Strategic Financial Management - Corporate Restructuring - Introduction - Notes - Finance, Study notes for Business Administration. Banaras Hindu University

Business Administration

Description: Introduction To Corporate Restructuring, 2meaning Of Corporate Restructuring, Reasons For Corporate Restructuring, Types/Forms Of Corporate Restructuring , Joint Ventures, Strategic Alliances , Sell-Off, Hive-Off, Demergeror Corporate Splitsor Division, Equity Carveout, Leveragedbuyout(Lbo), Restructuring, Diversification
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INTRODUCTION TO CORPORATE RESTRUCTURING

Before knowing the meaning and forms of corporate restructuring it is better to

know the different forms of business organisation and how an entrepreneur

structures his/her organisation. Entrepreneur who is planning to start an organisation either for manufacturing products or providing services need to

select the right form of business organisation. This is possible for those

entrepreneurs who are having knowledge about the advantages and disadvantages of

different forms of business organisations. There are four main forms of business

organisations, viz., sole proprietorship, partnership, cooperative society, and company

(public and private). Each of this form has its own advantages and disadvantages. At

the same time entrepreneur also determines the financial structure also. But the

same form of business organisation and financial structure may not be suitable for

changing business environment. Therefore, there is a need to restructure their

corporation.

3.1.1 INTRODUCTION TO CORPORATE RESTRUCTURING

It is very difficult for any firm to survive without restructuring the firm in the growing

stages. It may be possible to run a firm successfully for a short period, but in the long

run it may not be possible without restructuring because business environment

changes. Scanning of business environment helps in identifying business

opportunities and threats. Corporate restructuring is necessary whenever there is

change in business environment. For example, with liberalization, privatization,

and globalisation (LPG) many firms felt that there are lots of profitable

investment opportunities, and it also means increasing competition. A firm that feels globalisation is opportunity for the firm, then it need to leverage the benefits, which

require lot of funds and resources, and also need to go for restructuring. On the other

hand a firm that feels globalisation or liberalization or privatization is as competition, it

has to compete with the new competitors, by manufacturing products at high quality

and sell at reasonable prices, but it needs

more technological support and needs more funds. So firm need to go for

restructuring.

Today, restructuring is the latest buzzword in corporate circles. Companies are

vying with each other in search of excellence and competitive edge,

experimenting with various tools and ideas. Many firms try to turn the business around

by cutting jobs, buying companies, selling off or closing unprofitable divisions or

even splitting the company up. And the changing national and international

environment is radically changing the way business is conducted. Moreover, with the

pace of change so great, corporate restructuring assumes paramount importance. It is

because profitable growth is one of the objectives of any business firm. Maximization

of profit is possible either by internally, by change of manufacturing process,

development of new products, or by expanding the existing products. On the other

hand company would be able to maximize profit by externally merging with other

firm or acquiring another firm. The external strategy of maximizing profit may

be in the form of mergers, acquisitions, amalgamations, takeovers, absorption,

consolidation, and so on.

Put in simple words the concept of restructuring involves embracing new ways of

running an organization and abandoning the old ones. It requires organisations to constantly reconsider their organisational design and structure, organisational

systems and procedures, formal statements on organisational philosophy and may also

include values, leader norms and reaction to critical incidences, criteria for rewarding,

recruitment, selection, promotion and transfer.

3.1.2 MEANING OF CORPORATE RESTRUCTURING

Restructuring is the corporate management term for the act of partially

dismantling and reorganizing a company for the purpose of making it more

efficient and therefore more profitable. It generally involves selling off portions of the

company and making severe staff reductions. Restructuring is often done as part of a

bankruptcy or of a takeover by another firm, particularly a leveraged

buyout by a private equity firm. It may also be done by a new CEO hired

specifically to make the difficult and controversial decisions required to save or

reposition the company.

It indicates to a broad array of activities that expand or contract a firm‘s

operations or substantially modify its financial structure or bring about a

significant change in its organisational structure and internal functioning. It

includes activities such as mergers, buyouts, takeovers, business alliances, slump sales,

demergers, equity carve outs, going private, leverage buyouts (LBOs),

organisational restructuring, and performance improvement initiatives.

3.1.3 REASONS FOR CORPORATE RESTRUCTURING

There are a good number of reasons behind corporate restructuring. Corporate restructure their firms with a view to:

1 Induce higher earnings

2 Leverage core competencies

3 Divestiture and make business alliances

4 Ensure clarity in vision, strategy and structure

5 Provide proactive leadership

6 Empowerment of employees, and

7 Reengineering Process

1. Induce Higher Earnings: The prime goal of financial management is to

maximize profit there by firm‘s value. Firm may not be able to generate constant

profits throughout its life. When there is change in business environment, and

there is no change in firm‘s strategies. The two basic goals of corporate

restructuring may include higher earnings and the creation of corporate value.

Creation of corporate value largely depends on the firm‘s ability to generate

enough cash. Thus corporate restructuring helps to firms to increase their profits.

2. Leverage Core Competence: Core competence was seen as a capability or skill

running through a firm‘s business that once identified, nurtured, and developed

throughout the firm became the basis for lasting competitive advantage. For

example Dell Computer built its first 10-year of unprecedented growth by creating

an organisation capable of the speedy and in expensive manufacture and

delivery of custom-built PCs. With the concept of organisational learning

gaining momentum, companies are laying more emphasis on exploiting the rise

on the learning curve. This can happen only when companies focus on their core

competencies. This is seen as the best way to provide shareholders with increased

profits.

3. Divestiture and Business Alliances: Some times companies may not be able to run

all the companies, which are there in-group, and companies which are not

contributing may need to be divested and concentrate on core competitive business.

Companies, while keeping in view their core competencies, should exit from

peripherals. This can be realised through entering into joint ventures,

strategic alliances and agreements.

4. Ensure Clarity in Vision, Strategy and Structure: Corporate restructuring should

focus on vision, strategy and structure. Companies should be very clear about their

goals and the heights that they plan to scale. A major emphasis should also be

made on issues concerning the time frame and the means that influence their

success.

5. Provide Proactive Leadership: Management style greatly influences the

restructuring process. All successful companies have clearly displayed leadership styles in which managers relate on a one-to-one basis with their

employees.

6. Empowerment of Employees: Empowerment is a major constituent of any

restructuring process. Delegation and decentralised decision making provides

companies with effective management information system.

7. Reengineering Process: Success in a restructuring process is only possible through

improving various processes and aligning resources of the company. Redesigning a

business process should be the highest priority in a corporate restructuring exercise.

The above discussed are the prime reasons for corporate restructuring.

3.1.4 TYPES / FORMS OF CORPORATE RESTRUCTURING

Business firms engage in a wide range of restructuring activities that include

expansion, diversification, collaboration, spinning off, hiving off, mergers and

acquisitions. Privatisation also forms an important part of the restructuring

process. The different forms of restructuring may include: (1) Expansion, (2). Mergers

(Amalgamation), (3) Purchasing of a Unit or Division or Plant, (4) Takeover, (5)

Business Alliances, (6) Sell-Off, (7) Hive-Off, (8) Demerger or Corporate Splits or

Division, (9) Equity Carveout, (10) Going Private, and (11) Leveraged Buyout (LBO)

1.Expansion: It is the most common and convenient form of restructuring, which

involves only increasing the existing level of capacity and it does not involve any

technical expertise. Expansion of business needs more funds to be raised either in

the form of equity or debt or both and the funds are used to finance the fixed assets

required for manufacturing the expanded level of production. This increase firm‘s

profitability, thereby value of the firm

2.Merger: The term merger refers to a combination of two or more companies into a

single company where one survives and the others lose their corporate existence.

The acquired company (survivor) acquires the assets as well as liabilities of the merged company or companies. For example A Ltd., acquires the business of B Ltd.

and C Ltd. The Generally, the company, which survives, is the buyer, which retains

its identity, and the seller company is extinguished. Merger is also defined as

amalgamation. Merger is the fusion of two or more existing companies. All assets,

liabilities and stock of one company stand

transferred to Transferee Company in consideration of payment in the form of equity

shares of Transferee Company or debentures or cash or a mix of the two or three

modes. Mergers per se, may either be horizontal mergers, vertical mergers or

conglomerate mergers. In a tender offer, the acquiring firm seeks controlling interest

in the firm to be acquired and requests the shareholders of the firm to be acquired, to

tender their shares or stock to it.

Amalgamation: Ordinarily amalgamation means merger. Amalgamation refers to a

situation where two or more existing companies are combined into a new company

formed for the purpose. The old companies cease to exist and their shareholders are

paid by the new company in cash or in its shares or debentures or combination of

cash, shares, and debentures. Almost the same definition is give by 2 01 FHalsbury s Laws

of England describe amalgamation as a blending of two or more existing

undertakings into one undertaking, the shareholders of each blending company

becoming substantially the shareholders in the company, which is to carry on the

blended undertaking.

But there is technical difference between merger and amalgamation. In case of merger,

one existing company takes over the business of another existing company or

companies, while in the case of amalgamation; a new company takes over the

business of two or more existing companies. The company or companies merging

are called amalgamating company or companies and the company with which the

amalgamating merge or the company, which is formed as a result of the merger, is

called amalgamated company. For example C Ltd., is formed to take over A Ltd.

and B Ltd. However, in practice, no such distinction is observed. As a matter of

fact the term amalgamation includes merger also.

In the case Andhra Pradesh High Court held in S.S Somayajulu v Hope

Prudhommee & Co. Ltd., 2 01 6the word ―amalgamation has no definite legal

meaning. It contemplates a state of things under which two companies are so

joined as to form a third entity, or one company is absorbed into and blended with

another company. Amalgamation does not involve a formation of a new company to

carry on the business of the old company.

3.Purchasing of a Unit: Purchasing a unit or plant or division is becoming

common practice in corporate restructuring activity. This is because purchasing a unit

reduces the time involved in setting up of new unit, which is generally a lengthy

period and also brings some tax benefits. When a firm purchases one unit of the other

firm then it becomes to divesture for the selling firm. For example when Hindustan

Co. purchases a unit of Bharath Co. from Bharath company point of view it is

divesture. Generally firms sell a unit or plant or division, due to no performance, or

low performance. At the same time the low or no performance reduces the profits of

consolidated results of the firm.

4.Takeover: A ‗takeover‘ is acquisition and both the terms are used

interchangeably. Takeover differs from merger in approach to business

combinations i.e. the process of takeover, transaction involved in takeover,

determination of the share exchange or cash price and fulfillment of goals of

combination all are different in takeovers than in mergers. For example, process of

takeover is unilateral and the offeror company decides about the maximum price.

Time taken in completion of transaction is less in takeover than in mergers,

top management of the offeree company being more co-operative.

5.Business Alliances: The following are more commonly used forms of business

alliance:

Joint Ventures Occasionally two or more capable firms lack a necessary

component for success in a particular competitive environment. For example, no single

petroleum firm controlled sufficient resources to construct the Alaskan pipeline. Nor

was any single firm capable of processing and marketing all of the oil that would flow

through the pipeline. The solution was joint ventures. A joint venture is set up an

independent legal entity in, which two or more separate firms

participate. The joint venture agreement clearly indicates how the cooperating

members will share ownership, operational responsibilities, and financial risks and

rewards. Example of JV Fuji-Xerox, JV to produce photocopiers, for the Japanese

market.

Strategic Alliances A strategic alliance is cooperative relationship like JV, but is does

not create a separate legal entity. In other words companies involved do not take an

equity position in one another. In many instances, strategic alliances are partnerships

that exist for a defined period during which partners contribute their skills (transfer

technology, or provide R&D service, or grant marketing rights etc.) and expertise to a

cooperative project. For example, service and franchise based firms like Coca-Cola,

McDonald‘s and Pepsi have long engaged in licensing arrangements with foreign

distributors as a way to enter new markets.

Franchising A special form of licensing is franchising, which allows the

franchisee to sell a highly publicsed product or service, using the parent‘s brand name

or trademark, carefully developed procedures, and marketing strategies. In exchange, a franchisee pays a fee to parent firm, typically based on the volume of sales of the

franchisor in its defined market area. Most attractive franchisees are Coca-Cola,

Kentucky Fried Ckicken, Pepsi.

Licensing / Contract Manufacturing License is an agreement whereby a foreign

licensee buys the right to produce a company‘s product in the licensee‘s country for a

negotiated fee (normally, royalty payments on the sales volume). There are two popular

types of licensing. First type involves granting license for product, or process, or

specific technology, the second type of licensing involves granting licensing for

trademark or copyright. RCA for instance, once licensed its color television

technology to a number of Japanese companies.

6.Sell-Off: Sell-Off may be either through a spin-off or divestiture. Spin-Off creates

a new entity with shares being distributed on a pro rata basis to existing

shareholders of the parent company. Split-Off is a variation of Sell-Off.

Divestiture involves sale of a portion of a firm/company to a third party.

7.Hive-Off: It refers to the sale of loss making division or product or product line, by

a company. Put it simple it is discontinuing manufacture of a product or closing

down a division. This is beneficial for both the buyer and the seller. Saving the

acquisition cost of acquiring an established product benefits the buyer. On the other

hand concentrating more on profitable segments or products and consolidating its

business benefit seller. The recent example is hiving off Tata Chemicals share in

Excel Industries.

8.Demerger or Corporate Splits or Division: Demerger or split or division of a

company are the synonymous terms signifying a movement in the company just

opposite to combination in any of the forms defined above. Such types of

demergers or ‗divisions‘ have been occurring in developed nations particularly in

UK and USA.

In UK, the above terms carry the meaning as a division of a company takes place when

part of its undertaking is transferred to a newly-formed company or to an existing

company, some or all of whose shares are allotted to certain of the first company‘s

shareholders. The remainder of the first company‘s undertaking continues to be

vested in it and its shareholders are reduced to those who do not take shares in the other

company; in other words, the company‘s undertaking and shareholders are divided

between the two companies. In USA, too, the corporate splits carry the similar features

excepting difference in accounting treatment in post-demerger practices. In India, too,

demergers and corporate splits have started taking place in old industrial conglomerates

and big groups.

9.Equity Carveout: Equity carveout is the sale of its equity by parent company in a

wholly owned subsidiary. The sale of equity may be to the general public or strategic

investors. Equity carve out differs from spin off in two ways. First, in equity

carveout the equity shares are sold to the new investor, whereas in the

spin off the equity shares are sold to the existing shareholders. Secondly, equity

carveout brings cash to the firm (since the shares are sold to the new investor),

whereas in the spin off there is no cash infusion to the company because the shares

value is broken into small and the same are distributed to the existing shareholders.

For example, A company has 10,000 equity shares each Rs.10 face value. The

company is planning to spin off the shares, by dividing the face value into two equal

values. In this case firm divides share into two with face value of Rs.5 per share and

the same is distributed to the existing shareholders. Here the number of shares

increases to 20,000, but face value of the share is Rs.5.

10. Going Private: Ownership of a company can be changed through an

exchange offer, share repurchase or going public. Therefore, going private is one of

the ways of ownership restructuring. Generally public company stock is held with

public. Going private means converting public company into private company.

Privatisation is done through buying shares from the public, which increases the

stake of a small group of investors, who have substantial stake. The rationale behind

privation is to the costs (cost of providing investors with periodical reports,

communicating with financial analysts, holding shareholders meetings, fulfilling

various statutory obligations, etc.,) associated with public limited company form of

organisation and to bring long-term value into sharper focus. Castrol India and

Philips India are the recent examples of going private.

11. Leveraged Buyout (LBO): Leveraged buyout means buying any thing with

borrowed funds. For example, Dream Well Co., interested in divesting one of its

division, for Rs.50 crores (whose value is Rs.80 crores). Five executives of the same

division are keen on buying the division but each executive is able to contribute

Rs.10 lakhs. Here they fall short of funds to buy the division, still they want to buy

the same with a borrowings Rs.30 lakhs from a bank. It is known as leveraged

buyout.

12. Other Terms Used in Corporate Restructuring: Apart from the above

discussed form of corporate restructuring the following are other terms used:

Acquisition, consolidation, absorption, combinations, holding company,

takeover, restructuring, reconstructing and diversification. The terms are

required to be understood in the sense these are used. In different circumstances some

of these terms carry different meanings and might not be construed as mergers or

takeover in application of the sense underlying the term for a particular

situation. In the following paragraphs, the meaning of these terms have been

explained in the light of the definitions and explanations given by eminent scholars

and practitioners in their works.

i. Acquisition: Acquisition in general sense is acquiring the ownership in the

property. In the context of business combinations, an acquisition is the

purchase of by one company of a controlling interest in the share capital of another

existing company. An acquisition may be affected by (a) agreement with the

persons holding majority interest in the company management like members of the

board or major shareholders commanding majority of voting power; (b) purchase of

shares in open market; (c) to make takeover offer to the general body of

shareholders; (d) purchase of new shares by private treaty; (e) acquisition of share

capital of one company may be by either all or any one of the following form of

considerations viz. means of cash, issuance of loan capital, or insurance of share

capital.

ii. Consolidation: Consolidation is known as the fusion of two existing

companies into a new company in which both the existing companies

extinguish. Thus, consolidation is mixing up of the two companies to make them

into a new one in which both the existing companies lose their identity and cease to

exist. The mix-up assets of the two companies are known by a new name and the

shareholders of two companies become the shareholders of the new company. None of the consolidating firms legally survives. There is

no designation of buyer and seller. All consolidating companies are dissolved. In

other words, all the assets, liabilities and stocks of the consolidating

companies stand transferred to new company in consideration of payment in terms

of equity shares or bonds or cash or combination of the two or all modes of

payments in proper mix.

iii. Absorption: Absorption is a combination of two or more firms into an existing

corporation. All firms except one lose their identity in merger through absorption.

For example this type of absorption is absorption of Tata Fertilisers Ltd.

(TFL) by Tata Chemicals Ltd. (TCL). TCL, an acquiring firm. Survived after

merger, while TFL an acquired company, ceased to exist.

iv. Combination: Combination refers to mergers and consolidations as a

common term used interchangeably but carrying legally distinct interpretation. All

mergers, acquisitions, and amalgamations are business combinations.

v.Takeover: A ‗takeover‘ or acquisition and both the terms are used

interchangeably. Takeover differs from merger in approach to business combinations i.e. the process of takeover, transaction involved in takeover,

determination of the share exchange or cash price and fulfillment of goals of

combination all are different in takeovers than in mergers. For example,

process of takeover is unilateral and the offeror company decides about the

maximum price. Time taken in completion of transaction is less in takeover than in

mergers, top management of the offeree company being more co- operative.

vi. Reconstruction: The term ‗reconstruction‘ has been used in section 394 along

with the term ‗amalgamation‘. The term has not been defined therein but it has

been used in the sense not synonymous with amalgamation. In the Butter worth

publication, the term has been explained as under:

―By a reconstruction, a company transfers its undertaking and assets to a new

company in consideration if the issue of the new company‘s shares to the first

company‘s members and, if the first company‘s debentures are not paid off, in

further consideration of the new company issuing shares or debentures to the first

company‘s debentures holders in satisfaction of their claims. The result of the

transaction is that the new company has the same assets and members and, if the

new company issues debentures to the first company‘s debenture holders, the same

debenture holders as the first company, the first company has no undertaking to 2 0 1 6operate and is usually wound up or dissolved .

Reconstructions were far common at the end of the last century and the

beginning of this century than they are now. The purposes to be achieved by them

were usually one of the following: either to extend or alter of a company by

incorporating a new company with the wider or different objects desired; or (ii) to

alter the rights attached to the different classes of a company‘s shares or debentures

by the new company issuing shares or debentures with those different rights to the

original company‘s share or debenture holders; or to compel the members of a

company to contribute further capital by taking shares in the new company on

which a larger amount was unpaid than on the shares of the original company. The

first two of these purposes can now be achieved without reconstruction and the

third is now regarded as a species of coercion, which is strongly disapproved of by

the courts and is not pursued in practice. Consequently, reconstructions for these

reasons do not now occur. In Indian context, the term would cover various types of arrangements or comprises which may include merger as well as

demerger.

vii. Restructuring: Restructuring is the corporate management term for the act of

partially dismantling and reorganizing a company for the purpose of making it

more efficient and therefore more profitable. It generally involves selling off

portions of the company and making severe staff reductions. Restructuring is often done as part of a bankruptcy or of a takeover by another firm, particularly a

leveraged buyout by a private equity firm. It may also be

done by a new CEO hired specifically to make the difficult and controversial

decisions required to save or reposition the company. It indicates to a broad array of

activities that expand or contract a firm‘s operations or substantially modify its

financial structure or bring about a significant change in its organisational

structure and internal functioning. It includes activities such as mergers, buyouts,

takeovers, business alliances, slump sales, demergers, equity carve outs, going

private, leverage buyouts (LBOs), organisational restructuring, and performance

improvement initiatives.

viii. Diversification: Diversification is the process of adding new business to the

company that is distinct its established operations. A diversified or

multibusiness company is thus one that is involved in two or more distinct

industries. Firms go for diversification for reducing non-systematic risk.

Diversification implies growth through the combination of firms in unrelated

business. Such mergers are called conglomerate mergers.

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