Commercial activity in 2023 was bruised by higher inflation, higher borrowing costs and renewed geopolitical instability, which resulted in waning levels of business and consumer confidence as the year drew to a close. But for record levels of immigration and population growth, Australia would very likely be in recession.

With that somewhat downbeat backdrop, it is appropriate to consider how the distressed Mergers & Acquisitions (M&A) market may evolve in 2024 as companies look to protect themselves against deteriorating economic conditions, take advantage of competitors' woes, increase market share and diversify product lines and supply chains.

Time Crunch

Faced with demanding creditors or, in the case of insolvency appointments, formal timetables for sale, sellers will be looking to sell on an expedited basis. Prospective buyers who have financing in place are able to secure key counterparty and regulatory consents and can negotiate quickly and efficiently will have material advantages over the more ponderous suitors.

Information Vacuum

Distressed M&A is characterised by limited information of the target shares, business or assets – both by the external administrator sellers who may have little or no knowledge and history of key issues affecting the target and by the prospective buyers whose due diligence enquiries will inevitably suffer from the sellers' lack of knowledge and need for an expedited sale. Focused enquiries on the most material issues and either resolving them pre-sale or through risk allocation mechanisms in sale documentation will be critical to achieving a sale within the desired or required timetable.

Limited Contractual Protections and Impact on Price

Buyers know that an acquisition will often be on an 'as is, where is' basis with limited warranties and indemnities provided in the sale documentation. To assume and mitigate such risks, buyers and cooperative sellers may pursue more innovative solutions including warranty and indemnity insurance, pre-completion customer or supplier engagement, third-party guarantees and escrowed, deferred or contingent consideration.

Where the sellers are external administrators, they may prefer all consideration to be payable at completion (rather than via deferred or contingent amounts). This may promote efficiencies and cost savings in concluding the external administration process sooner and avoid the need for protracted future reporting and monitoring and multiple rounds of distributions to creditors of the seller. The sale price payable to external administrator sellers will likely be reduced to reflect the buyer taking a higher degree of risk where customary due diligence queries are unable to be answered due to lack of information or compressed timing and where the buyer is not able to rely on seller warranties and indemnities.

Structuring

In a distressed scenario, a buyer will be looking to maximise the value of the assets to be acquired and quarantine itself from the liabilities that led to the distressed sale and any other unknown or contingent liabilities. Alternatively, distressed sellers or external administrator sellers may be looking for a buyer to assume liabilities such as unpaid employee entitlements as part of the consideration. This inevitably adds complexity to the sale given the sale assets need to be identified and separated and business liabilities assessed and excluded / mitigated (or ascertained and quantified where being assumed).

Insolvency laws will also bear heavily on preferred structuring. Distressed M&A transactions may be voidable and subject to a 'claw-back' if, for example, they are transferred at below market value or are otherwise deemed to be uncommercial or constitute a disposal of company property that hinders the process of making the property available for the benefit of the seller's creditors. Where a seller's solvency is in doubt, a buyer may prefer for a sale to be conducted under a formal insolvency process, which is safer from claw-back (given statutory obligations to obtain market value or duties to creditors), is subject to statutory timetables (e.g. in reporting to creditors) and is less subject to the whims of a seller.

Other options include the use of debt-for-equity swaps and deeds of company arrangement (DOCAs), which can restructure organisations on a holistic basis for greater efficiencies than ad hoc sales of particular business units or assets. Where there would be no unfair prejudice to the interests of members (e.g. where equity value has been extinguished and only creditors have a financial interest in the sale outcome), DOCAs can be used to compulsorily transfer ownership of a company's shares, subject to court or shareholder approval. Use of a DOCA to complete an acquisition of the company itself may offer an attractive and efficient transaction structure where it avoids the cost, delay and uncertainty that would otherwise arise from transferring a range of business assets including significant numbers of leases, supplier and customer contracts or Intellectual Property (IP) and Information Technology (IT) contracts and mitigates any applicable duty arising on transfers of assets, whilst also compromising the target company's historic liabilities.

Industries

If 2023 was characterised by the construction industry collapses reeling from higher building material and labour input costs, certain reports suggest the following industries may also face significant headwinds in 2024:

• Discretionary retail and hospitality – weaker demand from cost of living pressures; and
• Non-renewable energy – as customers pivot to renewable sources and debt and equity financing options become more limited to industries with lower Environmental, Social and Governance (ESG) credentials.

Alternative Funding Sources

As more traditional debt and equity financing has become more challenging and costly in 2023, financing from other sources is likely to become more prevalent. Special purpose funds and private equity funds have already been established to scrutinise the availability of quality businesses facing difficulties that may either benefit from their expertise and prior investments or that will be better able to take advantage of the next stage of the economic cycle. Cashed-up family offices with minimal debt are also a potential driver of distressed M&A demand.

Foreign investments in distressed M&A are also likely to increase if the Australian dollar remains depressed and the regulatory environment remains stable.

Buyers and their advisers should be aware of such trends and take proactive steps to ensure they can take advantage of the opportunities afforded by distressed M&A. Similarly, obtaining early advice on how best to navigate these trends will assist companies facing market difficulties with achieving the best restructuring outcome possible.