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Corporate restructuring becomes a buzzword during economic downturns. A company going through tough financial scenario needs to understand the process of corporate restructuring thoroughly. Although restructuring is a generic word for any changes in the company, this word is generally associated with financial troubles.
Definition of Corporate Restructuring
Corporate restructuring is a corporate action taken to significantly modify the structure or the operations of the company. This usually happens when a company is facing significant problems and is in financial jeopardy. Often, the restructuring is referred to the ways to reduce the size of the company and make it small. Corporate restructuring is essential to eliminate all the financial troubles and improve the performance of the company.
The troubled company’s management hires legal and financial experts to assist and advise in the negotiations and the transaction deals. The company can go as far as appointing a new CEO specifically for making the controversial and difficult decisions to save or restructure the company. Generally, the company may look at debt financing, operations reduction and sale of the company’s portions to interested investors.
Reasons for Corporate Restructuring
Corporate restructuring is implemented under the following scenarios:
Change in the Strategy
The management of the troubled company attempts to improve the company’s performance by eliminating certain subsidiaries or divisions which do not align with the core focus of the company. The division may not seem to fit strategically with the long-term vision of the company. Thus, the company decides to focus on its core strategy and sell such assets to the buyers that can use them more effectively.
Lack of Profits
The division may not be profitable enough to cover the firm’s cost of capital and cause economic losses to the firm. The poor performance of the division may be the result of the management making a wrong decision to start the division or the decline in the profitability of the division due to the increasing costs or changing customer needs.
This concept is in contrast to the M&A principles of synergy, where a combined unit is worth more than the individual parts together. According to reverse synergy, the individual parts may be worth more than the combined unit. This is a common reasoning for divesting the assets. The company may decide that more value can be unlocked from a division by divesting it off to a third party rather than owning it.
Cash Flow Requirement
A sale of the division can help in creating a considerable cash inflow for the company. If the company is facing some difficulty in obtaining finance, selling an asset is a quick approach to raising money and reduce debt.
Methods to Divest Assets
There are various ways in which a company can reduce its size. The following are the methods by which a company separates a division from its operations:
Under divestitures, a company sells, liquidates or spins off a subsidiary or a division. Generally, a direct sale of the divisions of the company to an outside buyer is the norm in divestitures. The selling company gets compensated in cash and the control of the division is transferred to the new buyer.
Under equity carve-outs, a new and independent 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 its operations and management separated from the original company.
Under spin-offs, the company creates an independent company distinct from the original company as done in equity carve-outs. The major difference is that there is no public offering of the shares, instead, the shares are distributed among the company’s existing shareholders proportionately. This translates into the same shareholder base as the original company, with the operations and management totally separate. Since the stocks of the new subsidiary are distributed to its own shareholders, the company is not compensated by cash in this transaction.
Under split-offs, the shareholders receive new stocks of the subsidiary of the company in trade for their existing stocks in the company. The reasoning here is that the shareholders are letting go of their ownership in the company to receive the stocks of the new subsidiary.
Under liquidation, a company is broken apart and the assets or the divisions are sold piece by piece. Generally, liquidations are linked to bankruptcies.
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 good enough for a buyer to acquire the diminished company and take it back to profitability.