How to extract healthy profits from distressed companies

Some think it may be a difficult task to profit from troubled companies; however, it is easier than what you might think. It is considered one of the best-kept secrets in the business world today. The truth is, taking over bankrupt or troubled businesses can make you more money than you would ever imagine. You can create a perpetual money machine by buying them, quickly reorganizing them (of course, this requires some management skills), and then selling them for a substantial profit. Even if you're more interested in owning and operating a business than flipping it for a quick profit, you’ll benefit greatly from the opportunities that take-overs offer.
There are thousands of troubled businesses out there that you can buy without investing a penny of your own. The techniques for buying and making money with troubled companies are easy to apply.

Question: Why would I want to take over someone else’s problem?

Answer: In this situation, a company’s problems can work for you. Its existing debts actually offer you built-in financing for an easy no-cash deal. Let's say X Industries is asking $1,000,000 but the books show that the firm's debt to creditors is $965,000. At best, the seller can only get $35,000 from you if you agree to the asking price. Once that's understood between the two of you, you have locked in $965,000 worth of financing by assuming the seller's liabilities. Leveraging this amount to create a no-cash transaction is relatively easy (see previous strategies).

Question: Will this additional responsibility put my situation in jeopardy?

Answer: The situation is not nearly as terrible as it sounds. Many entrepreneurs specialize in takeovers and facilitate the deal by offering to the former owner a freedom from their debt. With this in mind, they know that, every day, new owners of troubled companies strike deals with creditors who agree to walk away with less than twenty-five cents on the dollar.

Question: Why would a creditor be satisfied with such a lousy ratio?

Answer: They look at the alternative—what they will get if the business is liquidated? Creditors will often accept virtually any amount that's greater than what they'd get if the business' assets were put on the auction block. If you offer them just a bit more than that, they will grumble and groan, but they will quite often accept it. They need to recover any amount from the business, so they’ll accept the proposed offer. Very often, a company will seek court-ordered protection from creditors during this process in order to have time to negotiate a settlement. This is what's known as "Chapter 11" of the Bankruptcy Code.

Question: What is the tagged price on liquidated assets?

Answer: Appraisers are specialists for this kind of situation. Since the assets cannot be appraised at their original value, appraisers evaluate the product not on what it is worth presently in the market, but what people are ready to pay for. This situation arises with foreclosure.

When the bank seizes a house due to an unpaid mortgage, they will try to resell it in what we call “the court’s footstep” at 75% of its appraised value. No tangible value is actually given to liquidated assets due to the high desire of the creditors to get rid of the assets on hand and to recuperate some of their money. Most of the auctioneers are aware of this and will start the auction low and then reach a maximum price, representing only a small portion of the actual price of the asset.

Question: What if creditors withdraw from your proposal? Is this common?

Answer: Yes, it is, but there's an advantage to this situation. Some call it the "Dump buy-back" technique. Here's how it works: You make a fair offer to the creditors and they shy away. They want more than what was offered. As an option—or a subtle menace, if you wish—consider letting the company go into liquidation. By getting a bank loan, you will be able to pay for all of the assets at a fraction of their worth. The creditors will vanish, and you'll own a business at an extraordinary price.

Question: So now I have a company for a fraction of a dollar. Should I be concerned about drowning because of this heavy responsibility?

Answer: This depends on your management skills. Most of the time it's bad management that weakens and makes a company go “belly up.” It may be the current operations of the business that are weak. Whatever skills you bring into the business are indicative of what you will get out of it.

Example: I like the story of a young entrepreneur who, at age 28, did something few individuals his age had ever done. He arranged a takeover of a bankrupted company, which manufactured coffee. By understanding the market of commodities (he was a stockbroker as well) involved in this industry (homework required), he discovered the best time to purchase the product, as well as in what quantity and at what price. As one of the only suppliers of green coffee in his area, he was able to stay competitive in the market and offer fresh roasted coffee beans at lower prices than the competition. By using several marketing strategies, he was able to reach a wider clientele by selling his roasted coffee online. He eventually resold the company to the former owner and made considerable profit on the resell. This example proves that any business can become a good business with innovative and knowledgeable management.
Question: What should I consider being a “bad business” to buy?

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