Net Assets: Advantages and pitfalls of buying insolvent businesses

Welcome to the eighth piece in our 'Building a resilient balance sheet for 2021' series looking at solutions and opportunities for 2021 viewed through the balance sheet.

Our last post looked at administration as a rescue mechanism. We now look from a buyer’s perspective. Over the coming months, there will be opportunities to acquire businesses at knock-down prices.  But will the overall cost be as attractive as the buying price? 

What are the benefits of buying a business from an administrator?

The benefits of buying from an administrator are many. You buy the assets and leave most (not all) of the liabilities. You get a fully functioning business for a knock-down price. Buying a competitor brings turnover and new customers. Buying a supplier brings supply chain security. Buying a customer or complementary business brings diversification. There may even be tax advantages such as receipt of any unclaimed capital gains allowance.

What are the disadvantages which must be considered?

However, there are also disadvantages which must be factored in. An administrator sells assets ‘as seen’ with no warranties or indemnities.  You will need to be sure that the assets you are buying (IP in particular) is actually owned by the seller. There are no refunds.    

Don’t overpay for stock which may be subject to retention of title and taken back the next day. Critical suppliers may require ransom payments before continuing supply. Credit limits will be reduced or removed meaning significant additional working capital will be required.  

It may also be necessary to rationalise overheads and this may have a significant cost. In particular employees will all transfer under TUPE with their accumulated rights intact.   

Is buying from an administrator an effective way of adding value to a balance sheet?

None of this should put off a potential buyer. Buying a business from administrators is often an effective way of adding value to a balance sheet. The successes of many turnaround investors illustrate this.  But you must go into it with your eyes open and a proper understanding of the overall cost. You will definitely need specialist legal advice to avoid the pitfalls.

In our next post, we move to the bottom half of the balance sheet and look at whether capital can be unlocked from inefficient equity structures.