This article has been written by Brijesh Devi, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from LawSikho.
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Almost all business organizations use a form of hierarchy system for the smooth running of business activities. This hierarchy system enables enterprises to run their businesses in a sort-off bureaucratic structure wherein the positions & responsibilities of employees are established. The most common structures of business organizations are sole proprietorships, limited liability partnerships, public companies, etc.
But all of these structures have one thing in common – to earn profits. From the day a company is established it has to go through various events and changes. To cope up with such changes the business organization must adapt and overcome these difficulties. Hence companies undergo reforms in relation to the company management, processes, and sometimes the whole business structure in general. By changing the business structure an organization can climb the development curve and increase the profit of its organization and get sustainable outcomes.
Reasons for such organisational change vary. They range from disruptive technologies and changing market conditions to the need to improve quality, productivity or profit. However, the main reason for restructuring a business is to execute a new strategy. A strategy sets out a plan that determines how a business will use its major resources to meet its strategic objectives.
What is corporate restructuring?
The process of corporate restructuring plays a very important role in eliminating all the financial burdens a company faces and enhances the company’s performance. For adopting the corporate restructuring process, the management of concerned corporate entities facing the financial crunches and other problems hires a financial and legal expert for advisory and assistance in the negotiation and the transaction deals. Generally, the entity looking to opt for corporate restructuring may look at debt financing, operations reduction, or any portion of the company to interested investors.
In addition to this, the need for a corporate restructuring arises due to the change in the ownership structure of a company. Such change in the ownership structure of the company might be due to the takeover, merger, adverse economic conditions, adverse changes in business such as buyouts, bankruptcy, lack of integration between the divisions, over-employed personnel, etc. Change in business strategy, cash flow requirements, reverse synergy, lack of profits are a few reasons why companies opt for corporate restructuring.
Types of Corporate Restructuring
- Organizational Restructuring: Organizational restructuring occurs when the company wants to reduce its hierarchy levels, redesign the employee positions, and changing their roles and responsibilities. This form of restructuring is done to reduce the cost burden and clear the debt in the company’s name so that the company operations can be kept going.
- Financial Restructuring: Financial restructuring occurs usually when the company’s overall sales take a blow due to the adverse economic situation and there is a dire need for the entity to either change the equity holdings/pattern, debt servicing schedule, and cross-holding pattern. This is a type of restructuring that is done to survive the market changes and maintain the profits of the company.
Kinds of Corporate Restructuring Techniques
- Merger: This is the concept where two or more business entities are merged either by way of amalgamation or absorption or by forming of a new company.
- Demerger: Under this corporate restructuring strategy, two or more companies are combined into a single company to get the benefit of synergy arising out of such a merger.
- Reverse Merger: In this technique, the private company acquires a majority stake in the public company under their name.
- Takeover/Acquisition: The technique which helps the acquiring company to take overall control of the target company is called acquisition. A takeover is a form of acquisition that occurs when there is resistance from the shareholders of the target company.
- Joint Venture (JV): In this technique, an entity is formed by two or more companies to undertake financial acts together. Both the parties agree to share the expenses, contribute in proportion as agreed to form a new entity and revenues and control of the company.
- Disinvestment: The process where a corporate entity sells out or liquidates its assets or subsidiary is called disinvestment.
- Franchising: Franchising is a method of distributing products or services involving a franchisor, who establishes the brand’s trademark or trade name and a business system, and a franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor’s name and system.
- Strategic Alliance: When two or more entities agree to ‘join hands’ with each other to achieve certain objectives while still acting as independent organizations.
- Slump Sale: Under this strategy, an entity transfers its one or more undertaking for lump sum consideration. Under Slump Sale, an undertaking is sold for consideration irrespective of the individual values of the assets or liabilities of the undertaking.
What is a merger?
A merger is a way of a business transfer wherein the assets of two companies are vested in a single company. This single company is not necessarily one of the two merging companies. The merging companies lose their old identity and amalgamate into a single entity and the shareholders of the old companies become shareholders of the newly formed entity. A Merger is said to happen when there is a need for internal restructuring of group companies to merge into one holding entity so that the administrative and compliance burden is reduced.
Kinds of mergers
Choosing an optimal company/organization is very important. Corporate Mergers can basically be divided into five types. They are as follows:
Conglomerate Merger: A Conglomerate Merger is a type of merger between two companies that are completely engaged in different types of business undertakings. Their union might be for a strategic purpose like extending their reach in different markets and products. An example of a Conglomerate Merger is Company A engaged in a clothing line of business mergers with Company B a computer-hardware company.
Product-Extension Merger: A product-extension Merger is a merger between two companies that are engaged in making products that are related to one another. These two companies operate in the same market and this sort of merger enables the merged company in getting elite clientele and eliminates the cut-throat competition the companies face. An example of such a merger is when Company A which is engaged in providing telecommunication services amalgamates with Company B who is engaged in providing networking-related services.
Market-Extension Merger: A merger that takes place between two companies engaged in the same in providing same/similar products or services but is engaged in different markets around the world is called a Market-Extension Merger. These types of mergers help companies to reach out to new markets and increase their profitability. Examples of such mergers are when Company A and Company B sell similar products however, they provide these products in different market areas. If they unite, they can sell their products in both the markets as per need.
Vertical Merger: A Vertical Merger is a merger between two companies that are engaged in business activities along the same supply chain. The main aim of this kind of merger is to bring together companies that are well-off operating together. For example, a retail company in the auto parts industry merges with a company that supplies raw materials for auto parts.
Horizontal Merger: A Horizontal Merger is a merger between two companies that are direct competitors of one another. These companies are engaged in the same industry. A union between two competing companies can increase their strength by double. An example of a Horizontal merger is when Company A & Company B both produce the same type of computer hardware, they decide to amalgamate their businesses.
Reasons for opting Merger/Amalgamation
A Merger provides an opportunity for companies to expand their resources. It also helps companies to increase their business activities and profits thereby ensuring their profits
The amalgamated companies after their union can explore and enter different industries as well. They can diversify their interests by providing different services and products and can make a name in a different area.
Reducing tax burden
A Company that attracts heavy tax implications can merge with a company that has incurred losses so that they can use these losses to reduce their tax burden.
Increasing their values
When two companies making a decent amount of profit merge their share’s face value also tends to increase. The value of the merged company is greater than the sum of the independent values of the merged companies.
Today it is not easy for a company to survive on its own due to the heavy competition they face. Hence, one of the main reasons companies merge is to cut their competition.
Sometimes mergers aren’t based on the willingness of a company to be amalgamated with another. Sometimes it becomes a question of survival. There are times when it is not feasible for a company to continue its business activities and has to look towards other companies for help.
Difference between corporate restructuring and merger
Corporate Restructuring is a very important way for an organization to succeed. Restructuring of any kind helps corporates to tackle difficulties. Similarly, Mergers & Acquisitions (M&A) are also playing a very big role in the corporate world. Corporate Restructuring, in general, is a much wider concept and Merger is a way of Organizational Restructuring. Hence Merger can be called as a brain-child of Corporate Restructuring.
The benefits of Corporate Restructuring are different from M & A. Corporate Restructuring includes Financial Restructuring models such as Refinancing, Liquidity Planning, etc. These types of Corporate Restructuring techniques help companies in identifying and dealing with financial risks. Companies can also restructure internally by organizing their management hierarchy. A Merger is a part of Organizational Restructuring. The main function of a merger is to reduce administrative and compliance burdens. Both the concepts are very lengthy and to utilize them to their fullest it is necessary to take the help of legal and financial experts.
Corporate Restructuring is an important technique for organizations to modify or change their operations, management, and financial structure. Mergers & Acquisition are a sub-type of Corporate Restructuring. There are five basic types of mergers. Corporate Restructuring along with Mergers are crucial for businesses to grow. Every Multinational Corporation (MNC) and other big companies use Corporate Restructuring techniques to expand their business activities.
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