Picking over the carcasses of bankrupt companies is tempting for private equity firms, but the more traditional buyout shops are showing caution bidding on assets entangled in the courts, experts say.

While there could be great opportunity to get companies on the cheap, experts note a list of obstacles -- complex bankruptcy processes, difficulty doing due diligence and an uphill task to persuade investors that the deal will work.

Traditional private equity firms have always been more conservative in terms of the process they go through to buy companies and most have branded themselves as specifically not doing deals that involve distress or turnaround, said Edward Reilly, a partner at law firm Goodwin Procter.

But Reilly sees opportunities for intrepid private equity executives to pick through the carnage and get bargains.

Private equity firms have a total of $807 billion to deploy, according to London-based research firm Preqin, in an environment where traditional leveraged buyout deals are no longer an option as there is a lack of cheap financing.

Many have raised specific funds for distressed investing, and the total amount of capital available for such deals is $51 billion, according to Preqin.

To some extent that is being spent -- firms spent $1.8 billion buying assets out of bankruptcy in the first quarter of 2009 in the U.S. against $340 million the same time a year earlier, according to data from Thomson Reuters. For 2008, deals totaled $1.9 billion, up from $1 billion in 2007.

Deals included mortgage lender IndyMac being bought by a group including Dune Capital Management and J.C. Flowers & Co, and gadget retailer Sharper Image Corp bought by Toronto-based Hilco Consumer Capital.

Experts note that deals typically involve specialist operators rather than buyout firms who are straying from their usual strategies -- or they involve firms bidding on assets they would have coveted as healthy businesses.

To the extent that it is not a company they were focused on before it filed for bankruptcy, they probably won't be interested, said Doug Warner, a senior member of law firm Weil, Gotshal & Manges' private equity practice. They're not just trailing round bankruptcy court looking for cheap assets.

The complexity of bankruptcy can put off those who have are inexperienced.

Bankruptcies are complicated visible processes, said Simeon Gold, a senior partner at Weil practicing M&A, private equity, securities and corporate restructurings. In almost every case the bankruptcy court orders an auction and the buyer could get outbid, he said.

But he pointed to advantages for the bidder, such as buying only those assets and assuming only those liabilities that they pick and choose and negotiate with the debtor.

If they're willing to deal with all the pain and suffering of the bankruptcy process, I think they can end up with a very good deal in terms of cleansed assets, compared to what they might get out of court, he said.


A major issue for firms is persuading investors -- the pension and endowment funds known as limited partners that put money into their funds -- to support the deal.

LPs commit capital when a fund is raised and pay it over the life of the fund as deals are done. During boom times, it is relatively easy for funds to call capital but in the current turmoil far more questions are asked.

How easy is it to explain to your LP that you're calling capital to buy something out of bankruptcy? said an executive at a buyout firm who asked not to be named. The first question faced would be how the fund could turn an investment around when others failed, that person said.

It is also hard if the fund wasn't originally set up with distressed investing in mind, or if the managers aren't experienced in such investments.

We are looking for people that have lived in this space for many years, not just raising their first fund today, said Jonathan Bergman, Chief Investment Officer at New York-based investment management firm Palisades Hudson Asset Management. Now is the time for bankruptcy experts to puff out their chests.

Bergman said the time is right to consider acquiring control positions of businesses out of bankruptcy, adding there's an opportunity to buy great businesses at a great price.

(Editing by Phil Berlowitz)