Management teams that are on the prowl for acquisitions may find themselves doing some treasure hunting. That’s because they likely will find a growing amount of opportunity in distressed assets, or the debt or equity of a company that has declared bankruptcy or is restructuring itself. That was one of the points that was made clear during a webcast hosted by Ernst & Young last week, titled, appropriately enough, “Buying Distressed Assets.”

After all, business bankruptcy filings more than doubled between 2006 and 2008, jumping from 19,695 to 43,546, reports the research group American Bankruptcy Institute. Filings in the third quarter of 2009 (the latest data available), at 15,177, were nearly three times those of the third quarter of 2006.

Similarly, the number of mass layoffs – a rough proxy for corporate restructurings – jumped from 938 for the month of February 2006 to 1,761 in January 2010, according to the U.S. Bureau of Labor Statistics.

So, how can financial executives best take advantage of the opportunities? A couple of pointers from the panelists:

Get comfortable with assets in bankruptcy. While most buyers prefer not to acquire assets through bankruptcy, it has its advantages. For starters, bankruptcy proceedings allow the buyer to shed the liabilities it doesn’t want, so that it ends up with the assets free and clear. In addition, the fact that a transaction is taking place through bankruptcy more or less forces all parties involved to come to agreement on issues that might otherwise impede a deal.

Recognize when bankruptcy is not the answer. Settling a transaction out of court has its advantages, as well. Coming to terms on a deal without going through the bankruptcy court generally is less expensive. In addition, you avoid the publicity that comes with bankruptcy.

Beware of clawback risk. If you purchase assets from a troubled organization that subsequently declares bankruptcy, the assets you acquired may be subject to a clawback provision. These allow the bankruptcy trustee to undo transactions completed just prior to the filing and let the assets that were transferred from the bankrupt company be made available to the company’s creditors.

Keep an eye on tangible and intangible costs. While lawyers’ fees may be the first expense that comes to mind when dealing with a distressed organization, the more significant cost is less visible. That’s the harm that can come to the business while it’s struggling through bankruptcy or reorganization: Customers and employees may leave and operations languish, particularly if the process drags on. While you need time to thoroughly study the company, taking too long can undermine your efforts.

Gain a thorough understanding of the business’s operations. In addition to scrutinizing assets and liabilities, you need to know how it generates revenue and its normal cash flow. For example, if the company conserved cash by stringing its vendors along, it’s best to uncover this now so that you can determine what a more typical cash flow looks like. You’ll also want to study the factors that drive its costs. In other words, as part of your acquisition plan, you need to plan for an operational, as well as a financial remedy for the firm.

Alicia Masse with Ernst & Young transaction advisory services group in New York noted during the webcast, “When you identify a distressed asset that have strategic or core value, is a diamond in the rough, and you’re willing to shine it up, it has to be of value and not just cheap.” ###