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Explaining the Benefits, Considerations, and Key Points of Buying A Closing Company


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In recent years, the number of companies facing closure due to declining performance or the absence of successors has been increasing. One widely recognized method to address such crises of closure is through mergers and acquisitions (M&A). This article aims to introduce the benefits, considerations, and schemes associated with acquiring companies facing closure.

1. Current Situation of Companies Facing Closure

Closure refers to the termination of business operations by individuals or companies. In 2021, the number of closures, suspensions, and dissolutions amounted to approximately 44,000 cases, which is about 7.3 times the number of bankruptcies, indicating the severity of the closure issue.

Although the number of closures, suspensions, and dissolutions decreased by 10.7% compared to the previous year, this reduction is attributed to the timely avoidance of closure due to government measures against the novel coronavirus. However, the reality is that many small and medium-sized enterprises are experiencing a decrease in repayment capacity for borrowed funds.

Excerpt from the Japan M&A Center's Basic Materials for Press Releases, July 2022

Furthermore, nearly 20% of all companies are profitable and have assets exceeding liabilities. This means that even companies that were expected to continue stable operations are increasingly facing closure.

From these trends, it can be inferred that the prolonged impact of the novel coronavirus is causing an increase in closures where companies, with even a little remaining resilience, are reluctantly abandoning business continuity.

2. Reasons for Choosing Buying a Closing company

When entrepreneurs are compelled to choose closure, commonly envisaged reasons include "financial distress due to declining performance" or "absence of successors," wouldn't you agree? However, in reality, there are various other reasons such as "lack of hope for the future of the industry" or "inability to secure personnel with necessary skills."

What they share in common is the judgment that "continuing the business as it is does not hold the potential for growth or recovery," leading to consideration of closure.

Therefore, if there's an outlook that "the current decline in performance is temporary, and there's potential for performance recovery in the future," the likelihood of choosing closure is low, and the business is likely to continue.

Moreover, even when a company's financial statements show profits, there are cases where mismanagement of funds or the absence of successors leads to bankruptcy or closure. For more on profitable bankruptcies, please refer to the related articles below.

3. Choosing M&A to Avoid Closure

Closure doesn't signify an ultimate end with a single decision. Considering its significant impact on stakeholders such as customers, partners, and employees, careful consideration is essential.

Therefore, many companies facing the threat of closure have opted for M&A, taking into account the welfare of their customers and employees.

For instance, when contemplating closure due to declining performance, joining a buyer company with potential synergy effects can increase the likelihood of reviving the struggling business. Moreover, by determining the successor company through M&A, one of the significant reasons for the closure, the issue of succession, can be resolved, allowing the acquiring company to confidently take over management.

Indeed, the use of M&A to avoid closure is becoming increasingly prevalent.

4. Benefits of Buying a closing company

Let's explore the benefits of acquiring companies facing closure.

Some may doubt the value of acquiring companies considering closure, except for cases where closure is being contemplated due to significant losses or debts. However, when taking over companies that were considering closure, various benefits arise:

4.1. Higher Potential for Smooth Negotiations:

In cases where the main objective of the transfer is to gain proceeds from the sale of the company, negotiations can be challenging due to disagreements on terms. However, when a company considering closure decides to transfer ownership, negotiations are often smoother as the main objectives revolve around business continuity and maintaining employee employment.

4.2. Inheriting Management Resources for Swift Business Initiation:

Starting a new business from scratch requires significant time and expenses to establish various management resources such as facilities and personnel. However, acquiring a company facing closure means inheriting existing business resources like clients, personnel, and expertise, enabling swift business initiation. This also shortens the time to generate revenue.

4.3. Cost Reduction Through Utilization of Procurement and Sales Channels:

Establishing new procurement routes and sales channels for business expansion requires substantial time and costs. Acquiring businesses related to existing operations allows the buyer to utilize the seller's procurement routes for raw materials and sales channels for products, thereby reducing costs.

Compared to starting a new business independently, early revenue generation can be expected through these means.

5. Considerations When Buying a closing company

While there are benefits, let's also examine some important considerations.

5.1. Possibility of Inheriting Unexpected Debts:

Hidden debts, known as off-balance-sheet liabilities, refer to undisclosed debts not recorded on the balance sheet. Acquiring a company with off-balance-sheet liabilities means assuming those debts.

For example, if the previous management secretly received loans from a bank, the obligation to repay those loans may be transfered to the acquiring company through the acquisition. Therefore, thorough due diligence is necessary beforehand to accurately assess the presence of off-balance-sheet liabilities.

5.2. Risks of Employee and Customer Departure:

There is a risk of employees and customers leaving in the new environment. If employees of the seller company accumulate dissatisfaction with the buyer company, they may choose to leave.

Additionally, existing clients may disagree with the buyer company's new management policies, leading to the termination of business relationships.

The departure of employees and clients can significantly impact future business operations. To prevent the departure of clients and employees, close communication with them after the M&A is crucial. Therefore, the buyer company needs to focus not only on the pre-acquisition process but also on the post-integration process.

6. Four Schemes for Buying a closing company

When considering acquiring companies facing closure, there are primarily four schemes to consider. Let's introduce the characteristics of each scheme.

6.1. Share Transfer:

Share transfer involves the owner of the selling company transferring (selling) shares they hold to the buyer company, thereby taking over the management of the company in an M&A scheme.

Upon signing a share transfer agreement, and upon payment of the share price to the selling company, updating the shareholder registry completes the process. It is a straightforward method compared to other M&A schemes, making it the most commonly used scheme in M&A transactions involving small and medium-sized enterprises.

The advantage of using share transfer is the ability to inherit contracts with clients and employment agreements with employees without having to renegotiate them individually, thus saving time and costs. Additionally, there is generally no need to undergo procedures for inheriting assets of the selling company.

6.2. Business Transfer:

Business transfer involves selling all or part of the business that a company operates to another company.

Unlike share transfer, where the entire company is sold, the significant difference lies in the ability to choose the specific business to be transferred.

Hence, one of the advantages is that there is no need to inherit unnecessary businesses. Additionally, in a business transfer, there is no need to inherit liabilities.

Moreover, unlike in share transfer, where only shares are transferred, in business transfer, risks associated with the original target company are not inherited. (Of course, if there are risks associated with the acquired assets themselves, they cannot be eliminated.)

From the perspective of cutting off potential risks associated with the target company, business transfer can be considered an excellent method.

However, it is difficult for the management of the selling company alone to decide on business transfer, and consent from employees and business partners is necessary. Therefore, concerns exist regarding the smoothness of procedures compared to share transfer, among other factors.

Additionally, attention is needed regarding the need to apply for new permits for the business, and according to the non-compete obligation (Article 21 of the Company Act), conducting business in the same industry within the same municipality may not be allowed.

6.3. Corporate Split

Corporate split involves separating all or part of a company's business and transferring it to another company in an M&A scheme.

In many cases, it is used to transfer businesses to a third party and reorganize the company.

The corporate split includes an "absorption-type split," where the business is transferred to an existing company, and an "establishment-type split," where the business is transferred to a newly established company.

Since specific businesses can be pinpointed for transfer, the scope of impact can be minimized. Additionally, inheriting contracts with business partners and employment agreements with employees is a benefit.

Furthermore, streamlining the organization can lead to operational efficiency. Since the consideration for the acquisition can include not only cash but also shares, it can alleviate the financial burden, which is another benefit.

However, there is a risk of inheriting the seller's liabilities. Additionally, in the case of the acquiring company being a listed company, there is a risk of decreasing profit per share and lowering stock prices.

Depending on the industry, the need to reacquire permits can be a bottleneck, and attention is needed to the possibility that the split may not be realized.

6.4. Merger

Merger involves integrating multiple companies into one. There are "absorption mergers," where the surviving company inherits all rights and obligations held by the disappearing companies, and "establishment mergers," where a newly established company inherits them.

The main advantages of a merger include the allowance for issuance of own shares as consideration for the merger, reducing the burden of raising funds, and the smooth transition as all rights, obligations, and assets and liabilities can be comprehensively inherited.

However, attention is needed regarding the disappearance of the seller's corporation, the possibility of bearing the risk of value fluctuations for the buyer, especially if the buyer is a non-listed company, and the difficulty in monetizing the issued shares for the buyer.

7. Points to Consider When Buying a closing company

Let's take a look at the key points to consider when acquiring a company facing closure.

7.1. Understanding the Reasons/Objectives for Closure

It is important to thoroughly understand the reasons why the target company is considering closure. As mentioned earlier, the triggers and backgrounds for management considering closure vary.

If the reasons for considering closure are clear, the acquiring company can devise strategies and approach the acquisition accordingly.

However, if the reasons are not clear, there may be hidden reasons or risks, such as undisclosed hidden debts. Therefore, it is crucial to thoroughly verify and understand these aspects beforehand.

7.2. Conducting Financial Due Diligence to Confirm Financial Status

If the reason for considering closure is due to poor performance and financial distress, it is necessary to consider the potential for the selling company's business to recover.

To do this, due diligence on the assets, liabilities, and financial status of the selling company is required.

Based on the results of due diligence, careful consideration should be given to whether to proceed with the M&A transaction or not.

7.3. Seeking Support from M&A Advisory Firms

When acquiring a company that is considering closure, it is recommended to seek support from M&A advisory firms.

By receiving support from M&A advisory firms, issues that may be difficult to confirm as a party directly involved in the M&A process, such as conducting due diligence, can be addressed, allowing for a smoother transaction process.

8. Conclusion

Even when considering closure, the reasons can vary beyond just financial distress, including issues such as succession or talent shortages, as mentioned. For example, if a company with unique technology, facilities, or talented personnel is considering closure due to succession issues, the acquisition could resolve those challenges and lead to significant transformation.

First and foremost, it is advisable to consult with an M&A advisory firm well-versed in the information of the company wishing to transfer ownership.