situation and all the issues at hand. By remaining, disciplined distressed situations can be win-win for both sides.
Before purchasing a distressed asset, establish a relationship with a Mergers and Acquisitions (M&A) specialist who can offer expert guidance. As in all aspects of your business life, it is never too soon to start planning ahead.
CAS oversees and executes on M&A engagements, investment opportunities, compliance/regulatory assessments, valuation and expert witness litigation matters for constituents of the Outsourced Business Services (OBS) sector.