If you are looking to buy a bankrupt business, it is important to know what to look for and the steps involved in buying one.
In this Golden Nugget of The ROI Online Podcast, we will discuss with author, consultant, and business owner Josh Patrick why or why not purchasing a bankrupt business is a good idea.
In spite of the best efforts to create a successful company, many companies are unable to maintain the momentum they need in order to stay afloat.
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A common reason for failed businesses is an uncompetitive environment that doesn't allow them access into key markets or reduced growth opportunities due to external factors like new regulations and increased competition from competitors.
Bankruptcy can be caused by over-expansion, poor internal management practices, or any other number of reasons including economic downturns which make it difficult for existing enterprises with good prospects but weak financial statements such as those who rely on short term debt financing instead of equity capitalization; these situations often lead projects once considered profitable now unprofitable when interest rates rise too high.
We share with you the main risks of investing in a bankrupt business.
It's easy to see how this process may seem like a no-brainer, but there are serious risks associated with investing in companies emerging from bankruptcy. For example, the new shares could be falsely priced, and selling them might make sense - either way they will likely end up being worth less than what you paid for them.
The problems that caused the company to go bankrupt in the first place still exist today so it is unlikely that anything has changed since then when those same issues reoccurred all over again.
Another threat to bankruptcy investing is so-called vulture investors. These are investment groups that specialize in buying large stakes (debt and bonds) in companies operating under Chapter 11 before new shares are issued, guaranteeing they will be among the largest shareholders after a company recovers from its financial breakdowns.
These groups have already discovered how valuable post-bankruptcy stocks can become when they sell off their own initial investments at an exorbitant profit once it becomes evident there's no going back for these bankrupt enterprises.
The bankruptcy reorganization process is long and complex, but some public companies are able to emerge from it as profitable again. These companies may represent the best-undervalued investment opportunities for investors who have a stomach for risk.
Josh Patrick's advice is actually not to do it! And here's why.
"What I would buy is what's called a zombie business. And a zombie business is a business that either private equity has not made successful, which is most of them, or you might be able to find a division of a publicly-traded company, where they've announced they're going to dump a division. And it could be a small division, it doesn't have to be when there's $100 million, it might be $2-3 million in sales, they get to October, they haven't found a buyer and it doesn't look like they're going to find a buyer. And then they'll start selling businesses for a bargain because the market will penalize them if they haven't gotten rid of that business by the time the year-end comes. Again, these are harder strategies though."
On a final note, he tells us that you can buy a business out of bankruptcy if you think or if you believe that there's something there to rebuild.
A bankrupt business isn't always such a good idea. Josh Patrick's advice is actually to go for other strategies. He also warns about the potential for vulture investors who will get in early on bankrupt companies before they can even recover from their financial difficulties and sell off at an expectant profit when there seem to be no more options left - making this type of investment risky but potentially rewarding if you're able to find just the right bankrupt company that seems poised for success. So now you have more tools to have a better more informed decision!