Purchasing distressed assets or acquiring distressed companies can be a lucrative undertaking, but it’s also one that requires a great deal of careful research and preparation. In addition to the basic questions that any investor should consider before buying a distressed business or any of its assets, several other key criteria can be examined to help prospective investors determine whether a distressed asset purchase will be a truly beneficial acquisition, or more trouble than it’s worth. These criteria are debt, ownership, and value: taken together, they are known informally as the D.O.V. method. Read on for a closer look at how to use the D.O.V. method to weigh the pros and cons of a potential distressed asset acquisition.
Debt.
The first step in the D.O.V. method is to determine what, if any, debt currently encumbers the asset. Is the individual asset affected by a bank loan or IRS lien? Is the company that owns the asset affected by an overriding lien or debt? It is critical to verify the debt in as much detail as possible, and to ensure that the seller has provided accurate information about the amount and number of debts affecting the asset to be sold. Neglecting this step could mean that a prior creditor with superior rights to the asset may be able to make claims against the purchaser in the future. |
Depending on the type of asset, the type of debt will be different, and will be more or less challenging to search for. Both real estate debt and equipment debt are quite easy to find, as creditors will usually file either a lien in the applicable real property records or a Uniform Commercial Code (UCC) statement. Debt that affects equity in a company, however, is more difficult to establish. Unsecured debt, held by creditors who have not filed a searchable lien, could affect the business and its assets without the purchaser being aware of it. For example, a company may have a credit card with thousands of dollars of debt, but that fact would not typically be known to anyone except the company and the creditor.
Ownership.
The second step is to verify that the party offering the asset for sale does in fact own the asset. If they do not, it could create significant complications in closing the deal; more seriously, it could also mean that an attempt is underway to defraud the true owner from the asset.
As with verifying debt, it is relatively easy to establish ownership when the assets are real property or equipment: real property will have county records, while equipment and personal property can be searched by titles and tax records and can be additionally verified by bills of sale from the seller.
A business entity can be searched by lien and tax records, just as for personal property. It is also important to check on corporate filings made by the entity, and the seller should certify that the entity is in good standing.
As with verifying debt, it is relatively easy to establish ownership when the assets are real property or equipment: real property will have county records, while equipment and personal property can be searched by titles and tax records and can be additionally verified by bills of sale from the seller.
A business entity can be searched by lien and tax records, just as for personal property. It is also important to check on corporate filings made by the entity, and the seller should certify that the entity is in good standing.
Value.
The third step of the D.O.V. method is to determine the actual value of the asset in question. While the steps concerning debt and ownership are used to determine whether any other person or entity has a stronger right to the asset than a prospective purchaser, the value step is often the deciding factor in establishing whether a distressed asset is worth the purchase.
In determining the value of a distressed asset, it is important to remember that value is not an objective quality or measure, but is only ever equal to what someone is willing to pay. It is therefore easiest to establish the value of an asset for which there is a market. For example, it is fairly straightforward to determine the current values of both real estate and personal property by examining such information as recent sales records, city and state codes, and the comparative prices listed by companies or websites selling comparable items.
Private companies, however, do not have an easily determined market, so it is necessary to use an alternative form of valuation. In most cases concerning equity in a company, the income stream method is used. This term refers to the process of measuring the value of an asset outside of a pre-existing market by examining the income generated or available from that asset. This method allows a prospective buyer to calculate the anticipated profit of the asset over the length of its foreseeable lifespan; when that amount is discounted by the time value of money, what results is the net present value of the asset, which takes into account not just the asset’s income, but the cost of holding the asset over time. Knowing the net present value of a distressed asset will greatly help purchasers decide whether the asset is likely to be a useful investment in the long term.
In determining the value of a distressed asset, it is important to remember that value is not an objective quality or measure, but is only ever equal to what someone is willing to pay. It is therefore easiest to establish the value of an asset for which there is a market. For example, it is fairly straightforward to determine the current values of both real estate and personal property by examining such information as recent sales records, city and state codes, and the comparative prices listed by companies or websites selling comparable items.
Private companies, however, do not have an easily determined market, so it is necessary to use an alternative form of valuation. In most cases concerning equity in a company, the income stream method is used. This term refers to the process of measuring the value of an asset outside of a pre-existing market by examining the income generated or available from that asset. This method allows a prospective buyer to calculate the anticipated profit of the asset over the length of its foreseeable lifespan; when that amount is discounted by the time value of money, what results is the net present value of the asset, which takes into account not just the asset’s income, but the cost of holding the asset over time. Knowing the net present value of a distressed asset will greatly help purchasers decide whether the asset is likely to be a useful investment in the long term.