Distressed Buyout

Updated on March 22, 2024
Article byAswathi Jayachandran
Edited byAswathi Jayachandran
Reviewed byDheeraj Vaidya, CFA, FRM

What Is A Distressed Buyout?

Distressed buyout refers to the process by which a private equity firm buys a troubled company for less than the market price. The purchase is done to help the business, but the end goal may be to sell the company for a higher price.

Distressed Buyout

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A company’s operational volatility, such as a cyclical business, and high financial leverage are the two leading causes of distress. Investors can purchase assets or businesses that would otherwise be impossible to acquire through these buyouts. This might enhance total profits and enable investors to diversify their portfolios.

Key Takeaways

  • Distressed buyout refers to the process by which a private equity firm buys a weakly performing company at a discount price. 
  • Here, the assets often present attractive acquisition opportunities for financially healthy businesses with high levels of liquidity. 
  • The value of the target company, survivability, and any potential legal difficulties need to be considered in the buyouts.
  • Valuation, deal structure, time factor, due diligence, and market analysis are factors that investors need to consider in a buyout.

Distressed Buyout Explained

A distressed buyout is acquiring a majority stake in a failing business when a reversal seems possible. Distressed companies or assets often present attractive acquisition opportunities for financially healthy businesses with high levels of liquidity. Moreover, this is because the valuations of insolvent businesses are usually substantially lower than those of healthy businesses or assets. Therefore, buying a distressed firm or asset could yield a significant return on investment (ROI) if the turnaround is successful.

Additionally, distressed buyouts are often carried out by private equity firms and turnaround specialists with expertise in restructuring and reviving struggling businesses.

Nevertheless, it’s crucial to keep in mind that the fundamentals of a distressed transaction differ from those of a typical purchase of assets. An in-depth analysis of the target company’s financial situation and potential liabilities is necessary. These are often required as part of the diligence process for such an acquisition. In addition, the restructuring procedure for a troubled acquisition can be more complex and time-consuming than a standard acquisition.

Before moving forward with a distressed buyout, the purchasing firm must evaluate several target company-related issues. These include:

1. The value of the target company,

2. Its ability to survive

3. Any potential legal or restructuring difficulties

4. Chances that creditors may convert to equity holders.

Hence, if the creditors are expected to convert to equity holders, they will get several privileges as full or partial company owners. Thus, it may give rise to highly significant problems about corporate control.

Overall, the post-acquisition, the investors implement strategic and operational changes to address the root causes of distress. Hence, this may involve restructuring the company’s operations, optimizing its cost structure, renegotiating debt agreements, and making management changes.

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Investment Criteria

The investment criteria for distressed buyouts may vary depending on the goals and objectives of the acquiring firm. Hence, here are some standard criteria that investors may consider in the process:

#1 – Valuation

Investors frequently search for troubled businesses that are inexpensive and have the potential to generate substantial returns. To assess the possible return on investment, they could use financial indicators like earnings ratios, cash flow analysis, financial statement analysis, and discounted cash flow (DCF) analysis.

#2 – Deal Structure

The company can structure the buyout transaction in the same way as a deal with a financially sound company. Therefore, this is done through the purchase of shares or assets supported by due diligence, customary warranties, and other contractual protections. This is possible if the distressed company has scope for improvement and is facing a manageable threat of insolvency. In addition, they may leave limited scope for diligence or negotiations.

#3 – Time Factor

When purchasing a distressed company or distressed assets, time is usually a critical factor. The longer the negotiation process takes, the more likely the company’s or assets’ value will continue to decrease, and goodwill will erode. Additionally, creditors may make demands on the company or assets, further complicating the transaction.

#4 – Due Diligence

Getting all the information and documentation needed for a thorough due diligence process can be difficult because distressed acquisitions are time-sensitive. Due diligence should be limited to materially essential areas, such as the causes of the company’s or an asset’s problems. This could involve assessing the company’s financial standing, liabilities, and potential legal and regulatory issues that might surface. Therefore, it’s crucial to assess the assets’ potential for growth and profitability and the factors that contributed to the company or assets being distressed.

#5 – Industry And Market Analysis

Investors often extensively investigate the market and industry in which the troubled company operates. To assess the possibility for future growth and profitability, they may consider elements including market trends, competitors, and the regulatory environment.


Here are a few examples to understand the topic better:

Example #1

Let’s say Intellect Soft is a company that develops software. The business has been experiencing financial difficulties for several years due to heightened competition, decreased demand, and rising costs. As a result, it is heavily indebted, experiencing revenue declines, and suffering from a damaged reputation in the market.

Suppose Financial investor Carlyle Group is a private equity firm focusing on distressed buyouts. They perceive a chance to purchase Intellect Soft Company for less money and reorganize its business practices to boost profitability. Hence, Carlyle Group took over the software company after the private equity firm purchased a controlling interest in it following a due diligence investigation.

Thus, the finance company’s management team and the software company collaborate closely to restructure the business and cut expenses. To make the business more competitive in the market, they also invest in cutting-edge technology and research and development (R&D). The buyout has given the software company a new life with the buyer’s help.

Example #2

The most prominent names in private equity, such as KKR and Bain Capital, are turning over financially troubled companies to competitors’ loan departments as they battle difficult economic times.

Hence, the wave of handovers to creditors highlights the challenges that many private equity firms encounter when dealing with portfolio companies that are facing supply chain disruptions, persistent inflation, and rising interest rates. Over the past few years, private credit has grown at a higher rate than takeovers for many of the largest companies in the sector, such as Apollo and KKR.

Meanwhile, a consortium of creditors led by European credit management Alcentra, Swiss private equity firm Partners Group, and Goldman Sachs has taken over control of German payments business Unzer from KKR’s private equity division.

According to a May Financial Times story, KKR’s stake in the US healthcare startup Envision was wholly erased in a deal that saw a group of senior lenders, including Blackstone, acquire the business.

Distressed Buyout vs Leveraged Buyout

Some of the differences between the two concepts are as follows:

Key pointsDistressed BuyoutLeveraged buyout
ConceptIn a distressed buyout, a financier or private equity firm buys a failing business or asset for a lower price.A leveraged buyout (LBO) is a corporate acquisition strategy that involves using borrowed funds, such as bonds or loans, to finance the purchase of another company.
ProcessHere, the acquiring business usually buys a controlling stake in the asset or company in trouble.The acquiring company issues bonds against the combined assets of the involved companies, meaning that the acquired firm’s assets can be used as collateral against the bonds.
AdvantageA distressed buyout’s key benefit is that it allows financial investors and private equity firms to purchase undervalued assets for a lower price.The primary benefit of a leveraged buyout process is that the acquiring business can acquire a much larger company by using only a tiny fraction of its assets as collateral.

Frequently Asked Questions (FAQs)

1. Who benefits from distressed buyouts?

The purchased company and the financial investor can profit from a distressed buyout. The purchased company may benefit from additional funding, restructuring, and employment preservation, while the investor may enjoy a significant return on investment. Meanwhile, increased economic activity and stability can also help the community and local economy.

2. What are the risks of distressed buyouts?

Distressed buyouts may be risky, as only some transactions are successful, and the loss incurred may be huge. Aside from the potential for legal or regulatory concerns, the restructuring process can also be difficult and time-consuming.

3. How long does the distressed buyout process take?

The timeline for distressed buyouts varies depending on the complexity of the situation and the success of the turnaround efforts. It can take several years to implement operational improvements and achieve the desired financial stability fully.

This article has been a guide to what is Distressed Buyout. Here, we explain its investment criteria, examples, and comparison with leverage buyout. You may also find some useful articles here –

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