1. A favourable economic context
In this uncertain economic environment, many companies subject to LBOs with high levels of debt are in trouble and experience unprecedented difficulties. While for some, the use of the state-guaranteed loan regime has been a vital solution to remedy short-term liquidity needs, for others it is most likely a temporary cure. Many companies will be required to call upon additional financial support to repay their debt and, above all, to cover their liquidity needs.
2. Key role of financial investors
Regardless of their business sector, one observation is clear: companies kept solvent as a result of the state-guaranteed loan regime will not be able to face such difficulties alone, they are likely to consider themselves better equipped if they allow a more solid financial partner to invest in the capital structure to clean up their balance sheet. In turn, such demand from companies should mean an increase in the supply of suitable financial partners with high liquidity who are looking for a portfolio with high profitability.
The prospect of acquiring companies with an already strong underlying business model for the symbolic, de minimis, price of one euro is an attractive one for some investors. First and foremost amongst these investors are Private Equity funds, hedge funds and special situation funds, as they have the skills, expertise and resources required to successfully turn around the company.
Whilst other, company-led, recovery strategies are possible for financially vulnerable targets (for example, share capital increases or bond issuances), depressed market valuations and lower levels of competition allow investors to create synergies, acquire a new product line or establish themselves in missing geographical areas.
Nevertheless, taking over a company short of liquidity has its own special issues, as evidenced by the constraints inherent in such operations and the quality of the investment expected by the target companies. In particular, if these transactions involve mechanisms such as the sale of securities or assets, as often contemplated when the target is financially viable, financial investors may also use more specific tools. Primarily, the conversion of debt into equity (lender led) can be an effective way to successfully complete a distressed M&A transaction, as this strengthens the target company’s balance sheet by carrying out a share capital increase, while also reducing its debt. Financial investors who have acquired high yield or bank debt on the secondary market, often at a price below the nominal value, can thus skillfully convert their debt into capital at a lower price and with a guaranteed rate of return. The virtues of adopting a lender led approach are especially striking when the target’s securities are admitted to trading on a regulated market since creditors will ultimately be able to benefit from the liquidity of their securities. A more “hostile” approach is the exercise by a creditor of a security package based on a double-luxco or trust (fiducie) over the target securities or assets, which may also result in a change of control at the expense of the existing shareholder.
Although financial investors are the key players during the implementation of these distressed turnarounds, addressing and minimizing the target’s failures (and future challenges) requires the intervention and support of other players. In addition to the usual negotiations between the new equity investors and the target’s shareholders, it is equally essential to coordinate with the lenders, security holders, management, lessors, suppliers, customers and employees of the target in order to ensure that the business, once acquired, remains viable. This is especially critical when a mutual agreement procedure is initiated to address difficulties relating to an ad hoc mandate or conciliation proceedings.
3. A legal framework that raises specific challenges
Unlike traditional LBO schemes, in a distressed transaction the target may be subject to restrictions due to its legal status. In consensual proceedings (mandat ad hoc, conciliation proceedings), the confidential nature of mutual agreement procedures enables financial investors to efficiently carry out the takeover process. Then, once the conciliation agreement has been established or approved, the commitments undertaken are secured through the guarantee of any new funds provided to the target company, thus avoiding the risk of the transaction being unwound or being afforded super priority status. The situation is more complex when the target is subject to collective proceedings (safeguard, reorganisation or liquidation proceedings), as the timetable of the transaction is necessarily constrained by the requirements of the proceedings (such as hearings, examination of alternatives proposed by potential investors, judicial supervision of the implementation of the plan). Nevertheless, even in this context, the acquisition of the target’s securities by a financial investor is possible, with or without a prepack prepared during conciliation proceedings. Such a transaction, if it is well structured, also offers the advantage that the investors may benefit from the provisions of the disposal plan set up as part of the proceedings, which thus minimises the indebtedness of the target structure that is the subject of the disposal plan.
Against this background, the real source of the company’s difficulties must be identified and understood (including any unaddressed financing needs), so that investors can provide the necessary funds to ensure recovery of the target. However, such an operation often retains the specific features of all M&A transactions along with an inflexible timetable: financial, legal and tax due diligence is inevitably reduced, but should not be neglected. The provision of mandatory information, the consultation process of the work council and the stricter operation timetable should also be taken into account, in addition to any regulatory authorisations and clearances (for example, in the case of a sensitive sector or merger control) which must be obtained and requested at the appropriate time to avoid blocking positions. It should be noted that an exemption from the suspensive effect of the merger control process may be granted (with certain conditions) in order to carry out a distressed transaction without prior clearance by the competition authority. To the extent possible, if the transaction is structured without shareholder support (e.g. through the exercise of double-luxco securities), these timing considerations should be analysed sufficiently in advance. It will be key to have access to the management team and thus the structuring of a management package, which takes into consideration all the complexities of such transactions (as opposed to a classic LBO).
Business transfers and external growth create opportunities and thus are traditional tools used to increase value in the world of Private Equity. In the current context, they will be an effective mean of reversing and protecting France’s economic and industrial network, provided that the complexity of the transaction is properly assessed.
