Before you buy a distressed company, you should do this one thing in due diligence
It could radically change your borrowing base
Too many times, I have seen internal processes break down in distressed companies especially in the last few months before new capital comes in to save the day. The employee base has likely been cut to bare bones &/or they are spending all their time on fire fights, dealing with nervous vendors/customers. Details get missed & even important processes are no longer followed. Chalk this up to a lack of time or motivation but it’s fairly common.
One key process that any new capital investor would be wise to spend their time on is reconciling the internal AR aging balance (found in the ERP system) with what your customers think they owe you; aka their internal AP aging schedule.
If your company is the business of selling a good or service, it’s very likely you’ll have a sales to invoice ERP process that helps guide the organization, every step of the way. It starts with an unapproved sales order, moves through to a work order & then a delivery. Once the entire process of that initial order has been documented in the ERP & completed, an invoice can be generated, booked as revenue & sent to the customer.
I have found millions of dollars of unaccounted for AR that has sat in either sales order, work order or unbilled invoicing that never hit the AR aging statement. Both the company and the bank think you’ll have far less of a borrowing base then what is the truth.
Once you have collected all those customer AP aging statements and do find they don’t match, reach deep into the ERP systems & you’ll likely start to find where the break in internal processes happened. I had a company recently who were down to just 5 staff, from 25 and the process “czar” was so busy he would just call the warehouse to tell them to ship specific pallets out to customers, thinking he’d get to the paperwork later. After leaving the company soon afterwards, no one took the reins and completed that task. Over $1.2M was left on the table for months without ever being collected on until we discovered the problem.
During your due diligence phase, instruct current ownership to send statements out ASAP and have them position it as a quarter or year end accounting exercise. No need to alert the customer base that serious issues are occurring & the company can’t even get billings right.
You may not find buried treasure in every situation but it’s still a well worthwhile exercise to undertake. You’ll find out how deep the breaks in operation internal controls go (which I like in a turnaround) even if there isn’t a lot of dollars to be found.