The techniques generally adopted in corporate restructuring and reorganization are shown in figure 18.1:
Technique # 1. Joint Ventures:
All joint ventures are typically characterized by two or more ventures being bound by a contractual arrangement which establishes joint control.
The contractual arrangements establish joint control over the joint venturers.
Such an arrangement ensures that no single venturer is in a position to unilaterally control the activity.
Joint venture may give protective or participating rights to the parties to the venture.
Protective rights merely allow a coventurer to protect its interests in the venture in situation where its interests are likely to be adversely affected.
Joint venture is a form of business combination in which two unaffiliated business firms contribute financial and/or physical assets, as well as personnel, to a new company formed to engage in some economic activity, such as the production or marketing of a product.
Joint venture can be formed between a domestic company and foreign enterprise in order to flow the skills and knowledge both the ways.
Technique # 2. Divestitures:
Divestitures are considered as one of the important techniques in corporate restructuring.
Divestitures does not deal with acquisition or combination but it frequently examine the various recently acquired assets and divisions to determine whether the assets or divisions are fit into overall corporate strategy in value maximization and its future plans.
If it does not serve the purpose, such assets or divisions are hived-off.
Technique # 3. Slump Sale:
When a company sells or disposes the whole or substantially the whole of the undertaking for a predetermined lumpsum amount as sale consideration is called ‘slump sale’.
The acquirer may be interested in purchase of an undertaking or part of it as a going concern and the acquirer is not interested in taking the whole company as part of the transaction.
While fixing the selling price, the value of assets are not individually counted and the liabilities are not separately considered while fixing the slump price.
A business transfer agreement will be entered into between the acquirer and seller and the hive-off deal passes the title for both movable and immovable properties and the related liabilities as a ‘going concern’.
Technique # 4. Strategic Alliances:
An ‘alliance’ is defined as associations to further the common interests of the members.
Strategic alliance is an arrangement or agreement under which two or more firms cooperate in order to achieve certain commercial objectives.
The motives behind strategic alliances is to reduce cost, technology sharing, product development, market access, availability of capital, risk sharing etc.
The concept of ‘alliance’ is gaining importance in infrastructure sectors, more particularly in the areas of power, oil and gas.
The basic objective is to facilitate transfer of technology while implementing large objectives.
The resultant benefits are shared in proportion to the contribution made by each party in achieving the targets.
In strategic alliance, two or more firms that unite to pursue a set of agreed upon goals, remain independent subsequent to the formation of an alliance.
The strategic alliances are generally in the forms like joint venture, franchising, supply agreement, purchase agreement, distribution agreement, marketing agreement, management contract, technical service agreement, licensing of technology/patent/trade mark/design etc.
Technique # 5. Equity Carveout:
It is a situation where a parent company sells portion of its equity in a wholly owned subsidiary to the general public or to a strategic investor.
An equity carveout enable the parent to generate cash inflow which can be used for further investments.
In a spin-off, the shares received from the acquirer of undertaking is distributed among the existing shareholders of the parent company.
But in equity carveout the shares of the parent company are sold out to outside investors.
Technique # 6. Franchising:
Franchising provides an immediate access to business operations and technology in profitable fields of operations.
It is an important means of doing business in several countries and represents an effective combination of the advantages of large business with the motivation and adaptation capabilities of small or medium scale enterprises.
It also enables linkages of large and small businesses within a framework of vertical division of labour.
The concept of franchising is quite comprehensive and covers an extensive range of marketing and distribution arrangements for goods and services.
Franchises are becoming a key mechanism for technological, marketing and service linkages between enterprises within a country as well as globally.
Technique # 7. Intellectual Property Rights:
The worth of a company lies more in its intangible assets (patents, trademarks, brands, copyrights etc.) than tangible assets (land, building, plant & machinery).
The intellectual property rights give real value to a company.
Patents, trademarks and strong brands lead to higher sales, economies of scale and profits.
Some business gains, however, instead of investing efforts, time and money in research and development for new patents, trademarks and brands, prefer to buy these from companies or go to the extent of acquiring the companies themselves.
Technique # 8. Holding Companies:
A holding company enjoys controlling interest in the subsidiary by acquiring substantial voting power in the form of acquisition of equity shares carrying voting rights.
When the holding company acquires 100% voting power in subsidiary, it is called ‘wholly owned subsidiary’.
Acquisition of controlling interest in subsidiary by holding company is form of combination and can also be used as a technique of restructuring.
The holding company is also called as ‘parent’ enterprise.
Technique # 9. Sell-Off:
In a strategic planning process, a company can take decision to concentrate on core business activities by selling off the non-core business divisions.
A sell-off is a sale of part of the organization to a third party in the following circumstances:
(i) To come out of shortage of cash and severe liquidity problems.
(ii) To concentrate on core business activities.
(iii) To protect the firm from takeover activities by selling-off the desirable division to the bidder.
(iv) To improve the profitability of the firm by selling-off loss-making divisions.
(v) To increase the efficiency of men, machines and money.
(vi) To facilitate the promising activities with enough funds by sell-off non-performing assets.
(vii) To reduce the business risk by selling-off the high risk activities.
Technique # 10. Going Private:
In a restructure program, the management of the widely held company may decide to go private by purchase of stocks from the outside public and delisting the shares in the stock exchanges where the shares are traded.
By going private, a company can avoid the predators from bidding the company.
It can avoid the listing fees of the stock exchanges and when the company is in financial difficulties this will avoid the fall in share prices.
It facilitates to avoid the declaration of periodical results for general public. By keeping-off from the public, trade secrecy can be maintained.
Technique # 11. Liquidation:
A business may go into decline when losses are made over several years.
The losses are setoff against past profits retained in the business (reserves), but clearly the situation cannot continue for very long.
In such case liquidation of company may be imminent.
In case of technological obsolescence, lack of market for the company’s products, financial losses, cash shortages, lack of managerial skills, the owners may decide to liquidate the business to stop further aggravation of losses.
With a strategic motive also, a business unit may be liquidated.
Technique # 12. Takeover by Reverse Bid:
Normally, a large company takeover a small company.
But when a small company acquires a big company, in a takeover mode, such situation is called ‘takeover by reverse bid’.
This would be possible when the substantial shares are in the control of small company or its directors.
It would also be possible when the small company is a cash rich company and big company is a sick company.
The takeover by reverse bid enables the acquirer to exploit the economies of scale.
BIFR had also encouraged this mode of takeover for rehabilitation and revival of sick industrial companies.
Technique # 13. Reverse Merger:
In normal practice, it is the larger company which acquire a smaller one.
But in case of reverse merger it is a smaller company acquires the larger company.
The reverse merger may be motivated by tax benefits available whenever at least one of the companies in deal has accumulated loss or unabsorbed expenses/allowance that can be carried forward and set off against future profit of the amalgamated company.
The takeover by the smaller firm would also be more appropriate if it had the better record and more promising future. In some cases the smaller company is listed but the larger company is not and, therefore, in order to keep the listing, without having to pay costs in obtaining a new one, the smaller listed company makes the acquisition.
The restructuring through reverse merger process is carried on following three steps:
(i) Capital reduction of the losing company to write-off the share capital not represented by assets.
(ii) Consolidation of shares after capital reduction to make face value of shares of the acquirer at par with that of the target.
(iii) Change of name after merger to publicize the name of the target.
Technique # 14. Demerger:
Demerger is adopted as a business strategy to separate business which don’t comfortably merge with each other.
Two businesses may have different strategies, operational or regulatory needs which are difficult to fulfill while they are still linked.
They may even be competing with each other for business.
A demerger is a form of reorganization where business activities owned by one company or group are separated out into several companies or groups.
Each business will usually have the same ultimate ownership as before.
A demerger may also be a step towards sale to third party.
The demerger refers to a situation, where an undertaking is separated and transferred to a separate company and decided to run into as an independent unit from the earlier enterprise.
The demerger is also called as ‘spin-off’ or ‘hiving off’.
By demerging the business activities, a corporate body splits into two or more corporate bodies with separation of management and accountability.
The strategic reasons resulting for demerger may be as follows:
(i) Restructuring the existing business, by segregating different uncommon activities into different corporate bodies.
(ii) Separation of management of different undertakings.
(iii) Introduction of the concept of responsibility accounting and accountability.
(vi) Protection of business from high risk activities and undertakings which are continuously incurring cash losses.
(v) Bringing clear lines of management.
(vi) Protection of crown jewel from the predator through hostile takeover.
(vii) Avoidance of frequent interference of government and its agencies in business.
(viii) Division of family managed business.
(xi) Tapping more opportunities and counter against threats.
(x) Separation of unwanted activities and to concentrate on core activities.
(xi) Enable management buy-out.
The potential disadvantages of demergers are as follows:
(i) Loss of economies of scale,
(ii) Lower turnover and profitability,
(iii) Increase in overhead,
(iv) Loss of benefits from synergy, and
(v) Loss of ability to raise extra finances.
Technique # 15. Management Buy-In (MBI):
The management team who have got special skills will search out and purchase business, to their interested area, which has considerable potential but that has not been run to its full advantage due to lack of managerial and technical skills, fails to establish the market for the company’s products.
After the identification of suitable unit for purchase, the management team will make arrangements with the venture capitalist for finance.
The management team will generally have lesser funds for investment and, therefore, debt component will be more in their purchase of the business unit.
The MBI is just reverse to MBO. In MBI, the management of other concern, not the management of the same company, acquires the majority shareholding and thus the existing management of the concern has to leave the concern.
Technique # 16. Management Buy-Out (MBO):
MBO is the purchase of a business by its management when the existing owners are trying to sell business to third parties due to its slow growth or lack of managerial skills in running the business.
The existing managers will come forward to purchase and run the business by taking it over from the owners.
In a MBO, the managers purchase all or part of the business from its owners.
The management team will take substantial controlling interest from the existing owners who are having control over the affairs of the company.
The management team may consist of one or more directors and employees, either with or without inviting for external associates.
It is a method of setting up of business by the management team itself.
The cases of MBO occurs when the existing owners unable to run the company successfully and when the very existence of the company is at stake.
The MBOs are used in restructuring the business and to tide over the recessionary tendency in business.
Technique # 17. Leveraged Buy-Out (LBO):
An LBO is defined as ‘the acquisition of an operating company with the funds derived primarily from debt financing, by a small group of investors’.
In LBO, debt financing typically represents 50% or more of purchase price.
The consideration for LBO is a mix of debt and equity components with high gearing.
The debt is secured by the assets of the acquired firm and is usually amortised over a period of less than ten years.
In a typical LBO program, the acquiring group consists of a small number of persons or organizations sponsored by buy-out specialists or investment bankers.
This group, with the help of certain financial instruments like high-yield, high-risk debt instruments (junk bonds), deferred payment instruments, private placement instruments, bridge financing, loans from venture capitalists, merchant bankers etc., acquire all or nearly all the outstanding shares of the target firm and takes the target firm private.
The buy-out group may or may not include current management of the target firm.
The typical targets for an LBO include any of the following:
(i) If the company does not have share-holdings more than 51%.
(ii) If the company is over leveraging with the debt components nearing to maturity.
(iii) If the company has diversified into unrelated areas and thus facing problems.
(iv) If the company is earning low operating profits due to poor management and there is a possibility of turnaround.
(v) If the company is having an asset structure which is grossly under-utilized.
(vi) If the company’s present management is facing managerial incompetence.