Corporate Restructuring

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Introduction

The recent financial crisis of the late organizations to constantly reconsider 1990s have underlined how extensive their organizational design and and severe weaknesses in corporate structure, organizational systems and finance and governance can have procedures, formal statements on unexpected and extremely serious organizational philosophy and may consequences on the social and also include values, leader norms and economic aspects of a country. As a reaction to critical incidences, criteria result of this, many international for rewarding, recruitment, selection, financial institutions recognized the promotion and transfer. need for a strategy to avoid the severity of crises in the corporate Corporate restructuring is the sector. Today, corporates extensively processes through which business rely upon reconstruction, mergers, organizations grow and restructure acquisitions, and takeovers to meet themselves for more profitability. the challenges of a dynamic and ever These processes are undertaken to changing global business enhance growth, increase shareholder environment. value and extract maximum synergy. The definitive objective of corporate Restructuring is the latest buzzword in restructuring is to achieve higher corporate circles. Companies are productivity and utilize all probable competing with each other in search of expansion opportunities. excellence and competitive edge, experimenting with various tools and The process of Corporate ideas. The changing national and restructuring has, over the last few international environment is radically years, run at an exceptional level. Due changing the way business is to rapid privatization, globalization and conducted. Moreover, with the pace of liberalization, India is re-shaping itself change so great, corporate from conglomerate structure to restructuring assumes paramount focused organizations in order to be importance. The concept of core competent. Corporate restructuring involves embracing new Restructuring has become a powerful ways of running an organization and tool to accomplish this objective. abandoning the old ones. It requires

Corporate Restructuring

Let us first understand what ‘restructuring’ is. Restructuring is the corporate management term for the act of partially dismantling or otherwise reorganizing a company for the purpose of making it more efficient and therefore more profitable. It is a general expression Corporate restructuring demands an for major corporate changes aimed at in-depth understanding of the nature greater efficiency and adaptation to of organizations, its internal and changing markets. Spin-Offs, external threads, functions, Recapitalizations, Strategic Buyouts processes and the cultural and and major management realignments human resource factor. It involves are all developments frequently restructuring the assets and liabilities associated with corporate of corporations, including their debt- restructurings. to-equity structures, in line with their cash-flow needs to promote A corporate reconstruction arises efficiency, restore growth, and where a corporate group reorganizes minimize the cost to taxpayers. its business structure like transferring Corporate governance refers to the assets between corporations that are framework of rules and regulations members of the corporate group and that enable the stakeholders to generally involves selling off portions exercise appropriate oversight of a of the company and making severe company to maximize its value and to staff reductions. Corporate obtain a return on their holdings. It restructuring is often done as part of involves the dismantling and a bankruptcy or of a takeover by rebuilding of areas within an another firm, particularly a leveraged organization that need special buyout by a private equity firm.1 One attention from the management and of the purposes of corporate CEO. The process of corporate restructuring is to have an optimum restructuring often occurs after buy- business portfolio, by deciding outs, corporate acquisitions, whether to retain, divest or diversify takeovers or bankruptcy and is the business. Business portfolio considered necessary where a restructuring can be done in a variety company needs to improve its of ways like amalgamations, merger, efficiency and profitability and demerger, slump sale, takeover, requires expert corporate disinvestment, joint venture, foreign management. franchises, strategic alliance, etc. Corporate restructuring provides the Another way of explaining corporate necessary objectivity and methodical restructuring is that it is a support to bring a company back on significant modification made to the the road to success. It involves debt, operations or structure of a making radical changes in the company. Such a type of corporate composition of the businesses in the action is usually made when there are company’s portfolio. This type of significant problems in a corporate action is usually made company, which are causing some when there are significant problems form of financial harm and putting the in a company, which are causing overall business in jeopardy. some form of financial harm and

© Kaushal Shah & Associates 2008 Page 4 putting the overall business in jeopardy. Provide Proactive Leadership: Management style greatly influences the restructuring process. All REASONS successful companies have clearly displayed leadership styles in which There are several reasons for managers relate on a one-to-one restructuring such as: basis with their employees.

Induce Higher Earnings: The two Empowerment: Empowerment is a basic goals of corporate restructuring major constituent of any restructuring may include higher earnings and the process. Delegation and decentralized creation of corporate value. Creation decision making provides companies of corporate value largely depends on with effective management information the firm’s ability to generate enough system. cash.

Control Core Competence: With the TYPES OF RESTRUCTURING concept of organizational learning gaining momentum, companies are Business firms engage in a wide laying more emphasis on exploiting range of activities that include the rise on the learning curve. This expansion, diversification, can happen only when companies collaboration, spinning off, hiving off, focus on their core competencies. This mergers and acquisitions. The is seen as the best way to provide different forms of restructuring may shareholders with increased profits. include:

Divestiture and Networking: Expansion : Expansions may include Companies, while keeping in view mergers, acquisitions, tender offers their core competencies, should exit and joint ventures. Mergers per se, from peripherals. This can be realized may either be horizontal mergers, through entering into joint ventures, vertical mergers or conglomerate strategic alliances and agreements. mergers. In a tender offer, the acquiring firm seeks controlling Ensure Clarity in Vision, Strategy interest in the firm to be acquired and and Structure: Corporate requests the shareholders of the firm restructuring should focus on vision, to be acquired, to tender their shares strategy and structure. Companies or stock to it. Joint ventures involve should be very clear about their goals only a small part of the activities of the and the heights that they plan to scale. companies involved. A major emphasis should also be made on issues concerning time the Sell-Off: Sell-Off may either be frame and the means that influence through a spin-off or divestiture. Spin- their success. Off creates a new entity with shares

© Kaushal Shah & Associates 2008 Page 5 being distributed on a pro rata basis to existing shareholders of the parent • Changes in corporate company. Split-Off is a variation of management (usually with Sell-Off. Divestiture involves sale of a golden parachutes 2). portion of a firm/company to a third party. • Outsourcing of operations such as payroll and technical Corporate Control: Corporate control support to a more efficient includes buy-backs and greenmail third party. where the management of the firm wishes to have complete control and • Moving of operations such as ownership. manufacturing to lower-cost locations. Change in Ownership: Change in ownership may either be through an • Renegotiation of labor exchange offer, share repurchase or contracts to reduce overhead going public. • A major public relations Characteristics campaign to reposition the company with consumers The selling-off of portions of the company, such as a division that is • Forfeiture of all or part of the no longer profitable, can greatly ownership share by pre improve the company's financial restructuring stock holders (if standing. Staff reductions are often the remainder represents only accomplished partly through the a fraction of the original firm, selling or closing of unprofitable it is termed a stub 3). portions of the company and partly by consolidating or outsourcing parts of the company that perform redundant Restructuring Methods functions such as payroll, human resources, and training. There are several methods of restructuring and each has its own set Other characteristics of restructuring of advantages and disadvantages for can include: companies and investors.

SELL-OFFS

• Reorganization of functions A sell-off, also known as a divestiture, such as sales, marketing, and is the outright sale of a company distribution. subsidiary. Normally, sell-offs are done because the subsidiary doesn't • Refinancing of corporate debt fit into the parent company's core to reduce interest payments strategy. The market may be

© Kaushal Shah & Associates 2008 Page 6 undervaluing the combined because its doing well, but because it businesses due to a lack of synergy is a burden. Such an intention won't between the parent and subsidiary. As lead to a successful result, especially a result, management and the board if a carved-out subsidiary is too loaded decide that the subsidiary is better off with debt, or had trouble even when it under different ownership. Besides was a part of the parent and is lacking getting rid of an unwanted subsidiary, an established track record for sell-offs also raise cash, which can be growing revenues and profits. used to pay off debt. SPIN-OFFS EQUITY CARVE-OUTS A spinoff occurs when a subsidiary many companies are resorting to becomes an independent entity. The equity carve-outs to improve the parent firm distributes shares of the shareholder value. A parent firm subsidiary to its shareholders through makes a subsidiary public through an a stock dividend. Since this initial public offering (IPO) of shares, transaction is a dividend distribution, amounting to a partial sell-off. A new no cash is generated. Thus, spinoffs publicly-listed company is created, but are unlikely to be used when a firm the parent keeps a controlling stake in needs to finance growth or deals. In the newly traded subsidiary. Spinoffs, the subsidiary becomes a A carve-out is a strategic avenue a separate legal entity with a distinct parent firm may take when one of its management and board. subsidiaries is growing faster and carrying higher valuations than other Like carve-outs, spinoffs are usually businesses owned by the parent. A about separating a healthy operation. carve-out generates cash because In most cases, spinoffs unlock hidden shares in the subsidiary are sold to the shareholder value. For the parent public, but the issue also unlocks the company, it sharpens management value of the subsidiary unit and focus. Once spinoff shares are issued enhances the parent's shareholder to parent company shareholders, value. The new legal entity of a carve- some shareholders may be tempted to out has a separate board, but in most quickly dump these shares on the carve-outs, the parent retains some market, depressing the share control. In these cases, some portion valuation. of the parent firm's board of directors may be shared. Since the parent has TRACKING STOCK a controlling stake, meaning both firms have common shareholders, the A tracking stock is a special type of connection between the two will likely stock issued by a publicly held be strong. company to track the value of one segment of that company. The stock However, there are times when allows the different segments of the companies carve-out a subsidiary not company to be valued differently by

© Kaushal Shah & Associates 2008 Page 7 investors. Let's say a slow-growth All innovations and inventions in terms company trading at a low price- of corporate and principles happen earnings ratio (P/E ratio) happens to abroad, and then are being carried to have a fast growing business unit. The Indian environment. Corporate company might issue a tracking stock restructuring, out of all emerging so the market can value the new concepts of findings ways to serve business separately from the old one shareholders better, has been a very and at a significantly higher P/E rating. successful concept abroad and its Why would a firm issue a tracking been followed all the more in high stock rather than spinning-off or context cultures like India. carving-out its fast growth business for shareholders? The company retains The rapidity with corporate finance control over the subsidiary; the two due to external factors like increased businesses can continue to enjoy price volatility, a general globalization synergies and share marketing, of the markets, tax asymmetric, administrative support functions, a development in technology, regulatory headquarters and so on. Finally, and change, liberalization, increased most importantly, if the tracking stock competition and reduction in climbs in value, the parent company information and transaction costs and can use the tracking stock it owns to also factors like liquidity needs of make acquisitions. 4 business, capital costs and growth perspective have lead to practice of corporate restructuring as a strategic Corporate Restructuring in India move to maximize the shareholder's value. Business Restructuring in India has been time-consuming and expensive. in the initial years of economic A strong requirement of conducive liberalization, Indian companies failed regulatory environment, a complex tax to create sufficient value from framework, court processes and an acquisitions, as compared to MNCs. endless list of compliance issues However, with the passage of time, obstruct the process and impair Indian companies have begun competent and valuable developing the necessary capabilities rearrangement of resources through to create more value from deals. restructuring. With the advent of foreign investment following Reorganizing and restructuring of liberalization in 1991, Indian industry business has been an on-going experienced global competition within process over the past few years and the country and it had to reorganize its corporates have resorted to own business in the manner best restructuring in one form or another. suited to competition and The need to restructure has been collaboration. driven by various factors such as:

• Consolidation of business in highly fragmented industries Multinational corporations are also like cement where volumes entering India. Meanwhile, Indian play a pivotal role in order to companies, sensing attractive make optimum use of the opportunities outside the country are capacities and to achieve also venturing abroad. Tata Steel has economies of scale in bought Singapore-based NatSteel for marketing. $486 million. Videocon has bought the colour picture tubes business of

Thomson for $290 million. • Companies which have diversified into unrelated Such global forays have become a business due to the licensing possibility because foreign exchange system, regulatory controls is no longer a scarce commodity. They and high corporate taxes are have also become a necessity now looking at the possibility because in globalizing industries, only of grouping of these business players with global scale and reach under one corporate entity, or can survive. moving out of their non-core business. Legal Implication of Restructuring The same business when spread over various companies of an industrial THE COMPANIES ACT, 1956 group proves to be an operational handicap, since in the liberalized Section 394 of the Companies Act scenario it would not be possible to largely talks about reconstruction, support the same business of another restructuring and amalgamation of entity in the group, with financing and companies. Chapter V containing other related business supports Sections 390 to 396A of the Act is a without first having to go through the complete code in itself. It provides for legal procedures of inter corporate the law and procedure to be complied loan, guarantees etc. In short with by companies for compromises, restructuring brings about a high arrangements and reconstruction. degree of focus and flexibility of approach. The scheme of compromise and Indian industry needs to significantly arrangement scheme under Section restructure and reorganize. The 391 of the Act provides for all matters existing legal provisions no doubt which the Company Court should covers reorganization and consider and also the conditions under restructuring, but the cost and the which it has to exercise its powers. delay are so enormous that it either prevents or dissuades the parties from Section 390 gives the interpretation of pushing certain important terms used in Sections 391 and 393 of the Act.

should be classified as ‘conveyance’ The Section 10 E of the Companies under the stamp act and subject to Act deals with the constitution of the payment of exorbitant amounts of Company Law Board. Though the stamp duty. Central Government constitutes the Board, the provisions indicate that it is The implications of such provisions of independent of government the stamp act is two fold; intervention in matters of exercise of its jurisdiction. Section 10 F provides • It seeks to impose stamp duty that appeals against orders of the on an instrument which is not Company Law Board can be filed an executed document before the concerned High Court. The between the parties but an Company Law Board has been executable order of the court empowered to make its own and; regulations and accordingly regulations have been framed in 1991. • By implication it seeks to override the vesting effect of INCOME-TAX ACT, 1961 the order under section 394 and make it subject to A restructuring in which the value of payment of stamp duty. the business undertaking is not en- cashed does not lead to taxable • It leads to an incongruous income. Under Section 47(vi) of the position of a State enactment Income Tax Act, transfer of assets to on stamp duty, amending the the transferee company pursuant to a provisions of Companies Act. scheme of amalgamation is not a ‘transfer’ and does not attract capital Conclusion gains tax. Corporate and financial restructuring Similarly, shares allotted to takes time. However, to avoid an shareholders of the transferor unnecessarily long period of company are not a transfer for uncertainty and slow growth, a attracting capital gains. country's government needs to enhance efforts to resolve these systemic problems. A comprehensive approach requires an active government that will eliminate IMPLICATIONS OF STAMP DUTY obstacles to restructuring; facilitate both formal and informal debt Different States in India have different workouts; and establish an effective rates of stamp duty for restructuring. new legal, regulatory, accounting, The order passed under section 394 and institutional framework. being of a vesting nature, it is inconceivable that the court order

Restructuring transactions for corporates should be outside the purview of Section 269 of the Income-

Tax Act approval to avoid unnecessary administrative delays to the restructuring process. The transfer of any immovable property arising out of the demerger should not attract any stamp duty. Restriction on acquisition and transfer of shares in respect of dominant undertakings under Sections

108A-108G under the Companies Act should be removed, and the transfer of capital assets as part of restructuring should not attract any 1 sales tax liability. See: http://en.wikipedia.org/wiki/Restructuring

2 It is essential to recast Section 72A of Golden Parachute is a clause (or several) in an executive's employment contract specifying that they the Income-Tax Act to support will receive certain significant benefits if their corporate mergers and acquisitions. employment is terminated. These benefits may include severance pay, cash bonuses, stock options Permission and uncertainties or a combination of the items. surrounding the Section have been a 3 major hurdle to industry. It would be A stub is the stock representing the remaining better if all the tax allowances of the equity in a corporation left over after a major cash sick merging company _ such as or security distribution from a buyout, a spin-out, a demerger or some other form of restructuring unabsorbed depreciation and removes most of the company's operations from business loss _ were allowed for the parent corporation. A stub may retain the carry-forward/adjustment by the name of the original corporation, or in some cases may take another name as part of the merged company without having to restructuring. obtain specific permission from the 4 prescribed authority. Nor should See: http://www.indianmba.com/Faculty_Columnl companies be forced to resort to such artificial stratagems as reverse mergers.