Corporate Reorganisation and Capital Reconstruction Schemes
1 Introduction
This chapter examines the financial restructuring possibilities open to UK companies. These include divestments, MBOs and more general schemes of reconstruction.
2 Demergers, sell-offs, unbundling and asset stripping
All of these involve splitting a company into two or more businesses. With a demerger existing shareholders are given shares in each of the two separate businesses – control is maintained.
Under a ‘sell-off’, at least part of the business will be sold to a third party. - control of part of the business is lost.
‘Unbundling’ means to take apart the components of a company with the intention of disposing of part or all of the parts separately at a higher price than the whole. This would usually be done via a ‘sell-off’. When done following a takeovers it is termed ‘asset stripping’.
3 Management buyouts
A management buyout is the purchase of all or part of a business from its owners by one or more of its executive managers
A management buy-in is where a team (usually assembled by a venture capitalist) identify a target company to take-over.
A buy-in / buy-out is where a team is drawn from a combination of the existing management and experts appointed via the venture capitalist.
Get these definitions exactly right, because confusing them means answering from the opposite side. In a demerger the shareholders end up with shares in each business, so control stays with the shareholders, not with the original company, and no cash is raised; in a sell-off part of the business goes to a third party in exchange for cash. A buy-out is by the business's own executive managers; a buy-in is by an outside team.
Parties to a buyout
the management team
the directors of the company
the financial backers of the management team (often including a venture capitalist)
Reasons for a buyout
from the buyout teams’ point of view:
to obtain ownership of the business rather than remain as employee
to avoid redundancy when the business is threatened with closure
from the seller’s point of view
to dispose of part of the company that does not fit in with the overall strategy of the company
to dispose of a loss-making segment of the business which the directors do not have time or inclination to turn around
in order to raise cash
it is often easier to arrange a management buyout than to try and sell off parts of a business in the open market
it may well avoid redundancy costs, strike action, etc. if closure if the only alternative
Why may buyouts generate shareholder value?
personal motivation of the buyout team
a more hands-on approach to management
keener decision making on such areas as pricing, debt collection etc.
savings in head office overheads
4 Capital reconstruction schemes
Restructuring a company is corporate surgery to enable a company to continue in business or to go into liquidation.
Legal framework
the company must receive the court’s permission to launch a scheme
compromises must be agreed by all parties – classes of creditors should meet separately so that substantial minorities are not voted down. Every class must vote in favour for the scheme to succeed.
Under the Insolvency Act a reconstruction can be achieved by transferring assets of the company to a new company in exchange for shares, these new shared being distributed to the existing shareholders. Creditors do not lose their rights in this arrangement.
Why restructure?
to write off large debit balances in the profit and loss accounts, so allowing the company to pay dividends in the future, and therefore encouraging the injection of new finance.
To rearrange the capital structure. Ordinary shares may be worth very little so that small monetary changes in value represent significant relative movements.
Approach to reconstructions
evaluate the position of each party if liquidation were to go ahead. This will represent the minimum acceptable payment for each group.
Assess sources of finance e.g. selling assets, issuing shares, raising loans.
Design the reconstruction (often given in the question)
Calculate and assess new position / marginal costs and returns to each group separately, and compare with (a). Do not forget the non-financial stakeholders.
Check the company is financially viable after the reconstruction.
5 Going private
All the listed shares of a company are bought by a small group of investors, and the company is de-listed.
both direct and indirect listing costs are saved
a hostile takeover bid is impossible
a small number of shareholders reduces the agency problem
6 ‘Calculation’ questions in the exam
You may be given a Statement of Financial Position prior to any reconstruction, and asked to redraft the statement after the reconstruction. This is primarily a Financial Accounts exercise and does not require any specific Financial Management techniques - it is mainly following the instructions given in the question.
To illustrate what is required, and the approach to the questions, the lecture will work through the following past exam question:
Fluffort (from the Sep/Dec 2015 sample questions). You should find this question in your Revision/Exam Kit, or alternatively you can download it from the ACCA website.