Excerpts: Buying a Distressed Business: 10 Tips for Entrepreneurs
As discussed below, it is generally advisable to purchase a distressed business after the target’s Chapter 11 filing pursuant to Section 363 of the Bankruptcy Code (a “Section 363 Sale”) due to its speed, benfits and flexibility.
Do Your Diligence. A comprehensive due-diligence investigation is a fundamental buy-side component of any acquisition, but it is particularly important in connection with the acquisition of a distressed business due to, among other things, the likelihood of limited (or a lack of) recourse post-closing.
Buy Assets, Not Stock (Equity). Generally speaking, it is usually advantageous for an acquiror of a private company to purchase assets, not equity, of the target for two principal reasons: (i) it will obtain a stepped-up tax basis in the acquired assets; and (ii) it will minimize the assumption of any unwanted liabilities. If the private company is severely distressed, however, there may not be tax benefits to an asset deal; it is nevertheless clearly the most prudent structure from a liability/risk perspective due to the greater likelihood of undisclosed/unknown liabilities of the target relating to the stresses of the circumstances, including potential tax liabilities, claims/lawsuits accruing pre-closing and perhaps fraudulent activities.
(The target, of course, will often push back and insist that the buyer take the entire company–warts and all.) The bottom line is that every deal is different and must be structured and negotiated with the assistance of competent counsel, including tax counsel.