Distressed investing has been an asset class in which a lot of money has been made over the last several decades. It's generally a less crowded field, though it’s getting more and more crowded each cycle.

“It's not for the faint of heart,” says James Loughlin, managing director of BDO Consulting LLC. “You're stepping into situations which are often burning platforms, so the investor needs to be prepared to step in and use all of the tools in the kit to be successful in turning around the business and making sure that they can generate the type of returns commensurate with the risks they're taking.”

When stepping into such a situation, Loughlin says first on his due diligence list is to understand what happened — how did the company end up on the list of distressed businesses in bankruptcy, going through restructuring, or finding themselves involved in a for-sale transaction.

Further, before investing, there needs to be a solid hypothesis in mind. While that's not unique to a distressed investment — a healthy company investment also requires a blueprint for the future. But in these situations where there's clearly some trouble, it's important to understand all the factors: was this a cyclical issue? Or is there something longer-term happening with this company or with this industry sector that could impact the ability of the business to turn itself around?

It’s also important to discern whether there are enough competitive advantages in the company to make the investment opportunity worthwhile, as well as a clear path to profitability.

“There's going to need to be, as part of the investment hypothesis, a turnaround strategy, a turnaround plan, to rev that business model back up to where it can grow again, generate the type of profits that are necessary to create value for the new investor,” Loughlin says.

Mike Teplitsky, Managing Director of Wynnchurch Capital, says when looking at distressed companies, early questions include how do you capitalize this business, does it survive if it continues, where is the macro economy overall headed, and what does the turnaround plan look like — is it an operational fix, is it a commercial fix, is it a strategic fix, or is it just a macro issue that an investor can wait out until the cycle comes back?

But likely the most important question investors always need to think about is management.

“Who's going to engineer the turnaround?” Teplitsky says. “Who's on the bus today? Are those people in the right seats? Do we need to bring in people from the outside? And what's ended up happening in the past is, overall, in all of our deals, we've had to bring in new CEOs about 60 percent of the time. But when you look at the most complicated deals, the distressed and turnaround deals, it's probably over 90 percent of the time.”

Loughlin and Teplitsky, along with BDO USA Managing Director of Business Restructuring Services Robert Berdanier, Bodman Member Robert Diehl Jr., and Comerica Bank SVP of Special Assets Group Manager Vlad Slapak, spoke at the recent Detroit Smart Business Dealmakers Conference, about what investing in distressed companies looks like, as well as how to analyze your company’s people, operations, and finances to understand if you need to restructure. Hit play on the video above to catch the full panel discussion.