Expansion of Business Concern | Financial Management

After reading this article you will learn about the Expansion of Business Concern:- 1. Reasons for Expansion of Business Concern 2. Forms of Expansion 3. Forms of Combination.

Reasons for Expansion of Business Concern:

Growth is always essential for the existence of a business concern. A concern is bound to die if it does not try to expand its activities. There may be a number of reasons which are responsible for the expansion of business concerns. Predominant reasons for expansion are economic but there may be some other reasons too.

Following are the reasons for expansion:

1. Existence:

The existence of the concern depends upon its ability to expand. In a competitive world only the fittest survives. The firm needs to control its costs and improve its efficiency so that it may be achieved if the activities of the firm are expanded. So, expansion is essential for the existence of the firm otherwise it may result into failure and may be out of business.

2. Advantages of Large Scale:

A large scale business enjoys a number of economies in production, finance, marketing and management. All these economies enable a firm to keep its costs under control and have an upper hand over its competitors. A large scale concern can also withstand the cyclical changes in the demands of their products.

3. Use for Higher Profits:

Every businessman aspires to earn more and more profits. The volume of profits can be increased by the expansion of business activities. Undoubtedly, profit is the main motive behind all types of expansions. The incurring of higher costs at the time of expansion may not be associated with higher profits.

If a new concern is purchased at a higher price without considering economic aspects, it will not be wise expansion plan. One should be very careful while planning expansion scheme and economic factors should be the motivating forces to enable a concern to increase its profits.

4. Monopolistic Ambitions:

One of the important factors behind business expansion is the monopolistic ambitions of business leaders. They try to control more and more concerns in the same line so that they may be able to dictate their terms. So expansions also result out of monopolistic ambitions.

5. Better Management:

A bigger business concern can afford to use the services of experts. Various managerial functions can be efficiently managed by those persons who are qualified for such jobs. On the other hand, a smaller concern is generally managed by the owners themselves and they may not be experts in all departments of the business.

6. Natural Urge:

The expansion is also a way of life. As everybody wants to go higher and higher in his private life and this is applicable to a business concern too. Every businessman wants to expand its activities in a natural way. It not only gives him more profits but also gives him satisfaction.

Forms of Expansion:

The expansion of a concern may be in the form of enlargement of its activities or acquisition of ownership and control of other concerns.

Thus, expansion may be:

(i) Internal expansion, and

(ii) External expansion.

Internal Expansion:

Internal expansion results from the gradual increase in the activities of the concern. The concern may expand its present production capacity by adding more machines or by replacing old machines with new machines with higher productive capacity. The internal expansion can also be undertaken by taking up the production of more units or by entering new fields on the production and marketing sides.

Internal expansion may be financed by the issue of more share capital, generating funds from old profits or by issuing long-term securities. The net result of internal expansion is the increase in business activities and broadening the present capital structure.

External Expansion:

External expansion refers to ‘business combination’ where two or more concerns combine and expand their business activities. The ownership and control of the combining concerns may be undertaken by a single agency.

Business combination is a method of economic organisation by which a common control, of greater or lesser completeness, is exercised over a number of firms which either are operating in competition or independently. This control may either be temporary or permanent, for all or only for some purposes.

This control over the combining firm can be exercised by a number of methods which in turn give rise to various forms of combinations. In the words of Haney, “To combine is to become one of the parts of a whole, and combination is merely a union of persons to make a whole or group for the persuation of some common purpose.”

From this definition it is clear that combination may be of varying degrees and is always for the achievements of common objectives. Combination is the coming together of persons or organisations and the main motivation behind such assembly is to secure maximisation of profits by eliminating competition.

In the process of combination, two or more units engaged in similar business or in different related process or sages of the same business join with a view to carry on their activities or shape their policies on common or co-ordinated basis for mutual benefit or maximum profits.

The combination may be among competing units or units engaged in different processes. After combination, the constituent firms pursue some common objectives or goals.

Forms of Combination:

There is some disagreement on the precise meaning of various terms relating to the forms of business combinations, viz.; merger, amalgamation, absorption, consolidation, acquisition, takeover, etc. Sometimes, these terms are used interchangeably, in broad sense even when there are legal distinctions between the kinds of combinations.

(a) Merger or Amalgamation:

A merger is a combination of two or more companies into one company. It may be in the form of one or more companies being merged into an existing company or a new company may be formed to merge two or more existing companies. The Income Tax Act, 1961 of India uses the term ‘amalgamation’ for merger.

According to Section 2 (1A) of the Income Tax Act, 1961, the term amalgamation means the merger of one or more companies with another company or merger of two or more companies to form one company in such a manner that:

(i) All the property of the amalgamating company or companies immediately before the amalgamation becomes the property of the amalgamated company by virtue of the amalgamation.

(ii) All the liabilities of the amalgamating company or companies immediately before the amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation.

(iii) Shareholders holding not less than nine-tenths in value of the shares in the amalgamating company or companies (other than shares already held therein immediately before the amalgamation by or by a nominee for, the amalgamated company by virtue of the amalgamation.

According to the Companies Act, 1956, the term amalgamation includes ‘absorption’. In S.S Somayajula v. Hop Prudhommee and Co. Ltd., the learned Judge refers to amalgamation as “a state of things under which either two companies are joined so as to form a third entity or one is absorbed into or blended with another.”

Thus, merger or amalgamation may take any of the two forms:

(i) Merger or amalgamation through absorption.

(ii) Merger or amalgamation through consolidation.

(i) Absorption:

A combination of two or more companies into an existing company is known as ‘absorption.’ In a merger through absorption all companies except one go into liquidation and lose their separate identities. Suppose, there are two companies, A Ltd. and B Ltd, Company B Ltd. is merged into A Ltd. leaving its assets and liabilities to the acquiring company A Ltd; and company B Ltd. is liquidated.

It is a case of absorption. An example of this type of merger in India is the absorption of Reliance Polyproplene Ltd. (RPPL) by Reliance Industries Ltd. As a result of the absorption, the RPPL was liquidated and its shareholders were offered 20 shares of RIL for every 100 shares of RPPL held by them.

(ii) Consolidation:

A consolidation is a combination of two or more companies into a new company. In this form of merger, all the existing companies, which combine, go into liquidation and form a new company with a different entity. The entity of consolidating corporations is lost and their assets and liabilities are taken over by the new corporation or company.

The assets of old concerns are sold to the new concern and their management and control also passes into the hands of the new concern. Suppose, there are two companies called A Ltd. and B. Ltd; and they merge together to form a new company called AB Ltd. or C Ltd; it is a case of consolidation.

The term ‘consolidation’ is also, sometimes used as ‘amalgamation.’ However, a merger through absorption may be distinguished from a merger through consolidation. One concern acquires the business of another concern without forming a new company in the case of an absorption whereas a new concern is formed by the union of two or more concerns in case of consolidation.

Consolidation, generally, takes place between two equal-size concerns and the size of concerns considerably differs in case of a merger through absorption. Generally a small concern is merged with a big concern. Though both the terms are used interchangeably. The methods and problems of financing mergers through absorption and consolidations are also similar.

(b) Acquisition and Take-Over:

An essential feature of merger through absorption as well as consolidation is the combination of the companies. The acquiring company takes over the ownership of one or more other companies and combines their operations. However, an acquisition does not involve combination of companies. It is simply an act of acquiring control over management of other companies.

The control over management of another company can be acquired through either a ‘friendly take-over’ or through ‘forced’ or ‘unwilling acquisition’. When a company takes-over the control of another company through mutual agreement, it is called acquisition or friendly take- over.

On the other hand, if the control is acquired through unwilling acquisition, i.e., when the take-over is opposed by the ‘target’ company it is known as hostile take -over.

(c) Holding Companies:

The other form of partial consolidation is a holding company which generally arises out of lust for power. A holding company is a form of business organisation which is created for the purpose of combining industrial units by owning a controlling amount of their share capital.

Legally, a holding company is one which holds directly or through a nominee, a majority of the voting shares in the subsidiary company or possesses the power to nominate the majority of the directors.

A holding company may have a number of subsidiary companies or subsidiary company may be a holding company of another company or companies. The subsidiary of a subsidiary company is also a subsidiary company of the holding company, although a subsidiary company has a separate legal entity but for all practical purposes subsidiaries are under the effective control of a holding company.