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A Guide to Distressed Private Equity Investing

Distressed private equity is a unique form of investing in private markets. Private equity funds target distressed companies, buying their underpriced equity or debt to sell for much higher when the companies return to financial health. Private equity companies can sell these assets to other private equity companies or to the public through stock exchanges.

Distressed private equity companies operate much the same as traditional private equity companies - they raise capital from accredited investors and institutions such as pension funds. Afterward, they invest the capital in private companies, often taking board positions in these companies to steer their management. That way, their business is part fundraising, part investing, and part operations.

The difference with traditional private equity investing is the quality of assets purchased. While traditional private equity funds look for financially healthy companies with strong balance sheets and stable revenues, distressed private equity funds look for the opposite. The former invests to maintain or scale an existing growth trajectory, while the latter invests to turn around a company from financial difficulty and near insolvency.

Companies become distressed for various reasons, including poor management, poor cash flow, or issues with their core products or services. Economic and geopolitical issues tend to exacerbate these problems, causing many companies to seek insolvency. Distressed private equity investors typically start by looking for companies displaying signs of distress, such as reducing cash flows, seeking debt repayment extensions, and reporting prospective covenant breaches in their financial statements.

Once distressed debt investors identify a distressed company, they perform extensive due diligence to see if the business is valuable. This includes analyzing its financial statements, business operations, and relations with stakeholders such as suppliers and employees. If investors determine that the business has potential despite its difficulties, they will invest.

Private equity funds use several strategies to invest in distressed companies. One strategy is distressed debt trading, in which private equity funds buy the distressed company's debt that is trading at a discount. When the company gains financial health, the private equity fund sells the debt at higher prices.

In a distressed debt non-control strategy, private equity funds buy underpriced debt to influence the coming bankruptcy or restructuring process. They negotiate favorable terms so the market value of their debt rises considerably.

Another strategy is distressed debt control, in which private equity funds buy underpriced debt to convert it to equity in the company, giving it a controlling stake in the business after bankruptcy. From there, the private equity company makes operational changes, such as selling unprofitable units, reducing employees, and increasing sales and marketing. If these go well, the company may return to profitability and its shares rise in value.

Distressed private equity investors can also directly buy a company’s equity. Afterward, they restructure the company to get it out of distress, then sell their shares. In other instances, funds can deploy a mix of strategies on a company to optimize realizable value.

Advantages of distressed private equity investing include the opportunity for high returns since funds purchase assets at low prices and sell at high prices if their strategies are successful. Socio-economic benefits also accrue from saving companies and employees’ jobs.

A disadvantage of distressed debt investing is that it is high-risk and challenging. Fund managers must spend time and use diverse skills to identify worthwhile companies and attempt to turn them around.

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The Turnaround Management Association

A master of business administration in finance graduate from Case Western Reserve University, Hunting Valley, Ohio-based Bassem Mansour is the co-chief executive officer of Resilience Capital Partners. To augment his work Bassem Mansour is a member of several professional organizations, including the Turnaround Management Association (TMA).

Established in 1988, TMA represents a diverse array of professionals from corporate restructuring, corporate, and renewal niches. It has over 10,000 members in 54 chapters worldwide, with 34 located in North America. The members include professionals in the academic field, business and investment, government, judiciary, and the turnaround practice.

Through the members' expertise, TMA aims to strengthen the global economy by saving distressed businesses, assisting healthy companies with risk mitigation, and helping executives navigate off-plan events. The organization also offers courses, certifications, publications, conferences, and events for members. One of the prominent programs is the TMA Distressed Investing Conference.

Focusing on the distressed investment space, the conference provides a networking and dealmaking forum for partners, capital providers, and other distressed investing professionals. The typical agenda for this annual event includes keynote speakers from the distressed investment climate, interactive discussions on surviving distressed investment, and professional development. The sessions are open to professionals such as hedge fund managers and debt purchasers.

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Considerations for Launching a Private Equity Firm

In the last few decades, private equity funds have proven successful as an asset class. During this time, private equity firms and the funds they manage have outperformed the Standard & Poor (S&P) 500 Index, which has attracted interest from investment bankers, institutional bankers, and high-net-worth individuals. Moreover, the increase of pandemic-related start-ups over the past few years and increased mergers and acquisitions activity has presented many opportunities for many to launch private equity firms. However, before launching a firm, prospective private equity firm founders must consider their business strategy, investment vehicle, fee structure, and raising capital. A private equity fund raises capital from investors. After raising funding, fund partners buy ownership in a company. Sometimes, private equity funds focus on buying a company outright or buying out the founder, funding investors who want to cash out, funding businesses that are scaling up, and providing funding for struggling businesses. Logistics firms and tech start-ups have provided much of the traction that has made launching private equity investments more attractive. Additionally, mergers and acquisitions activity accounted for a cumulative value of deals of $5 billion or more, totaling $456 billion during the third quarter of 2020. In September 2020, private equity experienced a 73 percent year-over-year growth. In 2021, private equity investment activity rose in the first five months culminating in more than 2,300 deals, a 22 percent year-over-year increase. Ultimately, these figures indicate that the market is teeming with opportunities for entrepreneurs with the initiative and innovation to raise money to invest in the next big thing. In establishing an equity fund, prospective founders must figure out a business strategy or find a market from which to launch the investment firm. To find a market, prospective general partners have to research potential markets or sectors that might be lucrative. Further, at the root of private equity investment is the ability to generate returns (money) for investors, so looking for areas with the highest returns is one way to begin strategizing. After choosing an area to invest, fund managers should also know the ins and outs of the area. This expertise positions the fund manager to offer investors valuable information on investments more likely to generate substantial returns. Private equity firms can generate money by raising money to invest in early-stage start-ups or venture capital. Other strategies include growth equity investment, which focuses on investing in a company in the middle stage of growth, and buyout, which involves buying out a company to improve it. After fleshing out which area the fund will focus on, prospective fund managers must choose an investment vehicle. The most common private equity investment firm model in the US and Europe contains the investors, fund managers, and the company receiving the investments. The investor groups can be individual, institutional, and pension fund investors or high-net-worth individuals referred to as limited partners (LP). The actual private equity firm is the general partner (GP) who is in charge of raising capital and making strategic investment decisions. In addition to finding a market niche and private equity vehicle, founders must establish a fee structure for management interest, hurdle rate of performance, and carried interest. The standard management fee a general partner might receive is two percent, so for a fund that raises $5 million each year, the general partner receives $100,000. This rate depends on the fund manager’s experience, with less experienced managers taking a smaller amount. The carried interest, or share of the profits the GP earns, is generally set at 20 percent above the amount of the fund’s return, and the hurdle rate requires the fund to earn a certain level above expectations to trigger incentive compensation for the general partner. For example, typical rates for a fund are set at five percent but say a fund performs at a rate of six percent; the GP only earns one percent on the amount over the set performance rate. At this point, the firm is ready to present the fund to investors. While it only involves selling the fund, the fund managers have to convince investors why the investment is lucrative.

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An experienced principal investor, Bassem Mansour serves as the co-founder, managing partner, and co-CEO of Resilience Capital Partners. Based in Ohio, this company is a private equity firm focused on acquiring companies in special situations, like restructurings or corporate divestitures. As co-CEO, Bassem Mansour oversees the firm’s portfolio companies, including the recent naming of Tim Seitter as CEO and president of its portfolio company CR Brands.

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CR Brands Sold Biz Stain & Odor Eliminator

A resident of Hunting Valley, Ohio, Bassem Mansour is the co-CEO of Resilience Capital Partners, a private equity firm based in Beachwood. At the firm, Bassem Mansour oversees acquisitions and divestitures in portfolio companies including CR Brands. In 2020, CR Brands announced it was selling its Biz Stain & Odor Eliminator and Dryel product lines to Scott’s Liquid Gold. They completed the sale in July. The two sold for $9.25 million. In 2019, the two product lines had sales of $11.2 million. They recorded a gross profit margin of $4.7 million. CR Brands grew the two product lines into household names available at retailers across the country. The brands enjoy strong customer loyalty because of their superior performance qualities. With the two sales, CR Brands sold off all its product lines except for the Arm & Hammer and OxiClean lines. The Arm & Hammer line comprises wipes, garbage disposal cleaners, and vegetable wash. The OxiClean line comprises stain remover pens.