After reading this article you will learn about the Financial Restructuring of a Firm:- 1. Meaning of for Financial Restructuring 2. Buyouts (BO) for Financial Restructuring 3. Leveraged Buy-Out (LBO) 4. Sell-Off 5. Debt-Equity Swaps 6. Mergers in India 7. Accounting for Amalgamations.
Contents:
- Meaning of for Financial Restructuring
- Buyouts (BO) for Financial Restructuring
- Leveraged Buy-Out (LBO) for Financial Restructuring
- Sell-Off for Financial Restructuring
- Debt-Equity Swaps for Financial Restructuring
- Mergers in India
- Accounting for Amalgamations for Financial Restructuring
Meaning of for Financial Restructuring:
Financial restructuring is a mode of restructuring a firm that has gone into financial distress and which has huge accumulated losses, overvalued or fictitious assets and negligible or negative net worth. As a corrective measure, such firms may sell major assets, merge with other firms, negotiate with creditors, banks, debentures-holders and shareholders to reduce their claims, swap debt-equity, leverage buy-out, etc.
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In the case of mergers and acquisitions the firm has to deal with the shareholders of the other firms. But, in-case of financial restructuring, it has to deal primarily with its own stakeholders. Financial restructuring can however be adopted by only those firms which are in financial distress at present but hold a prospect for better performance after the restructuring process is completed.
Financial restructuring involves formulation -of reconstruction schemes and legal sanctions. Internal reconstruction of a company is the simplest form of financial restructuring. Under this, various liabilities are reduced after negotiating with various stakeholders such as banks, financial institutions, creditors, debenture-holders and even shareholders.
The amount so available from the reduction or waiver of liabilities is utilised to write off the fictitious or overvalued assets and accumulated losses. The balance sheet of such a firm is reconstructed. Financial restructuring can help a firm to revive from the situation of financial distress without going into liquidation.
Buyouts (BO) for Financial Restructuring:
Another form of corporate restructuring that has become popular in the present days in a buy-out. A buy-out is a divestment technique to sell off the business of a firm. When a company is not being run successfully by its present owners it may be purchased by its management, i.e. directors and or managers. The management may consist of one or more directors, employees or even associates from outside.
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In a management buy-out, the management acquires substantial controlling interest from its existing owners. The existing owners/ group do not want to continue the line of business and thus sell the same to the management which knows the strengths and weaknesses of the firm. Such a buy-out usually offers a better bargain because of the inside information available to the management.
Leveraged Buy-Out (LBO) for Financial Restructuring:
A leveraged buy-out may be defined as the acquisition or buy-out of ownership financed largely of debt. In a management buy-out, when the potential management does not have sufficient resources to pay the acquisition price, it may approach outside sources such as banks, financial institutions, venture funds and others to finance the buy-out.
The outsiders may provide debit to the tune of 50% or more of the acquisition price depending upon the cash generating capacity of the business in future to repay the debt. Such a buy- out transaction which is primarily financed by debt is termed as leveraged buy-out (LBO). There may also be some equity participation by the outsiders but mainly the transaction is financed through debt.
A leveraged buy-out involves considerable financial risk because of high debt level in its financing. Thus, a leveraged buyout will not be suitable where the firm to be acquired has a high degree of business risk. An important step involved in the LBO is the determination of the maximum degree of financial leverage.
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After the successful implementation of leveraged buy-out, the acquiring group may again take the company to public, called the process of Reverse LBO. Despite of the effectiveness of LBO as an effective mode of corporate restructuring, it has been criticised on many accounts. If the acquiring management team is not able to repay the debt as scheduled, the firm should be exposed to the risk of liquidation.
Sell-Off for Financial Restructuring:
A sell off is a divestment technique where in a part of the organisation (such as a division or a product line) may be sold to a third party as a process of strategic planning. A firm may take such a decision to concentrate on its core business activities by selling non-core business.
A sell off may be desirable:
(a) To improve the liquidity position.
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(b) To reduce business risk by selling high risk activities.
(c) To concentrate on core business areas.
(d) To increase efficiency and profitability.
(e) To protect the firm from hostile takeovers etc.
Debt-Equity Swaps for Financial Restructuring:
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When a firm wants to increase or decrease its debt ratio, it may replace equity with debt or vice-versa. In many cases firms have resorted to debt for equity swaps to prevent hostile takeovers. However, the firm should study the effects of higher leverage before going into such a swap.
Similarly, an overvalued firm can negotiate with holders of debt instruments to take equity stake in the firm in lieu of some of its debt or it may issue new equity to pay off the existing debt.
Mergers in India:
In developed economics, corporate mergers and amalgamations are a regular feature where hundreds of mergers take place every day. In India, too mergers have become a corporate game today. In 1988, there were only 15 mergers whereas in 1998 there were over 500 mergers. Corporate takeovers in India were started by Swaraj Paul when he tried to take over Escorts.
Since than many takeovers have taken place in our country such as Ashok Leyland by the Hindujas; Shaw Wallace, Dunlop, and Falcon Tyres by the Chabbria Group; Ceat Tyres by the Goenkas and Consolidated Coffee by Tata Tea. The Institute of Chartered Accountants of India has issued Accounting Standard 14 on Accounting for Amalgamations.
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The government has also favoured mergers and amalgamations when these are in the interest of general public. The government has issued SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 to provide greater transparency in the acquisition of shares and takeover of companies. The major provisions of AS-14 and the SEBI regulations are given below.
Accounting for Amalgamations for Financial Restructuring:
The Accounting Standard 14, which came into force with effect from April 1, 1995, provides two methods of accounting for amalgamations namely (i) the pooling of interest method and (ii) the purchase method. The pooling of interest method is applicable to amalgamations in the nature of merger. The purchase method is used in accounting for amalgamations in the nature of purchase.
Under the purchase method, the transferee company is required to account for the amalgamation either by incorporating the assets and liabilities at their existing values or by allocating the consideration to individual items of assets and liabilities on the basis of their fair value at the date of amalgamation.
The Standard prescribes that if, at the time of amalgamation, the transferor and the transferee companies have conflicting accounting policies, a uniform accounting policy must be adopted following the amalgamation. The Standard also provides for treatment of ‘reserves’ on amalgamation.
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In the case of an amalgamation in the nature of a merger, the reserves appear in financial statements of the transferee company in the same form in which they appeared in the financial statements of the transferor company.
In the case of an amalgamation in the nature of purchase, the identity of reserves, other than reserves created under a statute, is not preserved. Similar treatment is provided in the Standard for treatment of the balance in profit and loss account of the transferor company.
The Standard also prescribes certain disclosures to be made in the first financial statements prepared following the amalgamation.
The important disclosures to be made are:
(i) Names and general nature of business of the amalgamating companies.
(ii) Effective date of amalgamation for accounting purposes.
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(iii) Particulars of the scheme sanctioned.
(iv) Description and number of shares issued together with exchange ratio.
(vi) The amount of difference between the consideration and the value of net identifiable assets acquired, and the treatment thereof.