Mergers, Acquisition & Corporate Restructuring 18MBAFM401

Unit: 6 Corporate restructuring: Meaning, Partnership (MLP), Limited Liability Partnership

(LLP) and joint ventures. (Theory significance and forms of restructuring–sell-off, spin-off,
divestitures, demerger, Equity Carve Out (ECO), Leveraged Buy Outs (LBO), Management
Buy Out (MBO), Master Limited).

CORPORATE RESTRUCTURING

Corporate restructuring
is an action taken by the
corporate entity to
modify its capital
structure or its operations
significantly. Generally,
corporate restructuring
happens when a
corporate entity is
experiencing significant problems and is in financial jeopardy. Corporate restructuring
refers to the changes in ownership, business mix, asset mix & alliance with a view to
enhance the shareholders’ value. Hence, corporate restructuring may involve ownership
restructuring, business restructuring, asset restructuring for the purpose of making it more
efficient and more profitable.

The process of corporate restructuring is considered very important to eliminate all the financial
crisis and enhance the company’s performance. The management of concerned corporate entity
facing the financial crunches hires a financial and legal expert for advisory and assistance in
the negotiation and the transaction deals. Usually, the concerned entity may look at debt
financing, operations reduction, 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.

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TYPES OF CORPORATE RESTRUCTURING

1. Financial Restructuring: This type of restructuring may take place due to a severe fall
in the overall sales because of the adverse economic conditions. Here, the corporate
entity may alter its equity pattern, debt-servicing schedule, the equity holdings, and
cross-holding pattern. All this is done to sustain the market and the profitability of the
company.
2. Organisational Restructuring: The Organisational Restructuring implies a change in
the organisational structure of a company, such as reducing its level of the hierarchy,
redesigning the job positions, downsizing the employees, and changing the reporting
relationships. This type of restructuring is done to cut down the cost and to pay off the
outstanding debt to continue with the business operations in some manner

REASONS FOR CORPORATE RESTRUCTURING

Corporate restructuring is implemented in the following situations:

• Change in the Strategy: The management of the distressed entity attempts to improve
its performance by eliminating its certain divisions and subsidiaries which do not align
with the core strategy of the company. The division or subsidiaries may not appear to
fit strategically with the company’s long-term vision. Thus, the corporate entity decides
to focus on its core strategy and dispose of such assets to the potential buyers.
• Lack of Profits: The undertaking may not be enough profit making to cover the cost
of capital of the company and may cause economic losses. The poor performance of
the undertaking may be the result of a wrong decision taken by the management to start
the division or the decline in the profitability of the undertaking due to the change in
customer needs or increasing costs.

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• Reverse Synergy: This concept is in contrast to the principles of synergy, where the
value of a merged unit is more than the value of individual units collectively. According
to reverse synergy, the value of an individual unit may be more than the merged unit.
This is one of the common reasons for divesting the assets of the company. The
concerned entity may decide that by divesting a division to a third party can fetch more
value rather than owning it.
• Cash Flow Requirement: Disposing of an unproductive undertaking can provide a
considerable cash inflow to the company. If the concerned corporate entity is facing
some complexity in obtaining finance, disposing of an asset is an approach in order to
raise money and to reduce debt.

CHARACTERISTICS OF CORPORATE RESTRUCTURING

➢ To improve the Balance Sheet of the company (by disposing of the unprofitable division
from its core business)
➢ Staff reduction (by closing down or selling off the unprofitable portion)
➢ Changes in corporate management
➢ Disposing of the underutilised assets, such as brands/patent rights.
➢ Outsourcing its operations such as technical support and payroll management to a more
efficient 3rd party.
➢ Shifting of operations such as moving of manufacturing operations to lower-cost
locations.
➢ Reorganising functions such as marketing, sales, and distribution.
➢ Renegotiating labour contracts to reduce overhead.
➢ Rescheduling or refinancing of debt to minimise the interest payments.
➢ Conducting a public relations campaign at large to reposition the company with its
consumers.

PURPOSE OF CORPORATE RESTRUCTURING

✓ The basic purpose is to enhance the shareholder value.

✓ The company should continuously evaluate its portfolio of businesses, capital mix &
ownership & assets arrangements to find opportunities to increase the share holders’ value.
✓ It should focus on asset utilization & profitable investment opportunities & reorganize or
divest less profitable or loss-making businesses/products.

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✓ The company can also enhance value through capital restructuring; it can innovate
securities that help to reduce cost of capital.

SIGNIFICANCE OF CORPORATE RESTRUCTURING

o Limit competition
o Utilize under-utilized market power
o Overcome the problem of slow growth and profitability in one’s own industry
o Achieve diversification
o Gain economies of scale and increase income with proportionately less
investment
o Establish a transnational bridgehead without excessive start-up costs to gain
access to a foreign market
o Utilize under-utilized resources- human and physical and managerial skills
o Displace existing management
o Circumvent government regulations

o Reap speculative gains attendant upon new security issue or change in P/E ratio.
o Create an image of aggressiveness and strategic opportunism, empire
building and to amass vast economic powers of the company.

Important Aspects to be Considered in Corporate Restructuring Strategies

➢ Legal and procedural issues

➢ Accounting aspects
➢ Human and Cultural synergies
➢ Valuation and funding
➢ Taxation and Stamp duty aspects
➢ Competition aspects etc.

LIMITATIONS OF CORPORATE RESTRUCTURING

Corporate Restructuring is essential for those companies which are in dire straits. The best
thing for these companies is to restructure operations so that things may improve. Corporate
Restructuring is not the panacea for all corporate ills. A number of limitations can be associated
with Corporate Restructuring, they are:

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(a) Work Assurance: Before the announcement of Corporate Restructuring, especially during
integration the employees of the ailing firm feel relief, but in most cases the reality becomes
better than the employees used to experience before integration. The management of the
acquiring firm takes policy for performance improvement resulting closure of certain divisions
or departments affecting a number of jobs.

(b) Retention of Best Management: Retaining the best management combination is always
an uphill task, with differing pay scales, responsibility levels, product and service portfolios,
and organizational vision. Companies pay more attention to the financial figures and benefit is
weighed only numerically but they remain very unprofessional in handling the transition
process, since new management provisions are rare, and often ineffective.

(c) Delay in Deal Finalization: New structures are announced after long delays and
communication is woefully lacking. After initial announcement of Corporate restructuring it
takes to finalize the deal as it involves so may issues like boardroom tussles, labour trouble and
queries from the shareholders.

(d) Executive Stress: In some cases, the divisions and products get closed after Corporate
Restructuring. After restructuring the control of the companies goes to separate set of
management creating a stress on the executives. While the restructuring takes place through
contraction by way of separation the distribution of management brings a large number of
denials from the management

(e) Workers’ Woes: At union levels, there is outright opposition to restructuring activities.
Number of mergers awaits legal clearance months after announcements. This is because unions
protest pays changes, proposed layoffs, outsourcing and asset liquidation.

(f) Cultural Mismatch: The situation mostly arises in merger and takeovers when the
organizational culture of one firm gets mismatch with other firm. This results in destroying
efficiency of the worker as well as management of both the firms

(g) Inability to Create Value: Corporate restructuring is aimed at generating value for the
firm and finally for the shareholders. But frequently it is observed that the organizations could
not create value instead they have destroyed it. Sudden change in the management and
organizational vision creates a gap leaving certain capacity idle and promoting inefficiency in
utilization of resources.

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FORMS/ METHODS OF CORPORATE RESTRUCTURING

The different forms of Corporate Restructuring are divided into three ways.

➢ EXPANSION TECHNIQUES

➢ DIVESTMENT/ DIVESTITURE TECHNIQUES

➢ OTHER TECHNIQUES

The Expansion Techniques are as follows

• Mergers
• Takeovers
• Tender offer
• Asset acquisition
• Joint venture
• Strategic alliance
• Holding companies
• Takeover by reverse bid
The Divestment Techniques are as follows

• Sell off

• Spin off/ Demerger

• Equity Carve Out

• Management Buy Out

• Leveraged Buy Out

• Liquidation
The Other Techniques are as follows

• Master Limited Partnership

• Limited Liability Partnership

• Buyback of Shares/ Share Repurchase

• Going Private

• Employee Stock Option Plan

• Reverse merger

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1. MERGERS
2. ACQUISITION Refer Unit 1 for explanation

3. TENDER OFFER

Tender offer involves making a public offer

for acquiring the shares of the target
company with a view to acquire
management control in that company. A
tender offer is a type of public takeover bid
constituting an offer to purchase some or all
of shareholders' shares in a corporation.
Tender offers are typically made publicly and invite shareholders to sell their shares for a
specified price and within a particular window of time. The price offered is usually at a
premium to the market price and is often contingent upon a minimum or a maximum number
of shares sold. To tender is to invite bids for a project or accept a formal offer such as
a takeover bid. An exchange offer is a specialized type of tender offer in which securities or
other non-cash alternatives are offered in exchange for shares.

The shares of stock purchased in a tender offer become the property of the purchaser. From
that point forward, the purchaser, like any other shareholder, has the right to hold or sell the
shares at his discretion.

A tender offer is a public solicitation to all shareholders requesting that they tender their stock
for sale at a specific price during a certain time.

The investor normally offers a higher price per share than the company’s stock price, providing
shareholders a greater incentive to sell their shares.

In the case of a takeover attempt, the tender may be conditional on the prospective buyer being
able to obtain a certain amount of shares, such as a sufficient number of shares to constitute a
controlling interest in the company.

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Ex: Flextronics International gave an open market offer at Rs. 548 for 20% paid-up
capital in Hughes Software systems.

Advantages of a Tender Offer

✓ Investors are not obligated to buy shares until a set number are tendered, which
eliminates large upfront cash outlays and prevents investors from liquidating stock
positions if offers fail.

✓ Investors gain control of target companies in less than one month if shareholders
accept their offers.

✓ They also generally earn more than normal investments in the stock market.

Disadvantages of a Tender Offer

✓ A tender offer is an expensive way to complete a hostile takeover as investors pay fees
for specialized services.
✓ It can be a time-consuming process as depository banks verify tendered shares and issue
payments on behalf of the investor.
✓ If other investors become involved in a hostile takeover, the offer price increases, and
because there are no guarantees, the investor may lose money on the deal.

4. ASSET ACQUISITION

Asset acquisition involves buying the assets of

another company. These assets may be tangible
assets like a manufacturing unit or intangible assets
like brands. The acquirer purchases only those parts
which benefits or satisfies firm’s needs. An asset
acquisition is the purchase of a company by buying
its assets instead of its stock. In most jurisdictions,
an asset acquisition typically also involves an
assumption of certain liabilities. However, because the parties can bargain over which assets

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will be acquired and which liabilities will be assumed, the transaction can be far more flexible
in its structure and outcome than a merger, combination, or stock purchase.

What factors are taken into consideration for acquiring Assets?

There are many complex factors to consider in an asset acquisition.

1.The buyer only acquires the assets and liabilities

It identifies and agrees to acquire and assume, subject to any liabilities imposed on the buyer
as a matter of law. This is fundamentally different from a stock acquisition or merger where
the buyer acquires all the assets and liabilities (including unknown or undisclosed liabilities)
of the target company as a matter of law.

2.The ability to pick and choose specific assets and liabilities provides the buyer with
flexibility.

The buyer does not waste money on unwanted assets and there is less risk of the buyer
assuming unknown or undisclosed liabilities. However, this also makes asset acquisitions more
complex because the buyer has to spend time identifying the assets and liabilities it wishes to
acquire and assume.

3.The acquirer and target company must agree on how the purchase price is to be
allocated among the assets in the deal.

The law indicates that the purchase price be allocated using the “residual method,” which
allocates the purchase price among the assets equal to their fair market value with any
remaining balance being applied to goodwill. The acquirer and target company both report the
same agreed upon purchase price allocation on their respective tax returns.

Advantages of Asset Acquisition

There are several advantages to purchasing a business by acquiring its assets and liabilities:

a. If the business is carried on by a corporation, the purchaser is not encumbered with

minority shareholdings from the acquired business. The minority shareholders are,

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however, entitled to dissent if the corporation sells all of its assets. If they do, they are
entitled to be bought out at the fair value of their shares.
b. The purchaser acquires only the liabilities stipulated in the agreement of purchase and
sale and, subject to “bulk sales” legislation, is not generally liable for the vendor’s
undisclosed liabilities.
c. A purchaser can be more selective in an asset acquisition and exclude any assets that
are not required.
d. The purchaser can negotiate the allocation of the purchase price among the assets
acquired. In an arm’s length transaction, the negotiated allocation will usually
determine the tax cost or the basis of the acquired assets.
e. The fair market value of business assets will usually exceed their tax basis. By
negotiating appropriate purchase price allocations, the purchaser can usually step-up
the cost base of the depreciable assets acquired and obtain larger Revenue write-offs in
the future. Similarly, the purchaser can step-up the basis of non-depreciable and other
assets and reduce the amount of capital gains that may ultimately be realized on
disposition of the assets. This can be particularly important if the purchaser intends to
divest any assets with accrued gains in the near future.

Disadvantages of Asset Acquisition

a. An asset acquisition is a complex transaction, because it involves the transfer of

individual assets, registration of title transfers and assignment of leases, contracts and
franchises. It can also involve other taxes (e.g., land transfer taxes) on the transfer of
certain assets.
b. The seller may need consent to transfer non-assignable contracts such as leases, licence
agreements and franchises. Obtaining the consent of third parties may be difficult and
expensive.
c. To avoid liability to creditors, it is usually necessary to comply with the bulk sales laws
of the jurisdiction in which the seller’s assets are located. The purpose of bulk sales
legislation is to protect the creditors of the seller and to discourage a disposition of
assets in bulk, leaving behind unpaid creditors. Non-compliance with the provisions of
the relevant bulk sales legislation renders the sale voidable and the purchaser liable to
the seller’s creditors.

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d. The seller’s long-term debt obligations may contain covenants which restrict the sale
of assets that have been pledged as security to creditors.
e. Because of the increased tax basis available to the purchaser (and the resulting
increased proceeds to the seller), the purchaser will generally have to pay a higher price
to acquire assets than for shares. Thus, the purchase price for a business depends upon
whether the purchase is structured as an asset or share acquisition.

5. JOINT VENTURE
A joint venture (JV) is a business arrangement in which two or more parties agree to pool their
resources for the purpose of accomplishing a specific task. This task can be a new project or
any other business activity. In a joint venture (JV), each of the participants is responsible
for profits, losses, and costs associated with it. However, the venture is its own entity, separate
from the participants' other business interests.

A joint venture is a business enterprise under-taken by two or more persons or

organizations to share the expense and profit of a particular business project. A JV is a
business arrangement in which two or more parties agree to pool their resources for the
purpose of accomplishing a specific task. They are a partnership in the colloquial sense of
the word but can take on any legal structure. A common use of JVs is to partner up with a
local business to enter a foreign market.

E.g. KIAL- Kempegowda International Airport Ltd. is a joint venture between Central Govt.,
State Govt. & Switzerland Airport Authority.
Eg. Maruthi Suzuki, Bajaj Allianz, Standard & Charted Bank.
A Joint venture is a legal entity formed between two or more parties to under-take economic
activity together. The parties agree to create a new entity by both contributing equity, and
they then share in the revenues, expenses, and control of the enterprise. The venture can be
for one specific project only, or a continuing business relationship such as the Sony Ericsson
joint venture. This is in contrast to a strategic alliance, which involves no equity stake by the
participants, and is a much less rigid arrangement.

Rational behind JV:

• Pooling of complimentary resources

• Access to raw materials

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• Access to new markets

• Diversification of risks
• Economies of scale
• Tax shelter
• Cost reduction
• Purchaser- supplier relationships
• Joint manufacturing

Types of a Joint Venture

There are mainly four types of a joint venture which includes –

a. Project-based joint venture – where the joint venture is done with the motive of
completing some specific task.
b. Vertical joint venture – where the joint venture takes place between the buyers and
the suppliers.
c. Horizontal joint venture – where the joint venture takes place between companies
having the same line of business.
d. Functional-based joint venture – where the joint venture is done with the motive of
getting mutual benefit on the account of synergy.

Advantages of Joint Venture

Economies of Scale: Joint Venture helps the organizations to scale up with their limited capacity.
The strength of one organization can be utilized by the other. This gives the competitive advantage
to both the organizations to generate economies of scalability.
Access to New Markets and Distribution Networks: When one organization enters into joint
venture with another organization, it opens a vast market which has a potential to grow and develop.
Innovation: companies can come up with new ideas and technology to reduce cost and provide
better quality products.

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Low Cost of Production: When two or more companies join hands together, the main motive is
to provide the products at a most efficient price. And this can be done when the cost of production
can be reduced, or cost of services can be managed. A genuine joint venture aims at this only to
provide best products and services to its consumers.
Brand Name: A separate brand name can be created for the Joint Venture. This helps in giving a
distinctive look and recognition to the brand. When two parties enter into a joint venture, then
goodwill of one company which is already established in the market can be utilized by another
organization for gaining a competitive advantage over other players in the market.

Access to Technology: Technology is an attractive reason for organizations to enter into a joint
venture. Advanced technology with one organization to produce superior quality of products saves
a lot of time, energy, and resources.
Better resources: Forming a joint venture will give you access to better resources, such as
specialized staff and technology.
Both parties share the risks and costs: In case the joint-group project fails, you are not alone
when bearing the costs of its failure.

Disadvantages of Joint Venture

Vague objectives: The objectives of a joint venture are not 100 percent clear and rarely
communicated clearly to all people involved.

Flexibility can be restricted: There are times when flexibility is restricted in a joint venture.
When that happens, participants have to focus on the joint venture, and their individual
businesses suffer in the process.

There is no such thing as an equal involvement: An equal pay may be possible, but it is
extremely unlikely for all the companies working together to share the same involvement and
responsibilities.

Great imbalance: Because different companies are working together, there is a great
imbalance of expertise, assets, and investment. This can have a negative impact on the
effectiveness of the joint venture.

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Clash of cultures: A clash of cultures and management styles may result in poor co-operation
and integration. People with different beliefs, tastes, and preferences can get in the way big
time if left unchecked.

Lack of clear communication: As a joint venture involves different companies from different
horizons with different goals, there is often a severe lack of communication between partners.

Reasons for Failure of JV

➢ Lower than expected turnover

➢ Expiry of technical tie up
➢ Economic Recession
➢ Reluctance of management to accept additional responsibility.
➢ Distance and language barrier.
➢ Unfavourable profitability ratio
➢ Post JV arrangements

6. STRATEGIC ALLIANCE
A strategic alliance is an arrangement between two companies to undertake a mutually
beneficial project while each retains its independence. The agreement is less complex and less
binding than a joint venture, in which two businesses pool resources to create a separate
business entity. A company may enter into a strategic alliance to expand into a new market,
improve its product line, or develop an edge over a competitor. The arrangement allows two
businesses to work toward a common goal that will benefit both. The relationship may be short-
or long-term and the agreement may be formal or informal.

A strategic alliance is an arrangement between two companies that have decided to share
resources to undertake a specific, mutually beneficial project. A strategic alliance agreement
could help a company develop a more effective process. Strategic alliances allow two
organizations, individuals or other entities to work toward common or correlating goals.

A strategic alliance in business is a relationship between two or more businesses that enables
each to achieve certain strategic objectives neither would be able to achieve on their own. The
strategic partners maintain their status as independent and separate entities, share the benefits

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and control over the partnership, and continue to make contributions to the alliance until it is
terminated. Strategic alliances are often formed in the global marketplace between businesses
that are based in different regions of the world.

Joint Venture Vs Strategic Alliance

JV Strategic Alliance
Formed to capitalize on knowledge in parent Formed in order to learn from the
firms and to generate knowledge partners knowledge

Two or more organizations set up a separate, B2B collaboration where two or more corporate
independent organization for shares resources and capabilities to achieve
a specific purpose some business purpose.

A formal contract is written Less formal than JV’s. A new entity need not
be created.

It has clear and legal boundaries Boundaries are defined by partnering

firms

Advantages of Strategic Alliance

➢ Entering New Markets: Creating an alliance with an existing organization already in

that marketplace is an extremely attractive alternative. Partnering with an international
company can make the expansion into unfamiliar territory much easier and less stressful
for a company.
➢ Reducing Manufacturing Costs: Strategic alliances may enable businesses to pool
capital or existing facilities to achieve economies of scale or increase the use of
facilities, thus lowering manufacturing expenses. Partnerships can help to lower costs,
particularly in non-profit areas like research & development.
➢ Shared risk: In today’s dynamic world major industries are extremely competitive that
no business has a guarantee of success when it enters a new market or develops a new
product. Strategic alliances allow the involved businesses to offset their market
exposure. Alliances probably perform best if the companies’ portfolio complement
each other, but do not directly compete.
➢ Developing and Diffusing Technology: Strategic Partnerships may also be utilized to

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build mutually on the technical expertise of a couple of businesses in developing

products technologically beyond the capability of the businesses operating
independently. Not all organizations can provide the technology that they need to
successfully compete in the markets. For this reason, they are joining up with other
businesses who do have the resources to provide the technology or who can pool their
resources so that together they can supply the required technology. Both parties take
advantage of the partnership.
➢ Winning the Political Obstacle: Getting a product into another country might confront
the business with political issues and strict regulations enforced by that government. A
few nations around the world are politically restrictive while some are worried about
the influence of foreign companies on their economics that they require foreign
businesses to engage in the joint venture with local companies. In such a situation,
strategic alliance will allow businesses to penetrate the local markets of the targeted
country.
➢ Economies of Scale: When businesses pool their resources and allow each other to
access manufacturing capabilities, economies of scale can be achieved. It relates to the
cost advantages which a producer gains from expansion. In business alliances, this
could include access to wider marketing channels, that a business might not otherwise
be able to afford outside the partnership. Costs savings may also come from joint
investments on things like R&D, or access to a partner’s operational facilities.
➢ Competitive Advantage: Synergy and competitive advantage are elements which lead
companies to greater success. Strategic partnerships are particularly appealing to small
businesses because they supply the tools businesses need to be competitive. For several
small companies the best way they can stay competitive and even survive in today’s
technologically advanced corporate environment is to create an alliance with another
company.

Disadvantages of Strategic Alliance

➢ Cultural and Language Barriers: Cultural conflict is probably the most significant
challenge which businesses in alliances experience today. These cultural problems
include language, egos, and different attitudes to business can make it tough. The first
thing which can cause problems is the language barrier which they might face. It is
crucial for the businesses that are functioning jointly to be able to communicate and

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understand each other well or they will likely fail. Language barriers sometimes can be
a source for delays and frustrations. Communication problems might also occur because
job definitions are much more specific in Western companies compared to Asian
companies.
➢ Uneven Alliances: When the decision powers are distributed very uneven, the weaker
alliance partner may be compelled to act in line with the will of the more powerful
partners even if it is actually not willing to do so.
➢ Lack of Trust: In several alliances one partner will point the failure finger at the other
partnering company. Transferring the blame will not solve the issue but increases the
stress between the alliance partners and usually ruins the alliance. Building trust is an
essential and yet most challenging element of a successful alliance. Only people can
trust each other, not the company. For this reason, alliances must be formed to improve
trust between individuals. Quite a few alliances didn’t work because of the lack of trust
leading to unsolved issues, lack of understanding, and despondent relationships.
➢ Damage to Goodwill: In case you create an alliance with another organization, the other
business’s poor public relations can harm your organization’s reputation. Even if your
alliance partner satisfies all of its obligations to you and faithfully promotes your
business, it might still be linked to other acts of bad faith which may stain your
organization.
➢ Differences in Management Styles: Failing to understand and adjust to “new style” of
management is an obstacle to success in an alliance. Adjustments are needed in
management style to run successful alliances. The adaptation of a new style of
management needs a change in corporate culture, which should be initiated and
nurtured by the top management. Some other challenges which may occur between
businesses in alliances are different attitudes among the companies. For example, one
partner may deliver its good or service behind schedule, or do a bad job producing their
goods or service, which can result in distrust between the two alliance partners.
➢ Potential for Conflicts: The understanding reached among the partners is crystallized
into an agreement of alliance. Having said that, no agreement will be able to capture
every detail of an understanding. The complexity grows when a situation originates that
is unexpected or not provided for in the agreement. This can create conflict over goals,
domain, and techniques that must be followed in the alliance activity among the
partners and could possibly lead to setbacks to the alliance.

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7. HOLDING COMPANY

A holding company is a parent corporation, limited liability company, or limited partnership

that owns enough voting stock in another company, that it can control that company's policies
and oversee its management decisions. Although a holding company owns the assets of other
companies, it merely maintains oversight capacities and therefore does not actively participate
in running a business's day-to-day operations.

A holding company is a type of financial organization that owns a controlling interest in other
companies, which are called subsidiaries. The parent corporation can control the subsidiary's
policies and oversee management decisions but doesn't run day-to-day operations. Holding
companies are protected from losses accrued by subsidiaries—so if a subsidiary goes bankrupt,
its creditors can't go after the holding company.

A prime example of a well-known holding company is Berkshire Hathaway, which owns assets
in more than one hundred public and private companies, including Dairy Queen, Clayton
Homes, Duracell, GEICO, Fruit of the Loom, RC Wiley Home Furnishings and Marmon
Group. Berkshire likewise boasts minor holdings in The Coca-Cola Company, Goldman Sachs,
IBM, American Express, Apple, Delta Airlines, and Kinder Morgan.

Advantages of Holding Company

• Ease of formation
It is quite easy to form a holding company. The promoters can buy the shares in the open
market. The consent of the shareholders of the subsidiary company is not required.

• Large capital
The financial resources of the holding and subsidiary companies can be pooled together. The
company can undertake large scale projects to increase its profitability.

• Avoidance of competition

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Competition between holding and subsidiary companies can be avoided if they are in the same
line of business.

• Economies of large-scale operations

The buying and selling of the holding company and the subsidiaries can be centralized. It can
enjoy the advantage of quantity discount and better credit terms because of bulk purchases. It
can also get better terms from buyers in case of sales.

• Secrecy maintained
Secrecy can be maintained as the authority and decision making are centralized. It can protect
itself from adverse publicity.

• Risks avoided
In case the subsidiaries undertake risky business and fail, the loss does not affect the holding
company. It can sell its stakes in the subsidiary company.

• Tax effects
Holding companies that own 80% or more of every subsidiary can reap tax benefits by
filing consolidated tax returns. A consolidated tax return is one that combines the financial
records of all the acquired firms together with that of the parent company. In such a case, should
one of subsidiary encounter losses, they will be offset by the profits of the other subsidiaries.
In addition, the net effect of filing a consolidated return is a reduced tax liability.

Disadvantages of Holding Company

1. Over capitalization
Since capital of holding company and its subsidiaries may be pooled together it may result in
over capitalization. Shareholders would get not get a fair return on their invested capital.

2. Misuse of power
The financial liability of the members of a holding company is insignificant in comparison to
their financial power. It may lead to irresponsibility and misuse of power.

3. Exploitation of subsidiaries

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The holding company may exploit the subsidiary companies. The subsidiaries may be
compelled to buy goods from the holding at high prices. They might be forced to sell their
produce to the holding company as very low prices.

4. Manipulation
Information about subsidiaries may be used for personal gains. For example information of the
financial performance of subsidiary companies may be misused to indulge in speculative
activities.

5. Concentration of economic power

There is concentration of economic power in the hands of those who manage the holding
company. Such concentration of economic power is harmful to the general economic welfare.

6. Secret monopoly
It may lead to the creation of secret monopolies. These secret monopolies may try to eliminate
competitors and prevent entry of new firms. They may exploit consumers by charging
unreasonable prices.

8. TAKEOVER BY REVERSE BID

Normally a large company takeover a small company. But when a small company acquires
a big company in a takeover manner, such a situation is called as takeover by reverse bid. It
happens when substantial shares of big company are in the hands of a small company. It is
possible when small company is a cash rich company and big company is a sick company.
A reverse takeover (RTO) is a type of merger that private companies engage in to become
publicly traded without resorting to an initial public offering (IPO). Initially, the private
company buys enough shares to control a publicly traded company. The private company's
shareholder then exchanges its shares in the private company for shares in the public company.
At this point, the private company has effectively become a publicly traded company. An RTO
is also known as a reverse merger or a reverse IPO.

Features of RTO

✓ A reverse merger is an attractive strategic option for managers of private companies

to gain public company status.
✓ It is a less time-consuming and less costly alternative to the conventional initial public
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offerings (IPOs).
✓ Public company management enjoy greater flexibility in terms of financing
alternatives, and the company's investors enjoy greater liquidity.
✓ Public companies face additional compliance burdens and must ensure that sufficient
time and energy continues to be devoted to running and growing the business.
✓ A successful reverse merger can increase the value of a company's stock and its
liquidity.
Benefits of a Reverse Takeover
The private company that merges into a publicly listed company enjoys the following benefits:

#1 No need for registration: Since the private company will acquire the public listed company
through the mass buying of shares in the shell companies, the company will not need any
registration, unlike in the case of IPO.
#2 Less expensive: Choosing to go public through the issue of an Initial Public Offering is not
an easy task for a small private company. It can be prohibitively expensive. The reverse
takeover route typically costs only a fraction of what the average IPO costs.
#3 RTO saves time: The IPO process of registration and listing can take several months to even
years. A reverse takeover reduces the length of the process of going public from several months
to just a few weeks.
#4 Gaining entry to a foreign country: If a foreign private company wants to become a
publicly listed firm in the United States, it needs to meet strict trade regulations, and incur
exorbitant expenses such as company registration, legal fees, and other expenses. However, a
private company can easily gain access to a foreign country’s financial market by executing a
reverse takeover.

Drawbacks of RTO
A reverse takeover presents the following potential drawbacks:

#1 Masquerading public shell companies

Some public shell companies present themselves as possible vehicles that private companies
can use to gain a public listing. However, some are not reputable firms and may entangle the
private company in liabilities and litigation.

#2 Liquidation mayhem

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A private company willing to go public using reverse takeover should ask itself, “After the
merger, will we still have enough liquidity?” The company may have to deal with a possible
stock slump when the merger unfolds. It’s critical that the new company has adequate cash
flow to navigate the transition period.

9. Sell Off

A sell-off is a transaction between two independent companies. The divestor may benefit
from the cash proceeds, which could be put to more profitable use in the businesses within
the group or used to mitigate financial distress.

Sell-off may also add to the divestor by eliminating negative synergy, or by

realizing managerial resource pre-empted by the divested business. It may also
sharpen the strategic focus of the remaining businesses & enhance the divestor’s
competitive strength. Selling a part or all of the firm by any one of means: sale,
liquidation, spin-off & so on is called Sell off.

Motives of Sell Off

1. Raising Capital
A common motive for sell off is to raise capital. Cash strapped firms seems to resort to
divestiture to shore up their liquidity.

2. Curtailment of losses
A prominent reason for sell off is to cut losses. More broadly, it may imply that the unit is
proposed to be divested is earning a sub normal rate of return.

3. Efficiency gains
A sell off results in an efficiency gain when the unit divested is worth more as part of some
other firms or as a stand-alone business. This happens when there is a reverse synergy. This
means that the value of the part is greater than the whole.

Sell Off Process

The sell off process are as follows

1. Developing Sales strategy: The company has to decide on the type of sale proceeds to
be adopted. The two different sale proceeds are
a) Negotiated Sale: In this method the potential buyers are directly approached

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by the firm or by its investment banker. In case they show serious interest in
acquisition, the negotiations are conducted between the seller and buyer. On
successful completion of the negotiation the deal is publicly declared. This
process ensures secrecy, avoids staff unrest and control market receptivity.
b) Auction Sale: In an auction sale the intention to sell is publicly announced.
Competitive bids are invited from various interested buyers. the company select
the most favorable bid and the divestiture is made in favor of bidder. The biggest
advantage of the auction process is that it enables the realization of the
maximum possible price. It also draws the attention of a large universe of
potential buyers and eliminates the biases in the selection of target buyers. It
also makes the entire sale proceeds time bound.

2. Valuation: The firm generally seek professional help for the valuation of the
assets/business put up for sale. This helps as an anchor in the later process of
negotiation. This is the basis on which the minimum cut off price for the divestiture is
determined.
3. Drafting of Offer Memorandum: A detailed offer memorandum is drafted by the firm
in consideration with their investment bankers, for the benefit of the potential buyers.
The content of the same are executive summary, sales proceeds, background of the
company, marketing, human resources, finance etc.
4. Identify Potential Buyer: The most obvious target segment is competitors. Normally
they pay a highest price for acquiring the rival business. The primary motive is to obtain
additional market share. It also helps the buyer in generating economies of scale.
Buying up competitors also reduces future competition in the market. Another target
group is suppliers and customers. This would enable the buyer to increase earning by
capturing value addition by vertically integrating the business. Another potential buyer
are companies looking for diversification, technology, venture capitalist etc.
5. Negotiation and Closing the Deal: The preliminary potential discussion with the
potential buyers should help in shortlisting a few serious buyers. The company can
negotiate with the short -listed buyers . Once there is an agreement with a potential
buyer with the terms and conditions agreed and signed, the negotiation will be
completed.

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10. SPIN OFF

When a company creates a new independent company by selling or distributing new shares of
its existing business, this is called a spinoff. A spinoff is a type of divestiture. A company
creates a spinoff expecting that it will be worth more as an independent entity. A spinoff is also
known as a spin out or starburst.

Businesses wishing to sell their less productive setups and streamline their operations
undertake spin offs. A company may wish to spin off its mature business units which are
experiencing no growth and is stagnant.
This permits the company to focus on the products with higher growth prospects. This benefits
the spun-off business as they hold a higher worth being an independent entity rather than a part
of a larger business. The spin-off is thereby considered to be one of the most profitable forms
of corporate restructuring.

Reasons for Corporate Spinoff

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Process of Corporate Spinoff

In the initial stage of the process, the company needs to declare its intention of the corporate
spinoff. It should specify the proportion in which the distribution of new company’s shares
among the existing shareholders, would take place.

Next, the company looks forward to the Internal Revenue Service to get a legal opinion on the
spinoff entity’s taxability. It is followed by the filing of SEC’s Form C, containing information
like financial statements, spun-off units, company’s value percentage, etc.

The company then decides whether to get the subsidiary listed for stock exchange or plan for
Over The Counter (OTC) trading. If required, the parent company may even take the approval
of its existing stockholders before spinning off the business.

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After getting listed, the company can initiate the ‘when-issued’ basis of trading for the shares
of the new subsidiary company. It facilitates the shares exchange, even before they are
distributed.

Thus, the market is set for the subsidiary’s shares. The existing shareholders are now allocated
the spinoff share units, which they can trade or hold.

Types of Spinoff

The corporate spinoff is a strategic activity. Given below are the four ways in which a company
can choose to spin off its division or subsidiary:

Pure Play

Being one of the purest forms of the corporate spinoff, in pure play, the parent company gives
out the shares of the new entity to its existing stockholders as a special dividend.

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Equity Carve-out

It is a partial spinoff where the parent company divides the total value of the subsidiary into
parts, i.e., 20% and 80%. The 20% shares are issued as an initial public offering to generate
capital. Whereas, 80% of the shares are allotted to the existing shareholders as a special
dividend.

Tracking Stocks

The primary strategy behind tracking stock is to benefit from the parent company’s enhanced
share price. Here, the company separates its subsidiary physically but not legally in terms of
assets and liabilities.

STUBS
Stubs is referred to the act of a company distributing shares to the public in the form of issuing
a new entity while still retaining part ownership of the same. The market value of the
investment by the parent company can be determined once the spun-off unit is traded publicly.

Advantages of Corporate Spinoff

It has been observed that many companies have saved themselves from loss, and some have
even increased their profits remarkably, only through a spinoff. Let us understand the various
benefits of the spinoff in detail below:

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• Independent Brand: Spinoff helps the company to develop the subsidiary under a
separate corporate identity.
• Profitability: As identified, the spun-off company grows impeccably, since it focuses
on the core business model along with attracting new shareholders.
• Secures Investors’ Interest: Seeing the growth opportunity and potential, institutional
investors show high interest in the spun-off stock.
• Develops Entrepreneurial Culture: The employees, when moved to a new entity, seek
opportunities to explore their creativity and innovation, for empowerment.
• Serves Investment Objectives: The existing and prospective investors see great
potential as they can view the subsidiary’s business independent from that of the parent
company.

Disadvantages of Corporate Spinoff

A company creates a new entity by utilizing its resources such as finance, personnel, assets,
etc. Thus, it may prove to be unfavourable, to the company as well as its employees in the
following ways:

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To the Company

A corporate spinoff is a beneficial approach for well-established companies. However, it has

the following limitations for the organizations:

• Contractual Obligation: A company is abided to various contracts such as vendor

contract, partnership deed, loan agreement, support agreement, etc. Thus, it has to get all
these contracts revised to mention the spinoff.
• Increases Cost: Spinoff also adversely affect the cost structure of the company by
escalating the fixed costs such as insurance, rent, maintenance and property tax.
• Requires Long-term Support: A SpinCo has been flourished under the facility of the
parent company, before the spinoff. But as an independent entity, it requires much more
managerial, operational, marketing and accounting backup.

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To the Employees

The employees who have been working for the parent company for years are moved to the
subsidiary now. They may take spinoff negatively due to the following reasons:

• Identity Dilemma: The employees see SpinCo as a small company and may consider it
as their demotion. Such thoughts lead to the unmotivated and underperforming
workforce.
• Insecurity: They usually view the new entity to be highly insecure as everything starts
with a scratch, doubting the future a SpinCo.
• Regret and Anxiety: They feel dissatisfied and concerned about their role and
responsibilities in the new environment.

Example of Spinoff

One of the prominent companies in the sector of C2C and B2C e-commerce is eBay Inc. The
company had spun off its money transfer business entity, PayPal in the year 2014.

The reason behind this corporate spinoff was that PayPal had higher growth potential and the
competitors like Apple Pay were ready to acquire its market. Thus, eBay sensed this
competitiveness and separated the subsidiary to enhance its value and scope.

11. EQUITY CARVE OUT

Equity carve-out (ECO), also known as a split-off IPO or a partial spin-off, is a type of
corporate reorganization, in which a company creates a new subsidiary and subsequently IPOs
it, while retaining management control. In a carve-out, the parent company sells some or all of
the shares in its subsidiary to the public through an initial public offering (IPO), effectively
separates a subsidiary or business unit from its parent as a standalone company.

Definition: The Equity Carveout is the corporate strategy wherein the company sells a
portion or a division in a wholly owned subsidiary through the IPOs and retain the full control
over the management. Under this arrangement, limited shares are offered to the public, while
the majority stake is retained by the parent company.

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Characteristics of Equity Carve-Out

• Strong Growth Prospects: If the subsidiary is in an industry with better growth prospects than
the parent, it will likely sell at higher price/earnings multiple once it has been partially carved
out of the parent.
• Independent Borrowing Capacity: A subsidiary that has achieved the size, asset base,
earnings and growth potential, and identity of an independent company will be able to generate
additional financing sources and borrowing capacity after the carve-out.
• Unique Corporate Culture: Subsidiaries whose corporate culture differs from that of the
parent may be good ECO candidates because the carve-out can offer management the freedom
to run the company as an independent entity. Companies that require entrepreneurial cultures
for success can especially benefit from this transaction.
• Special Industry Characteristics: Subsidiaries with unusual characteristics are often better
suited to decentralized management decision-making, which may allow management to
respond more quickly to changes in technology, competition, and regulation.
• Management Performance, Retention, and Rewards: Subsidiaries that compete in
industries where management retention is an issue and targeted reward systems are required
can benefit from an ECO.

Benefits of Equity Carve-Out

➢ Increases the focus of the firm

➢ Improves the autonomy of the component businesses
➢ Improve the managerial incentive structure by relating management performance
directly to the shareholder value.
➢ Enhance the visibility of the component businesses being divested.
➢ Minimize the conglomerate discount through this enhanced visibility &
increased information.
➢ improves access to capital markets for both the parent and the subsidiary.

Disadvantages of Equity Carve-Outs

✓ The scope for conflict between the two companies as operation level conflict occurs

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because of the creation of a new group of financial stakeholders by the mangers of the
carved-out company. The conflict between subsidiary and parent will hinder the
performance of the firm.
✓ Lack of separation between the two entities prevents the carved-out entity from
reaching its potential.

Difference between Equity Carve Out and Spin Off

Basis of Difference Equity Carve Out Spin Off
Meaning The Equity Carveout is the When a company creates a
corporate strategy wherein new independent company
the company sells a portion by selling or distributing new
or a division in a wholly shares of its existing
owned subsidiary through business, this is called a
the IPOs and retain the full spinoff.
control over the
management.
Creation of Shareholders It results in the creation of The shares of the subsidiary
new sets of shareholders. are issued to the existing
shareholders of the company.
Cash Flows There are positive cash flow Spin Offs do not results in
effects in ECO initial changes in parent
company cash flows.
Legal Regulations Greater scrutiny and stricter There is no such rigid
regulations are involved in regulations in the case of
equity carve out Spin Off
Control In ECO, parent sells only a In a Spin Off parent firm no
minority interest in longer has control over
subsidiary and retains control subsidiary assets.

12. LEVERAGED BUY OUT

A leveraged buyout (LBO) is the acquisition of another company using a significant amount
of borrowed money to meet the cost of acquisition. The assets of the company being acquired
are often used as collateral for the loans, along with the assets of the acquiring company.

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However, a leveraged buyout differs from a typical corporate purchase in two primary ways.

✓ An LBO involves a higher debt-to-equity ratio than most ordinary corporate

acquisitions.

✓ An LBO secures the acquisition debt with the acquired company. This is the defining
feature of an LBO.

Characteristics LBOs
✓ Large portion of buyout is financed through debt hence it is called as Leveraged
Buyouts.

✓ In LBO deals the assets and the cash flows of the target company are used for the
purpose of debt repayment.

✓ After the buyout, the company’s control is in the hands of LBO firm.

✓ The target business should have a good market position with profitable background.
✓ The target should have a relatively low level of debt and high-level assets.
✓ It must have the stable cash flows in order to meet the interest payment and
reimbursement.

What are the reasons of LBO?

➢ Private Investment firm may have interest in the target business firms business, and it
may think it will run that firm more efficiently.

➢ Acquirer may make that business achieve more growth.

➢ With borrowed fund, will help reducing the tax bill as firms won’t have to pay tax on
interest payments.

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Advantages of an LBO

➢ It can increase management commitment and effort because they have greater equity
stake in the company.

➢ LBO may enable the company to improve its market position.

➢ Responsibility to pay interest and repay the debt, forces the management to perform
better which results in increased productivity.

➢ Restructuring and use of the acquired firm’s asset saves the costs

➢ Economies of scale: For better performance technology is updated and large amounts
of production leads to economies of scale.

➢ Because of huge Debt, payments of dividends are not necessary.

➢ Tax shield: Because of debt financing, there are interest tax shields which increases
cash flow to the shareholders.

➢ More Efficiency: It can reduce operational expenses, which in turn can lead to an
increase in profits.

➢ Reduced Competition: A business can increase its profits by reducing its competition.
The buyout can offer the newly formed company increased economies of scale, as well
as eliminate the need to get into a price war with a competitor. That may lead to reduced
prices for the products or services of the company, which will be beneficial to its
customers.

➢ New Technology or New Products: The larger company benefits by incorporating the
new technology or products of the smaller company into its current product line,
without the need to pay to license the technology.

Disadvantages of an LBO

➢ If the company's cash flow and the sale of assets are insufficient to meet the interest

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payments arising from its high levels of debt, the LBO is likely to fail and the
company may go bankrupt.
➢ Paying high interest rates on LBO debt can damage a company's credit rating
➢ Because of high leverage, there will be inappropriate investment policy
➢ The leveraged company may downsize, which puts a lot of employees out of
work.

Stages/ Process of LBO Operations

Four stages are envisaged for the implementation of the LBO programme.

1. Arrangement of Finance: The first stage of the operation consists of the raising of
the funds required for the buyouts and working out a management incentive system.
The equity base of new firm consists around 10% of the cash put up by the company’s
top management or buy out specialists. 50% of the cash is raised by the borrowing
against company’s assets in secured bank acquisition loan from commercial banks.
Rest of the cash is obtained by issuing debt.
2. Taking Private: In this stage the organizing or sponsoring group purchases all the
outstanding shares of the target company and takes it private through stock purchase
or asset purchase.
3. Restructuring: In this stage the new management try to enhance the generation of
profit and the cash flows by reducing certain operating cost and expenses. This will
be achieved by consolidating and reorganizing the production facilities, changing the
product mix, and trimming the employees.
4. Reverse LBO: In this stage the investor group may take the company to public again
if the already restructured company emerges stronger and the goals set by the LBO
groups already been achieved. This is known as the process of reverse LBO and or the
process of going public. The sole purpose of this exercise is to create liquidity for
existing shareholders.

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13.MANAGEMENT BUYOUT (MBO)

A management buyout (MBO) is a transaction where a company’s management team purchases

the assets and operations of the business they manage. A management buyout is appealing to
professional managers because of the greater potential rewards and control from being owners
of the business rather than employees. MBO is a transaction where a company’s management
team purchases the assets and operations of the business.

Management buyout (MBO) is a type of acquisition where a group led by people in the current
management of a company buy out majority of the shares from existing shareholders and take
control of the company.

Advantages of a Management Buyout

Management Buyouts Are Simple And Easy To Arrange

Rather than having to invest significant amounts of time and energy (not to mention money)
into marketing your business in the hopes of finding a suitable third-party buyer, with a MBO
your buyers are already on your doorstep. This means that MBO’s are usually quicker, cheaper,
and easier. The contracts and sales process itself for MBO’s are also usually much simpler as
the buyers already have intimate knowledge of the company and so minimal due diligence is
required.

Confidentiality Can Be Maintained

As you are selling to internal buyers, confidentiality surrounding the sale can be much more
easily maintained. Not only can this ensure the continuation of confidence in the business by
clients, suppliers and staff, it also means that potentially sensitive company details do not have
to be divulged to external parties, which always carries an element of risk, even if they have
signed a Non-Disclosure Agreement.

High Chance of Success

In general, companies purchased through a MBO have a higher chance of ongoing success and
profit, than those that have been bought by an external buyer. This is normally attributed to the
fact that the new owners already have an in-depth knowledge of the business and so are able to
hit the ground running and often swiftly implement organisational and procedural changes that

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they have identified the need for and planned for several years prior to the MBO. It is also
easier to maintain relationships with key clients and suppliers that can be vital to the success
of the business.

Disadvantages of a Management Buyout

Difficulties of Raising Funding

In many cases the current management team are not able to raise enough capital to fund an
MBO themselves. This is generally due to lack of personal wealth and/or the business
experience required to raise high enough levels of personal funding. In these cases funding is
often sourced from banks or private equity firms. However, this can result in large amounts of
debt being amassed at the very beginning of the ownership which can increase pressure on the
business to perform. Also, especially in the case of private equity firms, this can change the
dynamics of the ownership team with there being an extra external party at the table meaning
that the new owners could still end up being answerable to someone after all.

Lack of Business Ownership Experience

In many cases the incumbent management team may be highly experienced in running a
business, but less so in the very different field of owning one. It is often difficult to quantify
exactly what qualities are required to be a successful business owner; however it tends to
become quickly apparent if the new ownership team is not in possession of them.

Insider Trading Risks

There have been some instances of the incumbent management team taking steps to reduce a
company’s profitability in the run up to a Management Buyout, in hopes of reducing the
purchasing price. Therefore, the departing owner must still ensure that they are keeping a very
close eye on both the business and the sale before their departure.

Managing the Current Owner’s Departure

Striking the right balance between letting the new owners take the reins and ensuring that vital
company information and contacts are not lost with the departure of the current owner can often
be difficult, especially if the current owner is maintaining an equity stake. It is often prudent to

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engage the services of an external professional to draw up to terms of any handover period to
ensure that this can be managed smoothly and effectively.

Steps in MBO Process

The Key steps in MBO process are as follows

1. Prepare Business Plan: The management team need to prepare a detailed

business plan including the financial projections.
2. Finalize management Team: The key stakeholders need to agree the
participating management team. The buy out team will decide about how much
capital they are willing to invest.
3. Seek approval from vendor’s board: Before the management team speak to
an external equity provider, it is important to have approval from their own
parent company.
4. Select potential investors: It is important that both vendor and management
should have confidence in investors or private equity firms. The criteria need to
consider are credibility and integrity, financial track record, transparent
investment and approval process and the ability to structure and fund the MBO
5. Term Sheet: Once the management appointed an investor or a private equity a
term sheet needs to be entered with their details.
6. Appoint advisors: The next step would be appointing the advisors for the
stakeholder including the lawyers, accountants
7. Conduct Due diligence: The advisor team will undertakes the due diligence
process which is the collection of information relevant for MBO.
8. Obtain debt funding: This part is about obtaining debt funding. The firm
should identify the sources of funds.
9. Prepare and negotiate legal documents: This step ensure that the investor
prepare legal documents which are necessary for the MBO transaction.

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14. LIQUIDATION

Liquidation occurs when a company is insolvent and unable to pay its overdues. The operations
of the company are closed and division of the assets between shareholders and creditors take
place as per the priority of their claims. In rare cases, solvent companies also file for liquidation.
Not all bankrupt companies eventually lead to liquidation; some companies rehabilitate the
entity and opt for corporate restructuring.

Reasons for Liquidation

➢ The business was started and run for the wrong reasons
➢ Business owner lacks skill sets
➢ Inadequate working capital
➢ Week financial skills
➢ The location is wrong
➢ Lack of planning
➢ Over-trading or under-trading
➢ Poor marketing
➢ Failing to set any strategic direction
➢ Inflexible business model

Types of Liquidation
Creditors’ voluntary liquidation
he creditors’ voluntary liquidation takes place when the shareholders of a company decide to
terminate a company, they hold shares in. However, at times the company is unable to pay back
all the creditors. The directors of the company initiate creditor’s voluntary liquidation.

Members’ voluntary liquidation

The shareholders of the company initiate the member’s voluntary liquidation in spite of the
company being solvent. The company holds enough cash to close operations without owing
money to any creditors. In this type of liquidation, the court will conduct the hearing for the
closedown of the company. A qualified insolvency practitioner will commence the process of
the liquidation. The directors will have to prove the worth of the company to pay all debts.

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Compulsory liquidation
The court can pass an order for winding-up and forcefully shutting down an organization. This
action could be done if someone connected to the business files a petition. This could be a
director of the company or a creditor awaiting payment. However, in cases of more than one
director, all directors need to jointly file the petition. A creditor at first files a petition in the
court. Despite statutory warning, if the debt owed to him has remained undisputed, ignored or
unpaid, the creditor may opt for liquidation.

15. MASTER LIMITED PARTNERSHIP ( MLP)

Master limited partnership is a limited partnership that is publicly traded on securities

exchange. It combines the tax benefits of a limited partnership with the liquidity of publicly
traded securities. There are two types of partners in an MLP: general partners and limited
partners. General partners oversee the daily operations of the MLP. All other investors in an
MLP are limited partners, and their role is to provide capital to the MLP. A master limited
partnership, or MLP, is a limited partnership that is traded publicly on an exchange. An MLP
combines the tax benefits of a limited partnership with the liquidity that publicly traded
securities -- like stocks and bonds offer.

A master limited partnership is a publicly traded business venture that combines the features
of a corporation with that of a partnership and exists as publicly-traded limited partnerships.
Such business ventures are exempt from corporate tax. Master limited partnership pools the tax
benefits of a private partnership and liquidity of a publicly traded business.

Features of MLP:

✓ Limited Liability.
✓ Centralized Management.
✓ Longer Life (Partnership forever)
✓ Transferability of Stock.

Advantages of a Master Limited Partnership

• A master limited partnership provides investors with consistent distributions.

Additionally, the investments are low risk, implying that the investors receive a stable
income over the investment period.

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• Almost 80% of the distributions in master limited partnerships are tax-deferred. It

means that the investors are not liable to pay tax until their portion is sold.
• It also offers tax benefits, as when the unit holders sell their portion, they pay taxes at
the capital gain rate instead of the personal income tax rate, which is usually higher.
• The investors receive more income yield than traditional equities – generally in the
range of 6%-7%.
• The tax exemption feature results in more capital, which can be used in future projects.

Disadvantages of a Master Limited Partnership

• Since master limited partnerships are in industries with slow growth, such as
exploration, there is a slow return on investments.
• The corporate tax liability in a master limited partnership is passed on to the investors,
which can negatively affect the return.
• The process of filing taxes may become complicated if the limited partners own units
in various states where the partnership operates.
• There is a smaller pool of investors for master limited partnerships, as institutional
investors incur tax liabilities for investing in units.

Types of MLP’s

➢ Roll up MLP: Combination of two or more partnerships forming one publicly

traded partnership.

➢ Liquidation MLP: Formed by complete liquidation of a corporation and

converting it into a MLP.

➢ Acquisition MLP: Formed by offering part of the MLP’s interest (shares) to

public and using the proceeds to purchase assets.
➢ Roll out MLP: Formed by a corporation’s contribution of operating assets in
exchange for general and limited partnership interests (shares) of the MLP
followed by a public offering of limited partnership interest.

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16. BUYBACK OF SHARES/ SHARE REPURCHASE

A share repurchase is a transaction whereby a company buys back its own shares from the
marketplace. A company might buy back its shares because management considers
them undervalued. The company buys shares directly from the market or offers its
shareholders the option of tendering their shares directly to the company at a fixed price.

Advantages of BUYBACK OF SHARES/ SHARE REPURCHASE

• Boost in share prices: Stock buybacks can offer a short-term bonus for investors. The buyback
means there are fewer shares trading on the public markets. This tends to strengthen the share
price, so your shares may be worth more, at least in the short term.
• Rising dividends: Sometimes the company will be able to increase dividend payment amounts
after a buyback because there are fewer shares on which the company must pay a dividend.
• Better earnings per share: When public companies announce profits, they track their progress
in part by looking at earnings per share. With fewer shares trading, the EPS number usually
rises. This can help the company beat market expectations for their performance and help drive
a higher stock price.
• Less excess cash: If a company has bundles of cash just sitting in a money market account,
that money isn’t doing much for the company. It’s earning a very low interest rate, which is a
portion of the company’s profitable activities. Removing the cash from the company books can
lift overall performance.
• Positive psychology: When a company buys back stock, investors usually see it as a sign the
company believes the price should be higher, that investors are not realizing the company’s
true value. This can sometimes kick off an upward swing in stock price.

Disadvantages of Share Repurchase

• Poor predictions: While the idea is for companies to buy up their stock when it’s cheap, often
that doesn’t happen. After all, who can predict the stock market? Companies often end up
buying their stock at what turns out to be high levels, making the buyback a bad use of capital.
• Sinking dividends: Sometimes companies spend a lot of money buying up shares and then cut
their dividend as a result. After spending money buying back shares, the company has less cash
to hand out in a quarterly dividend. So if you’re an investor who relies on dividend checks for
income, this could hit you in the pocketbook.

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• Poor use of capital: When a company is spending millions buying their own stock, a savvy
investor should ask: Why can’t they find something better to do with their money? Every dollar
used to buy up stock is a dollar that isn’t hiring more employees, ramping up marketing,
acquiring a competitor, developing a new product, or otherwise investing that money to grow
the business.
• Management self-interest: Stock buybacks often benefit big shareholders the most; and
frequently that means company managers who hold stock options. When the buyback boosts
the stock price, often temporarily, that rise may help the stock hit a target price the managers
need to exercise their options. The managers can then quickly resell their stock and pocket their
profits. So company management is enriched, while the company’s research and development,
marketing, hiring, and other departments are impoverished by the move. Managers may also
benefit from a buyback because their bonuses may be tied to hitting a particular earnings-per-
share figure. Fewer shares mean a higher EPS number.
• Cover for stock handouts: If a company is issuing tons of stock options to managers, a stock
buyback helps counter that by reducing the number of shares on the market. Otherwise
investors might see noticeable stock-price dilution. The buyback can help distract investors
from the fact that excessive stock handouts are taking place.

17. GOING PRIVATE

The term going private refers to a transaction or series of transactions that convert
a publicly traded company into a private entity. Once a company goes private,
its shareholders are no longer able to trade their shares in the open market.

Reasons for going private

• Easier access to capital

• More flexibility to think long term

• Deals close faster and more efficiently with lower closing risk

• Reduced costs and less time spent on compliance

• Focus more on future growth options and exploiting investment opportunities.

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18. EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)

An employee stock ownership plan (ESOP) is an employee benefit plan that gives workers
ownership interest in the company. ESOP is usually formed to allow employees the
opportunity to buy stock in a closely held company to facilitate succession planning if any.

Advantages of ESOP

• Capital appreciation: Companies sell their equity to employees and converts

corporate and personal taxes into tax free capital appreciation.

• Incentive based retirement: Provide a cost-effective plan to motivate employees.

• Tax advantages: This enables the tax advantaged purchasing of stocks of a retiring
company owner.

• ESOP is a market for lower marketability shares

• An avoidance of giving out confidential information to a competitor or other

potential buyers

Disadvantages of ESOP

➢ Corporate governance – the transaction can be placed at risk when ESOP trustees
and external advisers develop impatience with the sale-process timeline due to
potential delays inherent in the setup time required.

➢ There is the potential for dilution in the deal’s value when ESOP trustees utilize
their rights of approval to obtain a premium for their stock.

➢ The company may experience a cash flow drain since cash flow contributed to the
ESOP can limit the availability of the cash to reinvest in the business.

➢ ESOPs may require employees to make financial sacrifices including wages and
benefit rollbacks. Although, employees may agree to such agreements, it may not
appeal to them.

➢ There is additional cost to the company that includes retaining an independent

trustee, legal counsel, and financial advisor as well as the legal expenses associated
with an ESOP.

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19. LIMITED LIABILITY PARTNERSHIP( LLP)

A limited liability partnership is a partnership in which some or all partners have limited
liabilities. It therefore can exhibit elements of partnerships and corporations. In an LLP,
each partner is not responsible or liable for another partner's misconduct or negligence.

LLP stands for Limited Liability Partnership. It is an alternative corporate business form which
offers the benefits of limited liability to the partners at low compliance costs. It also allows the
partners to organize their internal structure like a traditional partnership. A limited liability
partnership is a legal entity, liable for the full extent of its assets. The liability of the partners,
however, is limited. Hence, LLP is a hybrid between a company and a partnership. But it should
not be confused with limited liability company.

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Salient Features of LLP

LLP is a body corporate

According to Section 3 of the Limited Liability Partnership Act (LLP Act), 2008, an LLP is a
body corporate formed and incorporated under the Act. It is a legal entity separate from its
partners.

Perpetual Succession

Unlike a general partnership firm, a limited liability partnership can continue its existence even
after the retirement, insanity, insolvency or even death of one or more partners. Further, it can
enter into contracts and hold property in its name.

Separate Legal Entity

Just like a corporation or a company, it is a separate legal entity. Further, it is completely liable
for its assets. Also, the liability of the partners is limited to their contribution in the LLP. Hence,
the creditors of the limited liability partnership are not the creditors of individual partners.

Mutual Agency

Another difference between an LLP and a partnership firm is that independent or unauthorized
actions of one partner do not make the other partners liable. All partners are agents of the LLP and
the actions of one partner do not bind the others.

LLP Agreement

The rights and duties of all partners are governed by an agreement between them. Also, the
partners can devise the agreement as per their choice. If such an agreement is not made, then the
Act governs the mutual rights and duties of all partners.

Artificial Legal Person

For all legal purposes, an LLP is an artificial legal person. It is created by a legal process and has
all the rights of an individual. It is invisible, intangible and immortal but not fictitious since it
exists.

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Common Seal

If the partners decide, the LLP can have a common seal [Section 14(c)]. It is not mandatory
though. However, if it decides to have a seal, then it is necessary that the seal remains under the
custody of a responsible official. Further, the common seal can be affixed only in the presence of
at least two designated partners of the Limited Liability Partnership.

Limited Liability

According to Section 26 of the Act, every partner is an agent of the LLP for the purpose of the
business of the entity. However, he is not an agent of other partners. Further, the liability of each
partner is limited to his agreed contribution in the Limited Liability Partnership. It provides
liability protection to its partners.

Minimum and Maximum Number of Partners in an LLP

Every Limited Liability Partnership must have at least two partners and at least two individuals as
designated partners. At any time, at least one designated partner should be resident in India. There
is no maximum limit on the number of maximum partners in the entity.

Business Management and Business Structure

The partners of the Limited Liability Partnership can manage its business. However, only the
designated partners are responsible for legal compliances.

Business for Profit Only

Limited Liability Partnerships cannot be formed for charitable or non-profit purposes. It is

essential that the entity is formed to carry on a lawful business with a view to earning a profit.

Investigation

The power to investigate the affairs of a Limited Liability Partnership resides with the Central
Government. Further, they can appoint a competent authority for the same.

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Compromise or Arrangement

Any compromise or arrangement like a merger or amalgamation needs to be in accordance with

the Act.

Conversion into LLP

A private company, firm or an unlisted public company can convert into an LLP in accordance
with the provisions of the Act.

E-Filing of Documents

If the entity is required to file any form/application/document, then it needs to be filed in an

electronic form on the website www.mca.gov.in. Further, a partner or designated partner has to
authenticate the same using an electronic or digital signature.

Significance of forming an LLP are as follows

• Organized

• Operates based on an agreement

• Offers flexibility without imposing detailed legal and procedural requirements

• Easy to form

• Offers limited liability to all partners

• Has a flexible capital structure

• Is easy to dissolve

Disadvantages of a Limited Liability Partnership

• Inclusion of Indian Citizen as a Partner – An NRI/Foreign national who wants to

incorporate an LLP in India shall have at least one partner who is an Indian citizen.
Two foreign partners cannot form an LLP without having one resident Indian partner
along with them.

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• Transfer of Ownership -If a partner wants to transfer his/her ownership rights then
he/she has to obtain the consent of all the partners.
• Filing of various returns - Public disclosure is the main disadvantage of an LLP. An
LLP must file Annual Statement of Accounts & Solvency and Annual Return with the
Registrar each year. Income Tax Return must also be filed to the Income tax department
for the LLP.
• Number of partners –A limited liability partnership must have at least two members.
If one member chooses to leave the partnership, the LLP may have to be dissolved.
• Non- recognition - LLPs are limited by state regulations due to which they are not
given due recognition in every state as a business structure.
• Huge penalties –The cost of non-compliance of procedural matters such as late filing
of e-forms is very high which would lead to huge sum of penalties owing to Rs.100 for
every day till the time the offence of late filing continues.

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