CORPORATE RESTRUCTURING AS A CORPORATE ACTION

INTRODUCTION

Corporate Restructuring though is not a recurring exercise in an organization but because of the enormous advantages, it promises it renders a lasting impact on the business. The advantages of corporate restructuring are immense such as improved corporate performance and better corporate governance etc. It is in this regard the company going through a financial crunch must possess an explicit and unequivocal understanding of the corporate restructuring process and its approach.

Incorporate restructuring the capital structure and operation of the corporate entity are significantly altered. This process is considered important to eliminate the financial crisis a company faces resulting in a significant increase in its performance. In this process, the management of the organization concerned hires a financial and legal expert to advise and assist in the negotiation and transaction deals. Oftentimes takeovers, mergers, adverse economic conditions, buyouts, bankruptcy, insolvency, lack of combination between the divisions, lack of integration, over-utilized workforce, or any unfavorable changes, etc. within an organization result in a change in the ownership structure of the organization. Further, this change in the ownership structure of the organization also often gives birth to the need for corporate restructuring.

Corporate rebuilding or Corporate restructuring is essential to eliminate the monetary emergency and improve the organization’s performance.

Corporate Restructuring

To put it simply, reorganizing the operations and structure of an organization to receive more profits is corporate restructuring. It is often referred to as a change in the business strategy of an organization such as diversifying or merging departments for increased performance and profitability. Through corporate restructuring, a company aims at consolidating its business operations and thereby strengthening its position for achieving organizational objectives and profits. Corporate restructuring, thus, helps a business to establish itself as a successful entity.

Corporate rebuilding or corporate restructuring involves several corporate actions to significantly revamp the structure and operations of a company. It is needed essentially to significantly reduce all the financial crunch a company faces which in turn refines the performance of the company. In this process, the capital structure of the corporate is organically altered along with a change in the tasks of the company.

Such a change or restructuring of a corporate entity often happens when the organization faces a financial precariousness. In such a situation revamping the structure and operations of the business becomes essential for the business to survive and establish itself as a successful entity.

The process of corporate restructuring entails refashioning an organization’s business model, management team, financial structure, etc. to effectively fight challenges and increase shareholder value. Such a move may involve major layoff or bankruptcy, though restructuring is designed in such a manner that there is minimum impact on employees, as far as possible.

A company may face threats of varying nature but the common catalysts for restructuring often remain a loss of market share, a reduction in profit, or even a decline in the power of the corporate brand. Therefore, companies often use ‘restructuring’ as a tool to ensure the long-term viability of the business. It is sometimes forced by shareholders or creditors of the company too if they observe that the organization’s current business strategies are incompetent to prevent a loss. Sometimes, factors such as an inability to retain talented professionals and major changes in the marketplace also force the restructuring of a corporate entity.

Thus, the process of corporate restructuring majorly involves changing a company’s business model, revamping its management team and financial structure to enhance shareholder value and address challenges.

Reasons for Restructuring

Corporate restructuring majorly concerns itself with arranging the activities of a business as a whole to achieve predetermined objectives at the corporate level. The reasons for such a move are many and is often done under the following scenarios:

1.Change in the strategy

The management of the distressed entity endeavors to improve the performance of the organization by removing certain divisions or subsidiaries which do not line up with the central or core strategy of the company. Such divisions don’t align with the long-term vision of the company. Hence, by doing this the company attempts to focus on its core strategies and selling those assets to its buyers that can use them more effectively.

2.Lack of Profits

The undertaking or the division may not be making sufficient profit to cover the company’s cost of capital thereby resulting in financial misfortune to the company. This poor performance of the division/ undertaking may be due to either the wrong decision on the part of the management to start the division or a decline in the profitability of the undertaking (division) due to an increase in costs or changing customer needs.

3.Switch synergy or Reverse synergy

This concept is opposed to the M&A principles of synergy in which a blended unit is considered worth more than the individual parts collectively. According to reverse synergy, the individual unit might be more than the combined unit. This is common reasoning for divesting the assets. The organization may decide that more value can be realized by divesting off a division to a third party rather than owning it.

4.Cash Flow Requirement

Whenever a company faces a financial crunch, disposing, or selling an unproductive undertaking becomes a quick approach to raising money and reducing debt. Thus, a company creates a considerable cash inflow through a sale of the division.

METHODS TO DIVEST ASSETS

A company can reduce its size in numerous ways. The following methods are often used by which a business cuts-off a division from its operations:

1.Divestitures

Under divestitures, a subsidiary or division of a company is sold or liquidated by it. The norm is a direct sale of the divisions of the company to an outside buyer. The selling company is compensated in cash for the same and the control of the division is transferred to the new buyer.

2.Equity carve-outs

Under this, a new and independent entity(company) is created by diluting the equity interest in the division and selling it to outside shareholders. The new subsidiary’s shares are issued in a general public offering and the new subsidiary becomes a different legal entity with separate management and operations from the original company.

3.Spin-offs

In this, the company creates an independent company which is different from the original company as done in equity carve-outs, however, the major difference is that instead of the public offering of shares, the shares are distributed among the company’s existing shareholders proportionately. This results in the same shareholder base as the original company but with totally separate management and operations. Since it’s the same shareholders of the original company that get the stocks of the new subsidiary so the company is not compensated in cash in this transaction.

4.Split-offs

Under this, the shareholders receive the new stocks of the subsidiary of the company in exchange for their existing stocks in the original company. The reasoning behind this is that the shareholders are letting go of their own in the original company to receive stocks of the new subsidiary.

5.Liquidation

Liquidations are generally linked to bankruptcies. In this, the company is broken apart and the assets or the divisions are sold piece by piece.

Types of corporate restructuring

The following two types of corporate restructuring are often followed by an organization:

1.Financial Restructuring

This may take place due to a drastic reduction or fall in the overall sales because of unfortunate economic conditions. Such restructuring may involve alteration of the equity pattern, debt-servicing schedule, cross-holding pattern, equity holdings, etc. by the corporate entity. All of this is done to sustain the market and profitability of the company.

2.Organizational Restructuring

This entails a change in the organizational structure of a company, which may involve reducing its level of the hierarchy, redesigning the job positions, downsizing the employees, and changing the reporting relationships. This type of restructuring is done to cut down the cost and to pay off the outstanding debt and to continue with the business operations somehow without any hindrance.

Important Aspects to be Considered in Corporate Restructuring Strategies

Various aspects need to be considered before, during, and after the restructuring process. These include:

• Valuation and Funding
• Legal and procedural issues
• Taxation and Stamp duty aspects
• Accounting aspects
• Competition aspects etc.
• Human and Cultural synergies
• Legitimate and procedural issues
• Bookkeeping angles
• Human and Cultural cooperative energies
• Valuation and subsidizing
• Tax assessment and Stamp obligation viewpoints
• Rivalry angles and so forth.

Based on the analysis of various aspects, the right type of strategy is chosen.

Types of Corporate Restructuring Strategies

Various types of corporate restructuring strategies include:

1.Merger

The merger involves the combination of two or more business entities that can be merged either by way of amalgamation or absorption or by forming a new company. This is generally done by exchanging securities between the acquiring and the target company. In this, the stockholders of one company are offered securities in the acquiring company in exchange for the surrender of their stock.

Mergers can further be divided into:

a) Horizontal Merger: It refers to the merger of two or more companies that compete in the same industry. It is a merger with a direct competitor and hence expands the firm’s operations in the same industry. Horizontal mergers are designed to achieve economies of scale and result in the reduction of competitors in the industry.

b) Vertical Merger: In this combination of two companies which are operating in the same industry but at different stages of production or distribution system, takes place. If a company takes over its supplier or producers of raw material, then it may result in backward integration of its activities. On the other hand, forward integration occurs if a company decides to take over the retailer or Customer Company. The vertical merger provides a way for total integration to those firms which are striving to own all phases of the production schedule together with the marketing network.

c) Co generic Merger: It is the type of merger, where two companies are in the same or related industries but do not offer the same products, but related products and may share similar distribution channels, providing synergies for the merger. The potential benefit from these mergers is high because these transactions offer opportunities to diversify around a common case of strategic resources.

d) Conglomerate Merger: These mergers involve firms engaged in unrelated types of activities i.e. the business of two companies is not related to each other horizontally nor vertically. In a pure conglomerate, there are no important common factors between the companies in production, marketing, research and development, and technology. Conglomerate mergers are mergers of different kinds of businesses under one flagship company. The purpose of the merger remains the utilization of financial resources enlarged debt capacity and also the synergy of managerial functions

It does not have a direct impact on the acquisition of monopoly power and is thus favored throughout the world as a means of diversification.

2.Demerger

It is a form of corporate restructuring in which the entity's business operations are segregated into one or more components. A demerger is often done to help each of the segments operate more smoothly, as they can focus on a more specific task after the demerger.

3.Reverse Merger

A reverse merger is an opportunity for the unlisted companies to become public listed companies, without opting for Initial Public Offer (IPO). In this process, the private company acquires the majority shares of the public company, with its own name.

4.Disinvestment

Disinvestment means the action of an organization or government selling or liquidating an asset or subsidiary. It is also known as "divestiture".

5.Takeover/Acquisition

The takeover means an acquirer takes over the control of the target company. It is also known as acquisition. Normally this type of acquisition is undertaken to achieve market supremacy. It may be a friendly or hostile takeover.

● Friendly takeover: In this type, one company takes over the management of the target company with the permission of the board.

● Hostile takeover: In this type, one company takes over the management of the target company without its knowledge and against the wish of their management.

6.Joint Venture (JV)

A joint venture is an entity formed by two or more companies to undertake financial activity together. The parties agree to contribute equity to form a new entity and share the revenues, expenses, and control of the company. It may be a Project-based joint venture or a Functional based joint venture.

● Project-based Joint venture: The joint venture entered into by the companies to achieve a specific task is known as a project-based JV.

● Functional based Joint venture: The joint venture entered into by the companies to achieve mutual benefit is known as a functional-based JV.

7.Strategic Alliance

Any agreement between two or more parties to collaborate, to achieve certain objectives while continuing to remain independent organizations is called a strategic alliance.

8.Franchising

Franchising may be defined as an arrangement where one party (franchiser) grants another party(franchisee) the right to use a trading name as well as certain business systems and processes, to produce and market goods or services according to certain specifications. The franchisee usually pays a one-time franchise fee plus a percentage of sales revenue as royalty and gains.

9.Slump sale

Slump sale means the transfer of one or more undertaking as a result of the sale of lump sum consideration without values being assigned to the individual assets and liabilities in such sales. If a company sells or disposes of the whole or substantially the whole of its undertaking for a predetermined lump sum consideration, then it results in a slump sale.

Conclusion

The corporate restructuring allows the company to continue to operate in some way. The management of the company tries all the possible measures to keep the entity going on. Even when the worst happens and the company is forced to pieces because of the financial troubles, the hope remains that the divested pieces can function well enough for a buyer to acquire the diminished company and take it back to profitability.

[Author: Kairvi Shashi is a 3rd-year BALLB student of Vivekananda Institute of Professional Studies (GGSIPU), New Delhi]

● http://www.investopedia.com/terms/r/restructuring.asp

● http://www.wisegeek.org/what-is-corporate-restructuring.htm

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