What is Corporate Restructuring Strategy? Meaning, Methods, Purpose, Characteristics

What is Corporate 8Restructuring Strategy?

Corporate restructuring is one of the most complex and fundamental phenomena that management confronts. Each company has two opposite strategies from which to choose: to diversify or to refocus on its core business. While diversifying represents the expansion of corporate activities, refocus characterizes a concentration on its core business. From this perspective, corporate restructuring is the reduction in diversification.

Corporate restructuring is an episodic exercise, not related to investments in new plant and machinery which involve a significant change in one or more of the following:

• Pattern of ownership and control
  
• Composition of liability
  
• Asset mix of the firm.

It is a comprehensive process by which a co. can consolidate its business operations and strengthen its position for achieving the desired objectives:

• Synergetic
  
• Competitive
  
• Successful

It involves significant re-orientation, re-organization, or realignment of assets and liabilities of the organization through conscious management action to improve the future cash flow stream and to make it more profitable and efficient.

Meaning and Need for Corporate Restructuring

Corporate restructuring is the process of redesigning one or more aspects of a company. The process of reorganizing a company may be implemented due to several different factors, such as positioning the company to be more competitive, surviving a currently adverse economic climate, or poising the corporation to move in an entirely new direction. Here are some examples of why corporate restructuring may take place and what it can mean for the company.

Corporate restructuring may also take place as a result of the acquisition of the company by new owners. The acquisition may be in the form of a leveraged buyout, a hostile takeover, or a merger of some type that keeps the company intact as a subsidiary of the controlling corporation.

When the restructuring is due to a hostile takeover, corporate raiders often implement a dismantling of the company, selling off properties and other assets to make a profit from the buyout. What remains after this restructuring may be a smaller entity that can continue to function, albeit not at the level possible before the takeover took place.

In general, the idea of corporate restructuring is to allow the company to continue functioning in some manner. Even when corporate raiders break up the company and leave behind a shell of the original structure, there is still usually hope, what remains can function well enough for a new buyer to purchase the diminished corporation and return it to profitability.

Purpose of Corporate Restructuring

To enhance shareholder value, the company should continuously evaluate its:

• Portfolio of businesses.
  
  
• Capital mix, Ownership & Asset arrangements to find opportunities to increase the shareholder’s value.
  
  
• To focus on asset utilization and profitable investment opportunities.
  
  
• To reorganize or divest less profitable or loss-making businesses/ products.
  
  
• The company can also enhance value through capital restructuring, it can innovate securities that help to reduce the cost of capital.

Characteristics of Corporate Restructuring

The following are the basic characteristics of corporate restructuring:

• To improve the company’s Balance sheet, (by selling unprofitable division from its core business).
  
  
• To accomplish staff reduction (by selling/closing of unprofitable portion)
  
  
• Changes in corporate management ‰ Sale of underutilized assets, such as patents/brands.
  
  
• Outsourcing of operations such as payroll and technical support to a more efficient third party.
  
  
• Relocating certain business units like the Manufacturing unit to a cost-effective location.
  
  
• Reorganization of functions such as sales, marketing, and distribution.
  
  
• Renegotiation of labor contracts to reduce overhead.
  
  
• Refinancing of corporate debt to reduce interest payments.
  
  
• A major public relations campaign to reposition the co., with consumers.

Category of Corporate Restructuring

Corporate restructuring entails a range of activities including financial restructuring and organisation restructuring.

Financial Restructuring

Financial restructuring is the reorganization of the financial assets and liabilities of a corporation to create the most beneficial financial environment for the company. The process of financial restructuring is often associated with corporate restructuring, in that restructuring the general function and composition of the company is likely to impact the financial health of the corporation. When completed, this reordering of corporate assets and liabilities can help the company to remain competitive, even in a depressed economy.

Just about every business goes through a phase of financial restructuring at one time or another. In some cases, the process of restructuring takes place as a means of allocating resources for a new marketing campaign or the launch of a new product line. When this happens, the restructuring is often viewed as a sign that the company is financially stable and has set goals for future growth and expansion.

Need for Financial Restructuring

The process of financial restructuring may be undertaken as a means of eliminating waste from the operations of the company. For example, the restructuring effort may find that two divisions or departments of the company perform related functions and in some cases duplicate efforts. Rather than continue to use financial resources to fund the operation of both departments, their efforts are combined. This helps to reduce costs without impairing the ability of the company to still achieve the same ends promptly.

In some cases, financial restructuring is a strategy that must take place for the company to continue operations. This is especially true when sales decline and the corporation no longer generates a consistent net profit. A financial restructuring may include a review of the costs associated with each sector of the business and identify ways to cut costs and increase the net profit. The restructuring may also call for the reduction or suspension of production facilities that are obsolete or currently produce goods that are not selling well and are scheduled to be phased out.

Financial restructuring also takes place in response to a drop in sales, due to a sluggish economy or temporary concerns about the economy in general. When this happens, the corporation may need to reorder finances as a means of keeping the company operational through this rough time.

Costs may be cut by combining divisions or departments, reassigning responsibilities and eliminating personnel, or scaling back production at various facilities owned by the company. With this type of corporate restructuring, the focus is on survival in a difficult market rather than on expanding the company to meet growing consumer demand.

All businesses must pay attention to matters of finance to remain operational and to also hopefully grow over time. From this perspective, financial restructuring can be seen as a tool that can ensure the corporation is making the most efficient use of available resources and thus generating the highest amount of net profit possible within the current set economic environment.

Organizational Restructuring

In an organizational restructuring, the focus is on management and internal corporate governance structures. Organizational restructuring has become a very common practice amongst firms to match the growing competition in the market. This makes the firms change the organizational structure of the company for the betterment of the business.

Need for Organization Restructuring

• New skills and capabilities are needed to meet current or expected operational requirements.
  
  
• Accountability for results is not communicated and measurable resulting in subjective and biased performance appraisals.
  
  
• Parts of the organization are significantly over or understaffed.
  
  
• Organizational communications are inconsistent, fragmented, and inefficient.
  
  
• Technology and/or innovation are creating changes in workflow and production processes.
  
  
• Significant staffing increases or decreases are contemplated.
  
  
• Personnel retention and turnover is a significant problems.
  
  
• Workforce productivity is stagnant or deteriorating.
  
  
• Morale is deteriorating.

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Features of Corporate Restructuring Strategy

Some of the most common features of organizational restructures are:

• Regrouping of Business: This involves the firms regrouping their existing business into fewer business units. The management then handles these lesser number of compact and strategic business units in an easier and better way that ensures the business earns a profit.
  
  
• Downsizing: Often companies may need to retrench the surplus manpower of the business. For that purpose offering Voluntary Retirement Schemes (VRS) is the most useful tool taken by firms for downsizing the business’s workforce.
  
  
• Decentralization: To enhance, the organizational response to the developments in a dynamic environment, the firms go for decentralization. This involves reducing the layers of management in the business so that the people in the lower hierarchy benefit.
  
  
• Outsourcing: Outsourcing is another measure of organizational restructuring that reduces manpower and transfers the fixed costs of the company to variable costs.
  
  
• Enterprise Resource Planning: Enterprise resource planning is an integrated management information system that is enterprise-wide and computer-based. This management system enables the business management to understand any situation in a faster and better way. The advancement of information technology enhances the planning of a business.
  
  
• Business Process Engineering: It involves redesigning the business process so that the business maximizes the operation and value-added content of the business while minimizing everything else.
  
  
• Total Quality Management: Businesses now have started to realize that an outside certification for the quality of the product helps to get goodwill in the market. Quality improvement is also necessary to improve customer service and reduce the cost of the business.

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Methods of Corporate Restructuring

• Joint ventures
  
• Sell off and spin-off
  
• Divestitures
  
• Equity carve out
  
• Leveraged Buy-Outs (LBO)
  
• Management buyouts
  
• Master limited partnerships
  
• Employee Stock Ownership Plans (ESOP)

Joint Venture

Joint ventures are new enterprises owned by two or more participants. They are typically formed for special purposes for a limited duration. It is a combination of subsets of assets contributed by two (or more) business entities for a specific business purpose and a limited duration. Each of the venture partners continues to exist as a separate firm, and the joint venture represents a new business enterprise. It is a contract to work together for some time each participant expects to gain from the activity but also must contribute.

Example: GM-Toyota JV: GM hoped to gain new experience in the management techniques of the Japanese in building high-quality, low-cost compact & subcompact cars. Whereas, Toyota was seeking to learn from the management traditions that had made GE the no. 1 auto producer in the world and in addition to learning how to operate an auto company in the environment under the conditions in the US, dealing with contractors, suppliers, and workers. DCM group and Daewoo Motors entered into JV to form DCM Daewoo Ltd. to manufacture automobiles in India.

Reasons for Forming a Joint Venture

• Build on the company’s strengths.
  
• Spreading costs and risks.
  
• Improving access to financial resources.
  
• Economies of scale and advantages of size.
  
• Access to new technologies and customers.
  
• Access to innovative managerial practices.

Rational for Joint Ventures

• To augment the insufficient financial or technical ability to enter a particular line or business.
  
  
• To share technology and generic management skills in organization, planning, and control.
  
  
• To diversify risk.
  
  
• To obtain distribution channels or raw materials supply.
  
  
• To achieve economies of scale.
  
  
• To extend activities with a smaller investment than if done independently.
  
  
• To take advantage of the favorable tax treatment or political incentives (particularly in foreign ventures).

Tax Aspects of Joint Venture

If a corporation contributes a patent technology to a Joint Venture, the tax consequences may be less than on royalties earned through licensing arrangements.

Example: One partner contributes the technology, while another contributes depreciable facilities. The depreciation offsets the revenues accruing to the technology. The J.V. may be taxed at a lower rate than any of its partners & the partners pay a later capital gain tax on the returns realized by the J.V. if and when it is sold.

If the J.V. is organized as a corporation, only its assets are at risk. The partners are liable only to the extent of their investment, this is particularly important in hazardous industries where the risk of workers, production, or environmental liabilities is high.

Spin-off

Spin-offs are a way to get rid of underperforming or non-core business divisions that can drag down profits.

Process of Spin-off

• The company decides to spin off a business division.
  
  
• The parent company files the necessary paperwork with the Securities and Exchange Board of India (SEBI).
  
  
• The spin-off becomes a company of its own and must also file paperwork with the SEBI.
  
  
• Shares in the new company are distributed to parent company shareholders.
  
  
• The spin-off company goes public.

Notice that the spin-off shares are distributed to the parent company shareholders. There are two reasons why this creates value:

• Parent company shareholders rarely want anything to do with the new spin-off. After all, it’s an underperforming division that was cut off to improve the bottom line. As a result, many new shareholders sell immediately after the new company goes public.
  
  
• Large institutions are often forbidden to hold shares in spinoffs due to the smaller market capitalization, increased risk, or poor financials of the new company. Therefore, many large institutions automatically sell their shares immediately after the new company goes public.

Simple supply and demand logic tells us that such a large number of shares on the market will naturally decrease the price, even if it is not fundamentally justified. It is this temporary mispricing that gives the enterprising investor an opportunity for profit. There is no money transaction in a spin-off. The transaction is treated as a stock dividend and tax-free exchange.

Split-off and Split-up

Split-off: It is a transaction in which some, but not all, parent company shareholders receive shares in a subsidiary, in return for relinquishing their parent company’s share. In other words, some parent company shareholders receive the subsidiary’s shares in return for which they must give up their parent company shares.

Features: A portion of existing shareholders receives stock in a subsidiary in exchange for parent company stock.

Split-up: It is a transaction in which a company spins off all of its subsidiaries to its shareholders & ceases to exist.

• The entire firm is broken up into a series of spin-offs.
  
  
• The parent no longer exists and
  
  
• Only the new offspring survive.

In a split-up, a company is split up into two or more independent companies. As a sequel, the parent company disappears as a corporate entity, and in its place, two or more separate companies emerge.

Squeeze-out: The elimination of minority shareholders by controlling shareholders.

Sell-off

Selling a part or all of the firm by any one of means: sale, liquidation, spin-off & so on or General term for divestiture of part/all of a firm by any one of a no. of means: sale, liquidation, spin-off and so on.

Partial Sell-off

• A partial sell-off/slump sale involves the sale of a business unit or plant of one firm to another.
  
  
• It is the mirror image of a purchase of a business unit or plant.
  
  
• From the seller’s perspective, it is a form of contraction; from the buyer’s point of view, it is a form of expansion.

Example: When Coromandal Fertilizers Limited sold its cement division to India Cement Limited, the size of Coromandal Fertilizers contracted whereas the size of India Cements Limited expanded.

Motives for Sell-off

• Raising capital.
  
• Curtailment of losses.
  
• Strategic realignment.
  
• Efficiency gain.

Strategic Rationale

Divesting a subsidiary can achieve a variety of strategic objectives, such as:

• Unlocking hidden value: Establish a public market valuation for undervalued assets and create a pure-play entity that is transparent and easier to value.
  
  
• Non-diversification: Divest non-core businesses and sharpen strategic focus when a direct sale to a strategic or financial buyer is either not compelling or not possible.
  
  
• Institutional sponsorship: Promote equity research coverage and ownership by sophisticated institutional investors, either of which tends to validate SpinCo as a standalone business.
  
  
• Public currency: Create a public currency for acquisitions and stock-based compensation programs.
  
  
• Motivating management: Improve performance by better-aligning management incentives with Spin Co’s performance (using Spin Co’s, rather than Parent Company, stock-based awards), creating direct accountability to public shareholders, and increasing transparency into management performance.
  
  
• Eliminating dis-synergies: Reduce bureaucracy and give Spin Company management complete autonomy.
  
  
• Anti-trust: Break up a business in response to anti-trust concerns.
  
  
• Corporate defense: Divest “crown jewel” assets to make a hostile takeover of the Parent Company less attractive.

Divestitures

Divestiture is a transaction through which a firm sells a portion of its assets or a division to another company. It involves selling some of the assets or division for cash or securities to a third party which is an outsider.

Divestiture is a form of contraction for the selling company and a means of expansion for the purchasing company. It represents the sale of a segment of a company (assets, a product line, a subsidiary) to a third party for cash and or securities.

Mergers, assets purchase, and takeovers lead to expansion in some way or the other. They are based on the principle of synergy which says 2 + 2 = 5! Divestiture on the other hand is based on the principle of “anergy” which says 5 – 3 = 3!

Among the various methods of divestiture, the most important ones are partial sell-off, demerger (spin-off & split off) and equity carve out. Some scholars define divestiture rather narrowly as a partial sell-off and some scholars define divestiture more broadly to include partial sell-offs, demergers, and so on.

Motives for Divestitures

• Change of focus or corporate strategy
  
• Unit unprofitable can mistake
  
• Sale to pay off leveraged finance
  
• Antitrust
  
• Need cash
  
• Defend against takeover
  
• Good price.

Equity Carve Out

A transaction in which a parent firm offers some of a subsidiary common stock to the general public, to bring in a cash infusion to the parent without loss of control. In other words, equity carve-outs are those in which some of a subsidiary’s shares are offered for sale to the general public, bringing an infusion of cash to the parent firm without loss of control. Equity carve-out is also a means of reducing their exposure to a riskier line of business and boosting shareholders’ value.

Features of Equity Carve Out

• It is the sale of a minority or majority voting control in a subsidiary by its parents to outsider investors. These are also referred to as “split-off IPOs”.
  
  
• A new legal entity is created.
  
  
• The equity holders in the new entity need not be the same as the equity holders in the original seller.
  
  
• A new control group is immediately created.

Difference Between Spin-off and Equity Carve Outs

• In a spin-off, distribution is made pro rata to shareholders of the parent company as a dividend, a form of noncash payment to shareholders. In equity carve out; the stock of the subsidiary is sold to the public for cash which is received by the parent company.
  
  
• In a spin-off, the parent firm no longer has control over subsidiary assets. In equity carve-out, the parent sells only a minority interest in the subsidiary and retains control.

Leveraged Buyout

A buyout is a transaction in which a person, group of people, or organization buys a company or a controlling share in the stock of a company. Buyouts great and small occur all over the world daily. Buyouts can also be negotiated with people or companies on the outside.

For example, a large candy company might buy out smaller candy companies to corner the market more effectively and purchase new brands which it can use to increase its customer base. Likewise, a company that makes widgets might decide to buy a company that makes thingamabobs to expand its operations, using an established company as a base rather than trying to start from scratch.

In a leveraged buyout, the company is purchased primarily with borrowed funds. As much as 90% of the purchase price can be borrowed. This can be a risky decision, as the assets of the company are usually used as collateral, and if the company fails to perform, it can go bankrupt because the people involved in the buyout will not be able to service their debt. Leveraged buyouts wax and wane in popularity depending on economic trends.

The buyers in the buyout gain control of the company’s assets, and also have the right to use trademarks, service marks, and other registered copyrights of the company. They can use the company’s name and reputation and may opt to retain several key employees who can make the transition as smooth as possible.

However, people in senior management may find that they are not able to keep their jobs because the purchasing company does not want redundant personnel, and it wants to get its personnel into key positions to manage the company following its business practices.

A leveraged buyout involves a transfer of ownership consummated mainly with debt. While some leveraged buyouts involve a company in its entirety, most involve a business unit of a company. Often the business unit is bought out by its management and such a transaction is called a management buyout (MBO). After the buyout, the company (or the business unit) invariably becomes a private company.

• What Does Debt Do?

A leveraged buyout entails considerable dependence on debt.

• What Does It Imply?

Debt has a bracing effect on management, whereas equity tends to have a soporific influence. Debt spurs management to perform whereas equity lulls management to relax and take things easy.

Risks and Rewards

The sponsors of a leveraged buyout are lured by the prospect of wholly (or largely) owning a company or a division thereof, with the help of substantial debt finance. They assume considerable risks in the hope of reaping handsome rewards. The success of the entire operation depends on its ability to improve the performance of the unit, contain its business risks, exercise cost controls, and liquidate disposable assets. If they fail to do so, the high fixed financial costs can jeopardize the venture.

Purpose of Debt Financing for Leveraged Buyout

• The use of debt increases the financial return to the private equity sponsor.
  
  
• The tax shield of the acquisition debt, according to the ModiglianiMiller theorem with taxes, increases the value of the firm.

Features of Leveraged Buyout

• Low existing debt loads;
  
  
• A multi-year history of stable and recurring cash flows;
  
  
• Hard assets (property, plant and equipment, inventory, receivables) that may be used as collateral for lower cost secured debt;
  
  
• The potential for new management to make operational or other improvements to the firm to boost cash flows;
  
  
• Market conditions and perceptions that depress the valuation or stock price.

Example:

• Acquisition of Corus by Tata.
  
• Kohlberg Kravis Roberts, the New York private equity firm, has agreed to pay about $900 million to acquire 85 percent of the Indian software maker Flextronics Software Systems is the largest leveraged buyout in India.

Management Buyout

In this case, the management of the company buys the company, and they may be joined by employees in the venture. This practice is sometimes questioned because management can have unfair advantages in negotiations, and could potentially manipulate the value of the company to bring down the purchase price for themselves.

On the other hand, for employees and management, the possibility of being able to buy out their employers in the future may serve as an incentive to make the company strong. It occurs when a company’s managers buy or acquire a large part of the company. The goal of an MBO may be to strengthen the managers’ interest in the success of the company.

Purpose of MBO

From the management point of view may be:

• To save their jobs, either if the business has been scheduled for closure or if an outside purchaser would bring in its management team.
  
  
• To maximize the financial benefits they receive from the success they bring to the company by taking the profits for themselves.
  
  
• To ward off aggressive buyers.

The goal of an MBO may be to strengthen the manager’s interest in the success of the company. Key considerations in MBO are fairness to shareholders’ price, the future business plan, and legal and tax issues.

Benefits of MBO

• It provides an excellent opportunity for the management of undervalued companies to realize the intrinsic value of the company.
  
  
• Lower agency cost: the cost associated with conflict of interest between owners and managers.
  
  
• Source of tax savings: since interest payments are tax-deductible, pushing up gearing rations to fund a management buyout can provide large tax covers.

Master Limited Partnership

Master Limited partnerships are a type of limited partnership in which the shares are publicly traded. The limited partnership interests are divided into units which are traded as shares of common stock. Shares of ownership are referred to as units. MLPs generally operate in the natural resource (petroleum and natural gas extraction and transportation), financial services, and real estate industries.

The advantage of a Master Limited Partnership is it combines the tax benefits of a limited partnership (the partnership does not pay taxes from the profit – the money is only taxed when unit holders receive distributions) with the liquidity of a publicly traded company.

There are two types of partners in this type of partnership:

• The limited partner is the person or group that provides the capital to the MLP and receives periodic income distributions from the Master Limited Partnership’s cash flow.
  
  
• The general partner is the party responsible for managing the Master Limited Partnership’s affairs and receives compensation that is linked to the performance of the venture.

Employees Stock Option Plan (ESOP)

An Employee Stock Option is a type of defined contribution benefit plan that buys and holds stock. ESOP is a qualified, defined contribution, employee benefit plan designed to invest primarily in the stock of the sponsoring employer. Employee Stock Options are “qualified” in the sense that the ESOP’s sponsoring company, the selling shareholder, and participants receive various tax benefits.

With an ESOP, employees never buy or hold the stock directly.

Features of ESOP

• Employee Stock Ownership Plan (ESOP) is an employee benefit plan.
  
  
• The scheme provides employees with the ownership of stocks in the company.
  
  
• It is one of the profit-sharing plans.
  
  
• Employers have the benefit to use ESOPs as a tool to fetch loans from a financial institute.
  
  
• It also provides tax benefits to the employers.

Benefits for Company

Increased cash flow, tax savings, and increased productivity from highly motivated workers. The benefit for the employees: is the ability to share in the company’s success.

How it Works?

• Organizations strategically plan the ESOPs and make arrangements for the purpose.
  
  
• They make annual contributions in a special trust set up for ESOPs.
  
  
• An employee is eligible for the ESOPs only after he/she has completed 1000 hours within a year of service.
  
  
• After completing 10 years of service in an organization or reaching the age of 55, an employee should be allowed to diversify his/her share up to 25% of the total value of ESOPs.