MnA_Module_9

MODULE 9
CORPORATE RECONSTRUCTION - REASONS, SAFEGUARDS AND

PITFALLS

9.1 Introduction:
The Corporate Reconstruction or Restructuring is the process of making changes in the
composition of a firm’s one or more business portfolios in order to have a more profitable
enterprise. Simply, reorganizing the structure of the organization to fetch more profits from its
operations or is best suited to the present situation.1

9.2 Ways of Corporate Restructuring:

9.2.1 Financial Restructuring:

The Financial Restructuring may take place due to a drastic fall in the sales because of the
adverse economic conditions. Here, the firm may change the equity pattern, cross-holding
pattern, debt-servicing schedule and the equity holdings. All this is done to sustain the
profitability of the firm and sustain in the market. Generally, the financial and / or legal advisors
are engaged to assist the firms in the negotiations.

9.2.2 Organizational Restructuring:

The Organizational Restructuring means changing the structure of an organization, such as
reducing the hierarchical levels, downsizing the employees, redesigning the job positions and
changing the reporting relationships. This is done primarily to cut the cost and pay off the
outstanding debts to continue with the business operations in some manner.

1Corporate Restructuring, Business Jargons.
https://businessjargons.com/corporate-restructuring.html

The need for a corporate restructuring arises because of the change in company’s ownership
structure due to a merger or takeover, adverse economic conditions, adverse changes in business
such as bankruptcy or buyouts, over employed personnel, lack of integration between the
divisions, etc.2

Mergers and acquisitions (M&A) is a general term that refers to the consolidation of companies
or assets through various types of financial transactions. M&A can include a number of different
transactions, such as mergers, acquisitions, consolidations, tender offers, purchase of assets and
management acquisitions. In all cases, two companies are involved.3

9.3 Types of Mergers and Acquisitions4:

From the perspective of business structures, there is a whole host of different mergers. Here are a
few types, distinguished by the relationship between the two companies that are merging:

9.3.1 Horizontal merger - Two companies that are in direct competition and share the
same product lines and markets.

9.3.2 Vertical merger - A customer and company or a supplier and company. Think of a
cone supplier merging with an ice cream maker.

9.3.3 Congeneric mergers - Two businesses that serve the same consumer base in
different ways, such as a TV manufacturer and a cable company.

9.3.4 Market-extension merger - Two companies that sell the same products in different
markets.

2Ibid.
3 Merger and Acquisition M&A, Investopedia
https://www.investopedia.com/terms/m/mergersandacquisitions.asp
4 Merger and Acquisition, Hampton Trading International
http://www.hamptontradingint.com/Mergers-and-Acquisitions.html

9.3.5 Product-extension merger - Two companies selling different but related products
in the same market.

9.3.6 Conglomeration - Two companies that have no common business areas.

There are two types of mergers that are distinguished by how the merger is financed. Each has
certain implications for the companies involved and for investors5:

9.3.2.1 Purchase Mergers - As the name suggests, this kind of merger occurs when one
company purchases another. The purchase is made with cash or through the issue
of some kind of debt instrument; the sale is taxable. Acquiring companies often
prefer this type of merger because it can provide them with a tax benefit.
Acquired assets can be written-up to the actual purchase price, and the difference
between the book value and the purchase price of the assets
can depreciate annually, reducing taxes payable by the acquiring company.

9.3.2.2 Consolidation Mergers - With this merger, a brand new company is formed and
both companies are bought and combined under the new entity. The tax terms are
the same as those of a purchase merger.

Acquisitions - In an acquisition, as in some mergers, a company can buy another company with
cash, stock or a combination of the two. Another possibility, which is common in smaller deals,
is for one company to acquire all the assets of another company. Company X buys all of
Company Y's assets for cash, which means that Company Y will have only cash (and debt, if
any). Of course, Company Y becomes merely a shell and will eventually liquidate or enter
another area of business.6

9.4 Corporate Restructuring Tools:

In India, the concept has caught on like wildfire, with a merger or two reported every now and
then. The process of restructuring through mergers and amalgamations has been a regular feature

5Supra Note 3.
6Supra Note 3.

in the developed and free economy nations like USA and European countries, more particularly
in the UK, where hundreds of mergers take place every year. There are many tools and strategies
by which or through which Corporate Restructuring can be processed such as amalgamations,
mergers, demergers, reverse mergers, takeovers, acquisitions, joint ventures, disinvestments,
buyback of shares etc. 7

9.4.1 By Amalgamation:
It is the process of combining or uniting multiple entities into one form. Generally speaking,
amalgamation is a legal process by which two or more companies are joined together to form a
new entity or one or more companies are to be absorbed or blended with another. As a
consequence, the amalgamating company loses its existence and its shareholder become the
shareholder of the new or amalgamated company.8

9.4.2 By Reverse Merger:
It is when a private company purchases control of a public company and then carries out a
merger with a private company. With a reverse merger, the private company shareholders
receive most of the shares of the public company and control of the Board. A reverse merger is a
quick way of going public with the time-table being only a couple of weeks. The reason a reverse
merger is so quick is that the public company has already completed all the necessary paper-
work and reviews in order to become public. 9 This process is quite common in USA and some
other countries, but such instances are very few in India.

9.4.3 By Normal merger:
Merger is an arrangement whereby the assets of two or more companies become vested in or
under the control of one company, which may or may not be one of the original two companies,
which has as its shareholders, all or substantially all, the shareholders of the two companies.10

7Mergers And Acquisitions, Share Repurchase
https://www.scribd.com/document/210291027/Final-Idp-Ak
8Mergers & Acquisitions, Corporate Restructuring
http://www.esupportkpo.com/images/Learning%20Pages%20-%20Articles%20-
%20Corporate%20Restructuring.pdf
9Ibid.
10Mergers And Acquisitions, Strategic Management

9.4.4 By Demerger:
The act of splitting off a part of an existing company to become a new company, which operates
completely separately from the original company. Shareholders of the original company are
usually given an equivalent stake of ownership in the new company. A demerger is often done to
help each of the segments operate more smoothly, as they can now focus on a more specific
task.11

9.4.5 By Joint Venture:
Two parties, (individuals or companies), incorporate a company in India. The business of one
party is transferred to the company and, as a consideration for such a transfer; shares are issued
by the company and subscribed by that party. The other party subscribes to the shares in cash.
The parties subscribe to the shares of the joint-venture company in agreed proportion, in cash,
and start a new business.12

9.4.6 By Buyback:
The repurchase of outstanding shares by a company, in order to reduce the number of shares on
the market. Companies will buy back shares either to increase the value of shares still available
or to eliminate any threats by shareholders who may be looking for controlling powers. In other
words, Buyback is the reverse of issue of shares by a company where it offers to take back its
shares owned by the investors at a specified price; this offer can be binding or optional to the
investors.13

9.5 Reasons for Corporate Reconstruction:

https://www.scribd.com/document/45644614/Paper-09
11De Merger, Mergers And Acquisitions, Stocks
https://www.scribd.com/document/229316133/De-Merger
12Supra Note 8.
13Supra Note 3.

Corporate restructuring is implemented under the following scenarios14:

9.5.1 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.

9.5.2 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.

9.5.3 Reverse Synergy: 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 (also called ‘unlocking’). 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.

9.5.4 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 reduces debt.15

9.5.5 Reduce Competition: One major reason for companies to combine is to
eliminatecompetition. Acquiring a competitor is an excellent way to improve a firm’s positionin
the marketplace. It reduces competition and allows the acquiring firm to use thetarget firm’s
resources and expertise. However, combining for this purpose may not be legal under the
Competition law and considered a predatory practice. Therefore, whenever a merger is proposed,
firms make an effort to explain that the merger is notanti-competitive and is being done solely to
better serve the consumer. Even if themerger is not for the stated purpose of eliminating

14 Corporate Restructuring, E-finance Management
https://efinancemanagement.com/corporate-restructuring
15Ibid.

competition, regulatory agenciesmay conclude that a merger is anti-competitive. However, there
are a number ofacceptable reasons for combining firms.

9.5.6 Cost Efficiency: Due to technology and market conditions, firms may benefit from
economies of scale. The general assumption is that larger firms are more cost effective than are
smaller firms. It is, however, not always cost effective to grow. Inspite of the stated reason that
merging will improve cost efficiency, larger companies are not necessarily more efficient than
smaller companies. Further, some large firms exhibit diseconomies of scale, which means that
the average cost per unit increases, as total assets grow too large. Some industry analysts even
suggest that the top management go in for mergers to increase its own prestige. Certainly,
managing a big company is more prestigious than managing a small company.16

9.5.7 Avoid Being a Takeover Target: This is another reason that companies merge. If a firm
has a large quantity of liquid assets, it becomes an attractive takeover target because the
acquiring firm can use the liquid assets to expand the business, pay off shareholders, etc. If the
targeted firm invests existing funds in a takeover, it has the effect of discouraging other firms
from targeting it because it is now larger in size, and will, therefore, require a larger tender offer.
Thus, the company has found an use for its excess liquid assets, and made itself more difficult to
acquire. Often firms will state that acquiring a company is the best investment the company can
find for its excess cash. This is the reason given for many conglomerate mergers.

9.5.8 Improve Earnings and Reduce Sales Variability: Improving earnings and sales stability
can reduce corporate risk. If a firm has earnings or sales instability, merging with another
company may reduce or eliminate this provided the latter company is more stable. If companies
are approximately the same size and have approximately the same revenues, then by merging,
they can eliminate the seasonal instability. This is, however, not a very inefficient way of
eliminating instability in strict economic terms.

16 Garry E. Mullins, Merger and Acquisition: Boon or Bane?,
https://www.uwsp.edu/busecon/Special%20Reports/2000-
2009/2001/Mergers%20and%20Acquisitions%20Boon%20or%20Bane.pdf

9.5.9 Market and Product Line Issues: Often mergers occur simply because one firm is in a
market that the other company wants to enter. All of the target firm’s experience and resources
are readily available of immediate use. This is a very common reason for acquisitions. Whatever
may be the explanation offered for acquisition, the dominant reason for a merger is always quick
market entry or expansion. Product line issues also exert powerful influence in merger decisions.
A firm may wish to expand, balance, fill out or diversify its product lines. For example,
acquisition of Modern Foods by Hindustan Lever Limited is primarily related product line.

9.5.10 Acquire Resources: Firms wish to purchase the resources of other firms or to combine
the resources of the two firms. These may be tangible resources such as plant and equipment, or
they may be intangible resources such as trade secrets, patents, copyrights, leases, management
and technical skills of target company’s employees, etc. This only proves that the reasons for
mergers and acquisitions are quite similar to the reasons for buying any asset: to purchase an
asset for its utility.17

9.5.11 Tax Savings: Although tax savings is not a primary motive for a combination, it can
certainly “sweeten” the deal. When a purchase of either the assets or common stock of a
company takes place, the tender offer less the stock’s purchase price represents again to the
target company’s shareholders. Consequently, the target firm’s shareholders will usually gain tax
benefits. However, the acquiring company may reap tax savings depending on the market value
of the target company’s assets when compared to the purchase price. Also, depending on the
method of corporate combination, further tax savings may accrue to the owners of the target
company.18

9.5.12 Cashing Out: For a family-owned business, when the owners wish to retire, or otherwise
leave the business and the next generation is uninterested in the business, the owners may decide
to sell to another firm. For purposes of retirement or cashing out, if the deal is structured
correctly, there can be significant tax savings.19

17Corporate Restructuring: Mergers & Acquisitions, Strategic Alliances: Mergers And Acquisitions (M&A)
https://sites.google.com/site/tribhuvansite/sm/sm305
18Supra Note 9.
19Supra Note 10.

9.6 Steps in Merger and Acquisition20:

Phase 1: Pre-acquisition review: this would include self assessment of the acquiring company
with regards to the need for M&A, ascertain the valuation (undervalued is the key) and chalk out
the growth plan through the target.21

Phase 2: Search and screen targets: This would include searching for the possible apt takeover
candidates. This process is mainly to scan for a good strategic fit for the acquiring company.22

Phase 3: Investigate and valuation of the target: Once the appropriate company is shortlisted
through primary screening, detailed analysis of the target company has to be done. This is also
referred to as due diligence.23

Phase 4: Acquire the target through negotiations: Once the target company is selected, the
next step is to start negotiations to come to consensus for a negotiated merger or a bear hug. This
brings both the companies to agree mutually to the deal for the long term working of the M&A.

Phase 5:Post merger integration: If all the above steps fall in place, there is a formal
announcement of the agreement of merger by both the participating companies.24

9.7 Drawbacks of Corporate Restructuring through Merger and Acquisition:

9.7.1 Faulty Assumptions: A booming stock market encourages mergers, which can spelldanger
for the unprepared or underprepared. Sometimes, deals are carried out in times when the funding

20Mergers and Acquisitions, EduPristine
https://www.edupristine.com/blog/mergers-acquisitions
21Rationale for Mergers and Acquisitions | Retirement or Cashing Out
http://www.indianmba.com/Faculty_Column/FC799/fc799.html
22Ibid.
23Mergers & Acquisitions: Meaning, Importance, Examples, Case Studies
https://www.edupristine.com/blog/mergers-acquisitions

24Ibid.

appears easy and economical, but underlying assumptions behind such deals is seriously flawed.
Many top managers tryto imitate others in attempting mergers, which can be disastrous for the
company. Mergers have quite often more to do with personal glory than business growth. The
executive ego plays a major in M&A decisions, which is fuelled further by bankers, dealmakers
and other advisers who stand to gain from the fat fees they collect from their clients engaged in
mergers. Most CEOs and top executives also get a big bonus for merger deals, no matter what
happens to the share price later.25

9.7.2 Mergers are also driven by fear psychosis: fear of globalization, rapid technological
developments, or a quickly changing economic scenario that increases uncertainty can all create
a strong stimulus for defensive mergers. Sometimes, the management feels that they have no
choice but to acquire a raider before being acquired. The idea is that only big players will survive
in a competitive world.26

9.7.3 Failure to carry out effective due-diligence: The failure to complete due-diligence often
results in the acquiring firm paying excessive premiums. Due diligence involves a thorough
review by the acquirer of a target company’s internal books and operations. Transactions are
often made contingent upon the resolution of the due diligence process. An effective due-
diligence process examines a large number of items in areas as diverse as those of financing the
intended transaction, differences in cultures between the two firms, tax concessions of the
transaction, etc.

9.7.4 Inordinate increase in debt: To finance acquisitions, some companies significantly raise
their levels of debt. This is likely to increase the likelihood of bankruptcy leading to
downgrading of firm’s credit rating. Debt also precludes investment in areas that contribute to a
firm’s success such as R&D, human resources development and marketing.27

25Mergers And Acquisitions (Growth Strategies Part 2 ) Stocks
https://www.scribd.com/document/87202791/Growth-Strategies-Part-2
26Ibid.
27Corporate Restructuring: Mergers & Acquisitions, Strategic Alliances: Mergers And Acquisitions (M&A)
https://sites.google.com/site/tribhuvansite/sm/sm305

9.7.5 Too much diversification: The merger route can lead to strategic competitiveness and
above-average returns. On the flip-side, firm’s may lose their competitive edge due to over
diversification. The threshold level at which this happens varies across companies, the reason
being that different companies have different capabilities and resources that are required to make
the mergers work. Crossing these threshold limits can result in overstretching these capabilities
and resources leading to deteriorating performance. Evidence also suggests that a large size
creates efficiencies in various organizational functions when the firm is not too large. In other
words, at some level the costs required to manage the larger firm exceed the benefits of
efficiency created by economies of scale.28

28Ibid.