STRATEGIC FINANCIAL MANAGEMENT

UNIT – 2

CORPORATE RESTRUCTURING

Corporate restructuring is the process of reorganizing the legal, ownership,

operational, or other structures of a company for the purpose of making it more profitable or
better organized for its present needs. It can involve significantly modifying the financial and
operational aspects of a company, usually when the business is facing financial pressures.
Companies undergo restructuring to achieve certain aims, such as to become more
competitive or to respond to changes in the market.

Corporate restructuring involves rearranging aspects of a company for increased

efficiency or profitability. The process of restructuring can include changing a company's
internal hierarchy, eliminating certain roles, merging others, creating new jobs, departments,
and teams, while eliminating others, which might cause shake-ups in working relationships.
There are multiple ways to approach corporate restructuring, and the strategy pursued
depends on the specific needs and goals of the organization.

Different types of restructuring include legal restructuring, turnaround restructuring,

cost restructuring, divestment, spin-off, repositioning restructuring, and mergers and
acquisitions.

STRATEGIC ALLIANCES

A strategic alliance is an agreement between two or more independent organizations

to pursue a set of agreed-upon objectives while remaining independent. It is a way to
supplement internal assets, capabilities, and activities with access to needed resources or
processes from outside players such as suppliers, customers, competitors, companies in
different industries, brand owners, universities, institutes, or divisions of government.
Strategic alliances are less involved and less permanent than joint ventures, in which two
companies typically pool resources to create a separate business entity. In a strategic alliance,
each company maintains its autonomy while gaining a new opportunity.

A strategic alliance is a cooperative arrangement between two or more businesses or

organizations with the goal of achieving mutual benefits or objectives. It involves
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collaborating on various activities, such as sharing resources, technology, or expertise, to gain
a competitive advantage or achieve common goals.

FACTORS INFLUENCING STRATEGIC ALLIANCES

1. Shared Objectives: Common goals and objectives between the parties involved often
drive the formation of alliances.

2. Complementary Resources: When organizations have complementary resources, such as

technology, expertise, or distribution channels, it can make forming an alliance attractive.

3. Market Access: Access to new markets, customers, or geographic regions is a significant

motivator for forming alliances.

4. Risk Sharing: Partnerships can help spread risk, whether it's related to market volatility,
R&D costs, or other factors.

5. Cost Reduction: Collaborating with another organization can lead to cost savings through
economies of scale or resource sharing.

6. Innovation: Collaboration can drive innovation through knowledge sharing and combined
R&D efforts.

7. Competitive Pressures: Responding to competitive threats or market changes can drive

organizations to seek alliances to maintain or enhance their competitive position.

8. Legal and Regulatory Environment: The legal and regulatory environment can either
encourage or restrict the formation of alliances.

9. Cultural Compatibility: Similar organizational cultures and values can make

collaborations more effective.

10. Trust and Relationship Building: Building trust is crucial for the success of strategic
alliances, as it fosters cooperation and open communication.

11. Long-term Vision: Organizations with a long-term strategic vision are more likely to
seek and maintain strategic alliances.

12. Technology and Communication: Advances in technology and communication make it

easier for organizations to collaborate, even across geographical boundaries.

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13. Globalization: In a globalized world, alliances can help organizations adapt to
international business dynamics.

14. Financial Considerations: Financial stability and investment capacity can influence an
organization's ability to enter into and sustain alliances.

TYPES

1. Joint Venture:

In a joint venture, two companies come together to form a third distinct legal business
entity, known as a "child company," by means of a binding contract. This type of alliance is
often used when the companies involved want to share resources and expertise to achieve a
common goal.

2. Equity Strategic Alliance:

In an equity strategic alliance, two companies share equity in each other, or one
company buys an equity stake in the other. This type of alliance is often used to reduce costs
and leverage each other's resources.

3. Non-equity Strategic Alliance:

In a non-equity strategic alliance, companies share core competencies and resources

to gain a competitive edge, but there is no equity participation in the partnership. This is the
most common type of strategic alliance.

STEPS

1. Strategy Development: The first step in creating a successful alliance is to develop a well-
thought-out alliance strategy. This is a critical step. It is worth remembering that if you do not
follow your strategy in a partnership, you may not achieve your goals.

2. Partner Selection: The second step is to identify potential partners that align with your
alliance strategy. This step involves evaluating potential partners based on their strengths,
weaknesses, and compatibility with your organization.

3. Negotiation and Agreement: The third step is to negotiate and agree on the terms of the
alliance. This step involves developing a formal agreement that outlines the roles,
responsibilities, and expectations of each partner.

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4. Implementation: The fourth step is to implement the alliance. This step involves putting
the agreement into action and ensuring that each partner is fulfilling their responsibilities.

5. Evaluation: The final step is to evaluate the alliance's success. This step involves
measuring the alliance's performance against the goals set in the strategy development phase
and making adjustments as necessary.

MERITS (or) FUNCTIONS of Strategic Alliances

1. Increased resources: Strategic alliances enable businesses to gain access to

supplementary resources in the form of knowledge, products, or other assets without
changing their core functions. Every business has its own expertise and most prefer to stick to
their core competencies. Being able to share the best of what each one has to offer and turn
them into something greater than the sum of its parts can take business relationships to
exponentially greater heights.

2. New-market penetration: Strategic alliances give access to new markets with a solution
that wouldn’t have been possible for either company on their own. For instance, companies
going global often work with a trusted local partner to get an advantage in an emerging
market.

3. Expanded production: Strategic alliances allow partners to increase their capabilities and
scale quickly to meet demand when it comes to manufacturing and distributing products.

4. Drive innovation: Strategic alliances can drive innovation by combining the best of both
companies to create something greater than the sum of its parts.

5. Risk management: Strategic alliances can help manage risks by identifying potential
issues early on and developing strategies to mitigate them. This is particularly important
when strategic alliances involve sharing sensitive information or relying on partners for
critical services or products.

DEMERITS of Strategic Alliances:

1. Communication challenges: Strategic alliances can experience communication challenges

due to differences in culture, language, and management styles.

2. Unequal benefits: Strategic alliances can result in unequal benefits for each partner, which
can lead to conflicts and dissatisfaction.

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3. Risk a company's reputation: Strategic alliances can risk a company's reputation if the
partner engages in unethical or illegal behavior.

4. Loss of autonomy: Strategic alliances can result in a loss of autonomy for each partner, as
they must work together to achieve a common goal.

5. Potential for conflicts: Strategic alliances can result in conflicts between partners due to
differences in goals, values, and expectations.

DIVESTITURE

Divestiture is a term used in finance and economics to describe the reduction of some
kind of asset for financial, ethical, or political objectives or sale of an existing business by a
firm.

According to Investopedia, divestment is the process of selling subsidiary assets,

investments, or divisions of a company in order to maximize the value of the parent
company. Divestiture, on the other hand, is the disposal of a business unit through sale,
exchange, closure, or bankruptcy. However, both terms are used to describe the process of
selling off assets or business units to streamline operations, cut costs, and focus on core
competencies.

TYPES

1. Sell-offs/Liquidation:

Sell-offs or liquidation is the most common type of divestiture. It involves selling off
assets or business units to generate cash proceeds.

2. Carve-outs:

Carve-outs involve the sale of a portion of a business unit or subsidiary to a third

party. This type of divestiture allows the parent company to retain a controlling interest in the
business unit or subsidiary.

3. Spin-offs:

Spin-offs involve the creation of a new, independent company from a business unit or
subsidiary. The parent company distributes shares of the new company to its shareholders.

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4. Split-ups:

Split-ups involve the division of a business unit or subsidiary into two or more
independent companies. This type of divestiture allows the parent company to focus on its
core business.

5. Equity carve-outs:

Equity carve-outs involve the sale of a portion of a business unit or subsidiary to the
public through an initial public offering (IPO). The parent company retains a controlling
interest in the business unit or subsidiary.

6. Demergers:

Demergers involve the separation of a business unit or subsidiary from the parent
company through a distribution of shares to the parent company's shareholders. The business
unit or subsidiary becomes an independent company.

7. Asset swaps:

Asset swaps involve the exchange of assets between two companies. This type of
divestiture allows each company to focus on its core business.

8. Management buyouts:

Management buyouts involve the sale of a business unit or subsidiary to its

management team. This type of divestiture allows the management team to take control of the
business unit or subsidiary.

9. Joint ventures:

Joint ventures involve the creation of a new, independent company by two or more
companies. This type of divestiture allows each company to share the risks and rewards of the
new company.

10. Liquidation:

Liquidation involves the sale of all assets of a business unit or subsidiary. This type of
divestiture is typically used when the business unit or subsidiary is no longer profitable.

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STEPS

1. Determine your goals: The first step in making any major business decision is to
determine the goal of the activity. What is the objective of the divestiture? What do you want
or need to get out of the deal? The goal will inform the rest of the divestiture process.

2. Choose the type of divestment: The goal determined in step 1 will enable you to choose
the most suitable type of demerger: sell-off, spin-off, split-up, or carve-out.

3. Include HR: HR has a critical role to play in a successful divestiture. From managing the
identification and movement of employees essential to the asset being divested, to liaising
between teams and facilitating the change, HR needs to be involved throughout the corporate
divestiture process.

4. Prepare documentation: Divestitures involve a lot of documentation—from employee-

related documents to questionnaires, surveys, contracts, and financial reports. The more
thorough and proactive you can be, the smoother the process will be.

5. Identify a buyer: Once a business unit has been flagged for possible divesting, a buyer
needs to be identified for the deal to proceed. The identification process is crucial because
extracting value from the divestiture requires receiving a price that must at least equal the
opportunity cost of not selling the business unit.

6. Perform the divestiture: The divestiture itself will encompass various aspects of the
business such as legal ownership, valuation and change of management, as well as retention
and severance of employees.

7. Manage the transition: Managing the transition is a critical step in the divestiture process.
This includes bringing in the people, processes, and tools required to execute the divestiture
process, which involves things such as managing the legal ownership transfer, transitioning
employees, and ensuring that the business unit continues to operate smoothly.

8. Buyer engagement: Once a buyer has been identified, it is important to engage with them
to ensure that the divestiture process proceeds smoothly. This includes negotiating the terms
of the deal, ensuring that the buyer has the necessary financing in place, and managing any
issues that arise during the due diligence process.

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FUNCTIONS

1. Focus on core business: Divestiture allows companies to cut costs, repay their debts,
focus on their core businesses, and enhance shareholder value. As companies grow, they may
become involved in too many business lines, so divestiture is the way to stay focused and
remain profitable.

2. Generate cash flow: Divestitures allow companies to generate cash flow, eliminate a
business segment that doesn't fit their main objective, lower debt, and increase shareholder
value.

3. Improve financial performance: Sometimes, companies face financial difficulties;

therefore, instead of closing down or declaring bankruptcy, selling a business unit will
provide a solution. By divesting some of its assets, a company may be able to cut its costs,
repay its outstanding debt, reinvest, focus on its core business(es), and streamline its
operations. This, in turn, can enhance shareholder value.

4. Compliance with regulations: To acquire some assets, anti-monopoly regulators may

stipulate that the companies should divest others.

5. Underperformance: The business unit or division may have been underperforming

(perhaps as a result of being non-core), thereby making a divestiture attractive.

MERITS of Divestiture

1. Streamlined operations: Divestiture allows companies to focus on their core businesses

and streamline their operations.

2. Greater cash on hand: Divestiture can generate cash proceeds that can be used to fund
reinvestments or to reposition the company strategically.

3. Cost-cutting: Divestiture is a form of cost-cutting and operational restructuring that can

unlock "hidden" value creation that was hindered by being mismanaged by the parent
company.

4. Building a stronger company: Divestiture can be a means to building a company that can
grow and prosper over the long haul.

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5. Creating new businesses: Divestiture can free up funds, management time, and support
function capacity that can be reinvested in creating shareholder value by creating new
businesses.

DEMERITS of Divestiture

1. Loss of assets: Divestiture involves the reduction or sale of assets, which can result in a
loss of resources for the company.

2. Reduced market share: Divestiture can result in a reduced market share for the company,
which can impact its competitiveness.

3. Negative impact on employees: Divestiture can have a negative impact on employees,

who may lose their jobs or be transferred to a new company.

4. Reduced economies of scale: Divestiture can result in reduced economies of scale, which
can impact the company's profitability.

5. Reduced diversification: Divestiture can result in reduced diversification, which can

increase the company's risk exposure.

OWNERSHIP RESTRUCTURING

Ownership restructuring is a type of corporate restructuring that involves significant

changes to the ownership structure of a company. This can include changes to the legal
ownership structure, such as the transfer of ownership from one party to another, or changes
to the operational ownership structure, such as the restructuring of a company's hierarchy.
Ownership restructuring can be undertaken for a variety of reasons, such as preparing
for a sale, buyout, merger, change in overall goals, or transfer of ownership. The process of
ownership restructuring can involve the consolidation of debt, the negotiation of lower
interest payments, the sale of equity in exchange for debt reduction, or the forfeiture of all or
part of the ownership share by pre-restructuring stockholders. The goal of ownership
restructuring is to limit financial harm and improve the business, leaving the company with
smoother, more economically sound business operations.

Ownership restructuring refers to the process of making changes to the ownership and
organizational structure of a company or business. This can involve buying or selling shares,
merging with or acquiring other companies, or changing the ownership percentages among

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existing shareholders. It's often done to improve the company's financial health, strategic
direction, or to adapt to changing market conditions.

FACTORS INFLUENCING OWNERSHIP RESTRUCTURING

1. Financial Performance: Poor financial performance may lead a company to consider

restructuring to improve profitability or address financial distress.

2. Market Conditions: Changes in the market, such as increased competition or shifts in

consumer preferences, can drive companies to restructure to remain competitive.

3. Mergers and Acquisitions: Companies may restructure to acquire other businesses, merge
with competitors, or divest non-core assets.

4. Ownership Changes: A desire to change the ownership structure, such as bringing in new
investors or buying out existing shareholders, can prompt restructuring.

5. Regulatory and Legal Factors: Changes in regulations, tax laws, or legal requirements
may necessitate restructuring for compliance or tax optimization.

6. Debt Management: High levels of debt may lead to debt restructuring, like debt-for-
equity swaps, to reduce financial leverage.

7. Strategic Goals: Companies may restructure to align with new strategic objectives, such
as focusing on specific product lines or entering new markets.

8. Operational Efficiency: Improving operational efficiency, reducing costs, and

streamlining processes can be a motivation for restructuring.

9. Ownership Disputes: Conflicts among shareholders or a desire to resolve ownership

disputes can lead to restructuring.

10. Global Economic Conditions: Economic downturns or recessions may prompt

companies to restructure in response to changing economic conditions.

11. Technology Advances: Embracing new technologies or adapting to digital

transformation can trigger restructuring efforts.

12. Industry Trends: Adapting to evolving industry trends and disruptions, like e-
commerce, sustainability, or electric vehicles, may necessitate restructuring.

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13. Environmental and Social Factors: Increasingly, companies are restructuring to address
environmental sustainability and social responsibility concerns.

FUNCTIONS

Corporate restructuring refers to the process of reconfiguring a company’s hierarchy,

internal structure, or operations procedures. Companies undergo restructuring to achieve
certain aims, such as to become more competitive or to respond to changes in the market.
Ownership restructuring is a type of corporate restructuring that involves changing the
ownership structure of a company.

1. Change in ownership: Ownership restructuring can involve a change in ownership, such

as a sale of the company or a transfer of ownership to a relative.

2. Improved efficiency: Ownership restructuring can lead to improved efficiency by

changing the way the company is managed or by bringing in new owners with fresh ideas.

3. Increased market share: Ownership restructuring can result in mergers or acquisitions

that increase the company's market share.

4. Divestiture: Ownership restructuring can involve divestiture, which is the process of

transferring ownership of a company's non-core assets to another party.

5. Improved profitability: Ownership restructuring can lead to improved profitability by

reducing costs or increasing revenue.

6. Responding to changes in the market: Ownership restructuring can help a company

respond to changes in the market by changing its ownership structure to better align with
market conditions.

Ownership restructuring can help a company become more competitive, efficient, and
profitable by changing its ownership structure to better align with its goals and the market.

STEPS

The steps involved in ownership restructuring can vary depending on the type of
business and the specific needs of the owner.

1. Determine the method of transfer: There are several methods of transferring business
ownership, including selling the business, reapportioning ownership among multiple owners,

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leasing the business, or transferring ownership via gifts or bequests. The method chosen
depends on the business owner's needs and plans, the market, and the structure of the
business.

2. Consult with lawyers and accountants: Ownership transfers have legal and financial
ramifications that vary by the type of transaction and the type of business structure. In
general, owners need to consult lawyers and accountants to ensure that all appropriate steps
are taken and correctly executed.

3. Negotiate the terms of the transfer: Negotiate the terms of the transfer with the buyer or
new owner. This includes the purchase price, payment terms, and any other conditions of the
sale.

4. Sign the Asset Purchase Agreement: Both parties sign the Asset Purchase Agreement,
which includes all of the deal terms that the buyer and seller agree to.

5. Transfer funds to the escrow agent: The buyer transfers funds to the escrow agent, who
holds the funds until the transaction is complete.

6. Transfer business assets to the buyer: The seller transfers business assets to the buyer,
including physical assets, intellectual property, and customer lists.

7. Release funds to the seller: Once the transfer is complete, the escrow agent releases the
funds to the seller.

8. Provide training to the buyer: The seller provides training to the buyer to ensure a
smooth transition of ownership.

9. Record the ownership change: Record the ownership change and draft or update the
necessary documents, such as the articles of organization or operating agreement.

10. Amend the company's guidelines: Follow the company's guidelines about selling or
buying shares. Ensure all required approvals are obtained.

11. Dissolve the company: Dissolve the company after the sale is complete. This will allow
the new owner to recreate it with your sold assets.

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MERITS of Ownership Restructuring

1. Synergy and Efficiency: Mergers and acquisitions can lead to synergies, where the
combined entity is more efficient and profitable than the individual companies.

2. Diversification: Restructuring can help a company diversify its product or market

portfolio, reducing risk and potentially increasing stability.

3. Access to Resources: Acquiring or merging with another company can provide access to
additional resources, such as technology, intellectual property, or distribution channels.

4. Market Expansion: Ownership restructuring can enable companies to expand into new
geographic regions, tapping into new customer bases.

5. Enhanced Competitive Position: By combining strengths, companies can better compete

in their industry, gain a competitive edge, and increase market share.

DEMERITS of Ownership Restructuring

1. Integration Challenges: The process of merging or acquiring another company can be

complex and lead to cultural clashes and integration difficulties.

2. Costs: Ownership restructuring often comes with significant transaction costs, including
legal, financial, and operational expenses.

3. Reduced Employee Morale: Uncertainty and changes in management can negatively

impact employee morale and productivity.

4. Regulatory Hurdles: Ownership restructuring may face regulatory scrutiny, requiring

approval from government agencies, which can delay the process or lead to rejection.

5. Strategic Misalignment: Sometimes, restructuring decisions do not align with the

company's core competencies and can lead to strategic missteps, resulting in financial losses.

LEVERAGED BUYOUTS

A leveraged buyout (LBO) is when a company or group of investors acquires another

company using a significant amount of borrowed money, often with the assets of the acquired
company serving as collateral for the loans. The goal is to use the target company's cash
flows and assets to repay the debt, potentially resulting in a profitable takeover.

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 A leveraged buyout (LBO) is a type of acquisition in which one company purchases
another using a significant amount of borrowed money, or leverage, to finance the
transaction. The assets of the company being acquired are often used as collateral for the
loans, along with the assets of the acquiring company.

Here are some key takeaways about LBOs:

• LBOs are often used to take a company private or to spin off part of an existing
business.
• The ratio of debt to equity in an LBO is generally around 90% to 10%, which
generally translates to lower credit ratings for the bonds.
• The company being acquired in an LBO must have sufficiently stable cash flows to
pay its interest expense and repay debt principal over time.
• LBOs can be management-led, with the incumbent management team acquiring a
sizeable portion of the shares of the company, or they can be external, with a private
equity firm making the acquisition.
• Private equity firms typically borrow up to 70% to 80% of the purchase price of a
company when enacting an LBO, with the remainder funded through their own
equity.

LBOs have garnered a reputation for being an especially ruthless and predatory tactic, as the
target company doesn't usually sanction the acquisition. However, some LBOs can be part of
a long-term plan to save a company through leveraged acquisitions.

FACTORS INFLUENCING LEVERAGED BUYOUTS (LBO)

1. Target Company Attractiveness: The financial health, growth prospects, and market
position of the target company are critical factors. LBOs are more attractive for companies
with stable cash flows and growth potential.

2. Financing Availability: Access to debt financing at reasonable terms is essential for

LBOs. The availability of willing lenders impacts the feasibility of the transaction.

3. Interest Rates: The prevailing interest rates can significantly affect LBOs, as higher rates
can increase borrowing costs and make the deal less attractive.

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4. Equity Investment: The amount of equity that the buyer and investors are willing to put
into the LBO affects the leverage ratio and risk associated with the transaction.

5. Due Diligence: Thorough due diligence is vital to assess the target company's financials,
potential risks, and synergies to determine if the LBO is viable.

6. Industry and Economic Conditions: The overall economic climate and industry-specific
conditions can impact the success of an LBO.

7. Regulatory Environment: Government regulations, antitrust considerations, and tax

implications can influence the feasibility and structure of LBOs.

8. Management Team: The skills and experience of the management team leading the LBO
are crucial for successfully executing and managing the acquired company.

9. Exit Strategy: Buyers need a clear exit strategy, such as selling the company or taking it
public, to realize their investment returns.

10. Investor Appetite: The willingness of investors, such as private equity firms or
individuals, to participate in LBOs is influenced by their risk tolerance and investment
strategies.

TYPES

1. Repackaging Plan:

This involves buying a public company through leveraged loans, making it private,
repackaging it, then selling its shares through an initial public offering (IPO).

2. Split-up Plan:

In this scenario, the buyer acquires a company and then sells off its assets or divisions
to generate cash.

3. Portfolio Plan:

This involves acquiring multiple companies in the same industry and combining them
to create a larger, more efficient entity.

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4. Savior Plan:

This type of LBO is used to save a struggling company by acquiring it through

leveraged loans and then restructuring it to make it profitable.

5. Management Buyout (MBO):

This is a type of LBO where the current management team of a company acquires it
using borrowed funds.

Leveraged buyouts can be risky, but they can also be profitable if planned and executed
correctly. The buyer must carefully assess affordability and potential before making a
leverage-based acquisition.

STEPS

1. Finding the Business to be Acquired: This involves evaluating your own financials and
potential risks that your balance sheet can withstand. A good acquisition is one that has the
capital and equity to grow from the additional assets that are purchased. There are many
different types of capital that can be used to complete a leveraged buyout such as senior cash
flow debt, integrated debt, seller financing, asset-based financing, or unitranche debt.

2. Structuring the Deal: This involves determining the amount of debt and equity financing
required to complete the transaction. The amount of debt used in LBOs varies, but usually
constitutes 70-80% of the total consideration paid. The remainder is paid with the buyer’s
equity.

3. Receiving the Capital – Due Diligence: For a lender to provide the capital to the leverage
buyout, the company must provide sufficient financial information that documents the
financial strength of the company. This may include balance sheets, profit and loss
statements, and cash flow statements.

4. Executing the Transaction: This involves finalizing the terms of the deal and closing the
transaction. After the transaction closes, the private equity firm and management have to add
value to the business by growing the top line, reducing costs, paying down debt, and finally
realizing their return.

5. Exit Strategy: This involves selling the company or taking it public to realize the return
on investment.

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 The process of an LBO involves finding a suitable business to acquire, structuring the
deal, receiving the capital, executing the transaction, and planning an exit strategy.

FUNCTIONS

1. Acquisition of a Company: LBOs allow companies to acquire other companies using

borrowed funds, which can be used to finance the acquisition.

2. Financial Leverage: LBOs use financial leverage to increase the potential return on
investment. By using borrowed funds, the buyer can control a larger business with a smaller
investment.

3. Debt Financing: LBOs rely heavily on debt financing, which can be used to finance the
acquisition of the target company. The debt is usually secured by the assets of the target
company.

4. Equity Financing: LBOs also involve equity financing, which is used to finance the
remaining portion of the acquisition price. The equity is usually provided by the buyer or
private equity firm.

5. Exit Strategy: LBOs provide an exit strategy for business owners. The buyer can either
sell the company or take it public to realize a return on investment.

MERITS

1. Larger Business Acquisition: LBOs allow entrepreneurs to use financial leverage (e.g.,
debt) to acquire a larger business than they could with their own equity.

2. Higher Rate of Return: Investors like LBOs because they amplify their rate of return. A
smaller investment allows investors to control a larger business, and their potential rate of
return also increases.

3. Minimizes Equity Contribution: LBOs minimize the size of the buyer's equity
contribution, allowing them to spend less of their own money and get a higher return.

4. Tax Advantages: LBOs can provide tax advantages for the buyer and the target. The
interest payments on the debt are tax-deductible.

5. Profitable Exit Strategy: LBOs can provide a profitable exit strategy for business owners.
If the company is underperforming, the investor company would take on the debt in the hope

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that by keeping the business for a predetermined period of time, its value would rise, enabling
them to pay off the debt and turn a profit.

DEMERITS

1. High Debt: LBOs saddle the acquired company with a lot of debt, which can strain its
profitability and cash flow. Companies acquired with LBO financing are more likely to go
bankrupt than others.

2. Limited Flexibility: The high debt also limits the target's flexibility and ability to invest in
new opportunities or respond to challenges.

3. Minimal Financial Cushion: LBOs provide minimal financial cushion to manage

problems. If the business is unable to make the required payments, the lender may foreclose
on the property or impose other penalties.

4. Reduced Staff Morale: Sometimes the employees of the acquired company are not
aligned with the vision of the new leadership.

5. Default Risk: There is a significant risk of defaulting on the loan. If the business is unable
to make the required payments, the lender may foreclose on the property or impose other
penalties.

SELL OFFS

A "sell-off" refers to a situation in the financial markets where there is a sudden and
significant selling of assets, such as stocks, bonds, or other investments. This can lead to a
sharp decline in the prices of these assets. It's often driven by various factors like economic
concerns, investor sentiment, or specific news events. In simple terms, it's when a lot of
people start selling their investments, causing prices to drop.

A sell-off is a period of time when selling activity prevails over buying, causing the
price of an asset or security to fall sharply. It occurs when a large volume of securities are
sold in a short period of time, causing the price of a security to fall in rapid succession. Sell-
offs can be triggered by any number of events, such as negative news, missed estimates, or
unexpected events. They tend to pick up momentum as investor psychology begins to shift
toward fear or panic. Sell-offs are a reflection of investor psychology and can present an
opportunity for contrarian investors to buy at low prices.

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 During a sell-off, there tend to be many sellers of a specific stock, and only a handful
of buyers are interested in buying the stock, causing a sharp decline in the stock price. Sell-
offs follow the principle of supply and demand, where there is an excess supply of shares
without an equivalent number of interested buyers.

Sell-offs can happen to the entire market or to a particular asset, like a stock or a
commodity. They can be identified by analyzing various indicators, such as technical
indicators, unexpected events, or market rumors. Although sell-offs may be dramatic, they
are often short-lived and may be an overreaction. Afterwards, they can stabilize or reverse
relatively quickly.

In the event of a sell-off, investors could consider purchasing the oversold stock,
because a sell-off usually drives prices lower due to supply-demand dynamics. However, it is
important to have a plan and avoid making emotional investment decisions.

FACTORS INFLUENCING SELL OFFS

1. Economic Data: Poor economic indicators, such as rising unemployment, declining GDP,
or high inflation, can trigger sell-offs as they raise concerns about the overall health of the
economy.

2. Market Sentiment: Investor sentiment and emotions play a significant role. Fear,
uncertainty, and panic can lead to mass selling, causing a sell-off.

3. Geopolitical Events: Events like wars, conflicts, or political instability can create
uncertainty and prompt investors to sell assets.

4. Corporate Earnings: Negative earnings reports or warnings from major companies can
trigger sell-offs in their stocks and sometimes have a broader impact on the market.

5. Interest Rates: When central banks raise interest rates, it can make borrowing more
expensive and decrease consumer spending, which can impact stocks and lead to sell-offs.

6. Market Valuations: Overvaluation or excessive speculation in certain sectors or assets

can lead to corrections or sell-offs when market participants believe prices are not justified by
fundamentals.

7. Liquidity Concerns: A lack of liquidity in the market can make it difficult to sell assets,
causing investors to panic and sell at lower prices.

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8. Natural Disasters: Major natural disasters can disrupt economic activity and lead to sell-
offs, particularly in sectors directly affected, like insurance or infrastructure.

9. Regulatory Changes: New regulations or changes in government policy can have a

significant impact on specific industries, leading to sell-offs.

10. Global Events: Events like pandemics, as seen with COVID-19, can have a profound
impact on the markets, causing widespread sell-offs.

11. Black Swan Events: Unpredictable and rare events, such as the financial crisis of 2008,
can lead to massive sell-offs as they catch investors off guard.

12. Technological Factors: Hacks, cybersecurity breaches, or technical glitches in trading

systems can trigger sudden sell-offs.

TYPES

Sell-offs refers to the rapid selling of securities, such as stocks and bonds, which leads
to a decline in their price. They can be triggered by any number of events and will tend to
pick up momentum as investor psychology begins to shift toward fear or panic. There are
different types of sell-offs, and recognizing why a sell-off is happening is the key to
understanding whether it's safe to buy.

Here are some types of sell-offs:

1. Garden-variety pullbacks: These are normal market corrections that occur when stocks
decline by 5% to 10% from their recent highs.

2. Wholesale breakdowns: These are severe sell-offs that can occur during a financial crisis
or recession.

3. Overseas sell-offs: These can be scary for investors, but unless the foreign woes
fundamentally impact U.S. companies in some way, they are usually overblown.

4. Sell-offs related to initial public offerings: When too many companies go public and
then sell their shares via secondary offerings, it creates too much supply in the stock market,
leading to a sell-off.

5. Sell-offs related to political risk: These tend to be especially fear-inducing, but they're
often overblown.

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Different order types can result in vastly different outcomes, so it's important to understand
the distinctions among them.

Here are some types of orders that can be used during a sell-off:

1. Market orders: This is an order to buy or sell a security at the prevailing market price.
Market orders can leave a buyer or seller exposed to changes in the current price available in
the market.

2. Limit orders: This is an order to buy or sell a security at or better than a specified price. A
buy limit order can be executed only at or below the limit price, while a sell limit order can
be executed only at or above the limit price.

3. Stop orders: This type of order can help limit losses if a stock falls more than you'd like.
A sell stop order is entered at a stop price below the current market price, while a buy stop
order is entered at a stop price above the current market price. When triggered, the order
becomes a market order, with shares sold at the current market price[6]. Investors use stop
orders as a tool to manage market risk.

FUNCTIONS

1. Opportunity to buy: Sell-offs can create buying opportunities for investors who are
looking to purchase stocks at a lower price. Recognizing why a sell-off is happening is the
key to understanding whether it's safe to buy. For instance, if the sell-off is due to a
temporary event, such as a company's disappointing earnings report, it may be a good time to
buy the stock if you believe the company will recover.

2. Opportunity to sell: Sell-offs can also be an opportunity for investors to sell stocks that
they believe are overvalued or have reached their peak. If you have a stock that has been
performing well and you think it has reached its peak, a sell-off may be a good time to sell
and take profits.

3. Market correction: Sell-offs can be a natural part of the market cycle and can help to
correct overvalued stocks. A garden-variety pullback, for example, is a normal market
correction that occurs when stocks decline by 5% to 10% from their recent highs.

4. Risk management: Stop orders can be used during a sell-off as a tool to manage market
risk. A sell stop order is entered at a stop price below the current market price, while a buy

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stop order is entered at a stop price above the current market price. When triggered, the order
becomes a market order, with shares sold at the current market price. Investors use stop
orders as a tool to limit losses if a stock falls more than they'd like.

5. Indicator of market sentiment: Sell-offs can be an indicator of market sentiment and can
provide insight into investor psychology. If a sell-off occurs after a new earnings report, for
example, it may indicate that investors were overly optimistic about the security when they
bought it beforehand. Understanding market sentiment can help investors make informed
decisions about buying and selling stocks.

MERITS of Sell Offs

1. Opportunity to buy: Sell-offs can create buying opportunities for investors who are
looking to purchase stocks at a lower price.

2. Risk management: Stop orders can be used during a sell-off as a tool to manage market
risk.

3. Market correction: Sell-offs can be a natural part of the market cycle and can help to
correct overvalued stocks.

4. Indicator of market sentiment: Sell-offs can be an indicator of market sentiment and can
provide insight into investor psychology.

5. No new debt: A major advantage of selling partial ownership is that you don't have to take
on new debt.

DEMERITS of Sell Offs

1. Loss of ownership and control: A major disadvantage of selling shares of stock to raise
funds is that you also give up some level of ownership and control.

2. Unknown liabilities: When buying a corporation, the buyer inherits the seller's
depreciable base, which can result in unknown liabilities.

3. Additional time to close: Asset sales must comply with California Uniform Commercial
Code-Bulk Sales, which can cause additional time to close and requires mandatory public
notification of sale.

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4. Sales tax: Asset sales require the buyer to pay sales tax on furniture, fixtures, and
equipment.

5. Potentially unlimited losses: Short selling can result in potentially unlimited losses if the
stock price rises instead of falls.

LEVERAGED RESTRUCTURING

A leveraged recapitalization is when a company increases its debt significantly to pay

a special dividend or buy back its own shares. This can be a financial strategy used to return
value to shareholders or change the company's capital structure by taking on more debt. It's
essentially using borrowed money to make payments to shareholders or repurchase company
stock.

A leveraged recapitalization is a corporate finance transaction in which a company

changes its capitalization structure by replacing the majority of its equity with a package of
debt securities consisting of both senior bank debt and subordinated debt. This means that the
company will borrow money in order to buy back shares that were previously issued, and
reduce the amount of equity in its capital structure. Leveraged recapitalizations are executed
via issuing bonds to raise money and using the proceeds to buy the company's stock or to pay
dividends. Such a maneuver is called a leveraged buyout when initiated by an outside party,
or a leveraged recapitalization when initiated by the company itself for internal reasons.

Leveraged recapitalizations are used by privately held companies as a means of

refinancing, generally to provide cash to the shareholders while not requiring a total sale of
the company. Debt (in the form of bonds) has some advantages over equity as a way of
raising money, since it can have tax benefits and can enforce a cash discipline. The reduction
in equity also makes the firm less vulnerable to a hostile takeover. Leveraged
recapitalizations can be used by public companies to increase earnings per share. The Capital
structure substitution theory shows this only works for public companies that have an
earnings yield that is smaller than their after-tax interest rate on corporate bonds, and that
operate in markets that allow share repurchases.

Leveraged recapitalizations are a useful financial strategy often used in conjunction

with management buyouts (MBOs) or other forms of restructuring. Higher leverage is
beneficial to the company in times of strong growth; therefore the objective of a leveraged

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recap is often to bolster future growth prospects. Leveraged recapitalizations provide
incentives for management to be more disciplined and improve operational efficiency, in
order to meet larger interest and principal payments. They are often accompanied by a
restructuring, in which the company sells off assets that are redundant or no longer a strategic
fit in order to reduce debt.

In summary, a leveraged recapitalization is a strategy whereby a company alters its capital

structure by reducing equity and increasing debt. This is done by borrowing money to pay off
debt or equity, and can be used to provide cash to shareholders, increase earnings per share,
or prepare the company for a period of growth. Leveraged recapitalizations can be used by
both private and public companies, and are often used in conjunction with MBOs or other
forms of restructuring.

FACTORS INFLUENCING LEVERAGED RECAPITALIZATIONS

1. Company Financial Health: A company needs to have a solid financial foundation to

consider a leveraged recapitalization. This includes consistent cash flow, profitability, and
manageable existing debt levels.

2. Interest Rates: The prevailing interest rates in the financial market are crucial. Lower
interest rates make it more attractive to borrow funds for a recapitalization.

3. Market Conditions: Favorable stock market conditions can make it an opportune time for
a company to return capital to shareholders or take on more debt.

4. Shareholder Pressure: Shareholders may push for a leveraged recapitalization if they

believe it will enhance the value of their holdings.

5. Tax Implications: The tax consequences of a leveraged recapitalization can be significant.

Companies need to consider the tax implications for themselves and their shareholders.

6. Debt Capacity: A company's ability to take on additional debt and service it is a critical
factor. Lenders and credit rating agencies will assess this.

7. Investor Sentiment: Perception and confidence in the company can affect the success of a
leveraged recapitalization. If investors believe it will create value, it can be more attractive.

8. Regulatory Environment: Regulatory changes can impact the feasibility of leveraged

recapitalizations. Companies must consider compliance with laws and regulations.

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9. Industry Trends: The state of the industry in which the company operates can influence
the decision. Economic conditions, competition, and market trends should be considered.

10. Management's Strategy: The company's leadership team plays a key role in determining
if a leveraged recapitalization aligns with its overall strategic goals.

11. Credit Market Conditions: The availability of credit and the willingness of lenders to
provide financing can impact the feasibility of a recapitalization.

12. Existing Debt Structure: The terms and conditions of the company's existing debt, such
as covenants and maturity dates, can affect its ability to take on additional debt.

13. Cost of Capital: The cost of equity and debt for the company can influence the decision.
A lower cost of capital can make a leveraged recapitalization more attractive.

TYPES

1. Internal leveraged recapitalization:

This is initiated by the company itself for internal reasons.

2. External leveraged recapitalization:

This is initiated by an outside party, such as a private equity firm, and is also known
as a leveraged buyout.

3. Minor leveraged recapitalization:

This involves minor adjustments to the capital structure of the company.

4. Major leveraged recapitalization:

This involves large changes involving a change in the power structure as well.

Leveraged recapitalizations can also be used by privately held companies as a means of

refinancing, generally to provide cash to the shareholders while not requiring a total sale of
the company.

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STEPS

1. Agreeing on the value of the business: The first step in a leveraged recapitalization is to
agree on the value of the business. This is important because it determines how much debt
and equity will be used in the transaction.

2. Accessing debt capital: The company will need to access debt capital, which can come
from both senior and mezzanine debt. This debt will be used to buy back shares and reduce
the amount of equity in the company's capital structure.

3. Accessing equity capital: The company may also need to access equity capital, which can
come from third-party financial investors. This equity will be used to provide liquidity to the
selling shareholders.

4. Structuring the transaction: The transaction will need to be structured in a way that is
feasible for the company and its shareholders. This may involve determining the appropriate
level of financial leverage relative to ongoing capital investment needs, as well as considering
the sustainability of the cash flow and/or cyclicity of the business.

5. Executing the transaction: Once the transaction is structured, it can be executed. This
involves using the debt and equity capital to buy back shares and reduce the amount of equity
in the company's capital structure.

6. Managing the new capital structure: After the transaction is complete, the company will
need to manage its new capital structure. This may involve making interest and principal
payments on the debt, as well as ensuring that the company has enough equity to support its
ongoing growth.

FUNCTIONS (or) MERITS

1. Increased earnings per share: Leveraged recapitalizations can increase earnings per
share by reducing the amount of equity in the company's capital structure and increasing debt.

2. Preparation for growth: Leveraged recapitalizations can prepare the company for a
period of growth by leveraging debt, which is more beneficial to a company during growth
periods.

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3. Defense against hostile takeovers: Leveraged recapitalizations can be used to prevent a
hostile takeover by another company by making the company less attractive to potential
acquirers.

4. Liquidity for shareholders: Leveraged recapitalizations can provide liquidity to

shareholders by allowing them to sell their shares back to the company.

5. Refinancing debt: Leveraged recapitalizations can be used by privately held companies as

a means of refinancing, generally to provide cash to the shareholders while not requiring a
total sale of the company.

DEMERITS of Leveraged Recapitalizations

1. Increased financial risk: Leveraged recapitalizations increase the financial risk of the
company by increasing the amount of debt in the capital structure.

2. Reduced credit rating: Leveraged recapitalizations can lead to a reduced credit rating for
the company, which can make it more difficult to access debt capital in the future.

3. Increased interest expense: Leveraged recapitalizations increase the interest expense of

the company, which can reduce profitability.

4. Reduced flexibility: Leveraged recapitalizations can reduce the flexibility of the company
by limiting its ability to make future investments or acquisitions.

5. Potential for bankruptcy: Leveraged recapitalizations increase the financial risk of the
company, which can increase the potential for bankruptcy in the event of an economic
downturn or other adverse event.

DISTRESS RESTRUCTURING

Distress restructuring, in simple terms, refers to the process of reorganizing or

changing the financial and operational aspects of a company that is facing significant
financial difficulties or distress. This is typically done to help the company overcome its
problems and potentially avoid bankruptcy. It may involve negotiations with creditors,
changes in debt terms, asset sales, or other measures to improve the company's financial
health.

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 Distress restructuring is a process that companies may consider when they cannot
meet their financial obligations and are experiencing financial distress. It involves
renegotiating debts and changing repayment terms to improve liquidity, allowing the
company to continue operations. Distress restructuring is often prompted by a specific
catalyst that has caused the company to become distressed, and management may hire a
restructuring bank to provide advisory services to develop a workable solution for all
stakeholders. The goal of distress restructuring is to turn a financial challenge into an
opportunity to revitalize the business, and it can involve complex in-court and out-of-court
acquisitions, restructurings, reorganizations, recapitalizations, workouts, and liquidations.
Distress restructuring can be a reversible process through adopting restructuring
strategies, and it can help companies mitigate the adverse effects of liquidity and other
challenges through contingency planning aimed at avoiding a downward spiral while the
company still has alternatives to bankruptcy. Distressed debt investing is another aspect of
distress restructuring, where investors buy a portion of the debt of a financially distressed
company with the goal of gaining a controlling position and influencing the restructuring
process.

FACTORS INFLUENCING DISTRESS RESTRUCTURING

1. Financial Distress: The level of financial distress a company is experiencing is a primary

driver of distress restructuring. Companies facing insolvency, excessive debt, or declining
profitability are more likely to undergo restructuring.

2. Economic Conditions: The overall economic environment, including factors like

recession, inflation, or changes in interest rates, can influence distress restructuring.
Economic downturns can lead to more distressed companies seeking restructuring.

3. Legal and Regulatory Framework: The legal and regulatory environment in a particular
jurisdiction can significantly impact the restructuring process. Laws related to bankruptcy,
insolvency, and creditor rights play a crucial role.

4. Creditor Involvement: The stance and preferences of creditors, including banks,

bondholders, and other financial institutions, can shape the restructuring negotiations. Their
willingness to provide concessions or take a more adversarial approach can affect the
outcome.

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5. Management Competence: The capability of a company's management team to navigate
and lead the restructuring process is important. Competent leadership can make a difference
in whether the company successfully emerges from distress.

6. Industry Dynamics: The nature of the industry in which the distressed company operates
can influence the restructuring options available. Some industries may have specific
challenges or opportunities in distress situations.

7. Asset Valuation: The valuation of the company's assets and liabilities, including the
potential for asset sales, can impact the restructuring approach. Accurate valuation is crucial
for negotiations.

8. Stakeholder Interests: Various stakeholders, such as employees, suppliers, and

customers, may have different interests in the restructuring process. Balancing these interests
is essential for a successful outcome.

9. Access to Capital Markets: A company's access to capital markets and its ability to raise
funds can influence the restructuring strategy. Limited access may necessitate more
aggressive restructuring measures.

10. Market Conditions: Market conditions, including the availability of financing and
investor sentiment, can affect a company's ability to execute a restructuring plan or attract
potential investors.

11. Government Support: Government policies and support programs, particularly during
economic crises, can impact distress restructuring. Assistance or intervention from
government agencies may be a factor.

12. Creditors' Agreements: The terms and covenants within debt agreements or bond
contracts can dictate the options available to a distressed company. Negotiating changes to
these agreements may be necessary.

TYPES

1. Debt restructuring:

This is a process used by companies, individuals, and even countries to avoid the risk
of defaulting on their existing debts. It involves changing the terms of loans to make them
easier to pay back, such as by negotiating lower interest rates or extending the due dates for

29
paying them back. Debt restructuring can be a win-win for both the borrower and the lender,
as it provides a less expensive alternative to bankruptcy when a debtor is in financial turmoil.

2. Managed wind-down/liquidation:

This strategy involves winding down the company's operations in an orderly manner,
selling off assets, and paying off creditors. It is usually used when the company is no longer
viable and cannot be restructured.

3. General assignment for the benefit of creditors (ABC):

This is a legal process that allows a company to transfer its assets to a third-party
trustee, who then sells the assets and distributes the proceeds to the company's creditors. It is
similar to a managed wind-down/liquidation, but it is a court-supervised process.

4. Bankruptcy:

This is a legal process that allows a company to reorganize its debts and operations
under the supervision of a bankruptcy court. Bankruptcy can be a complex and expensive
process, but it can provide a company with a fresh start and a chance to restructure its
operations.

5. Downsizing:

This strategy involves reducing the number of employees in the company to cut costs.
It is a useful cost-cutting strategy for companies experiencing a degree of financial distress.

STEPS

1. Identify financial distress: The first step is to identify that the company is in financial
distress. This can be done by analyzing the company's financial statements, cash flow, and
profitability.

2. Assess the causes of financial distress: The next step is to assess the causes of financial
distress. This can be done by analyzing the company's capital structure, financial
underperformance, macro and external events, secular shifts and trends disrupting industries,
and company-specific factors.

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3. Evaluate the company's distress: After identifying the financial distress and assessing its
causes, the next step is to evaluate the company's distress. This can be done by analyzing the
company's cash flow, debt structure, value drivers, and other factors.

4. Develop a restructuring plan: Once the company's distress has been evaluated, the next
step is to develop a restructuring plan. This plan should include both financial and operational
restructuring options, depending on the nature and extent of the problem.

5. Implement the restructuring plan: The final step is to implement the restructuring plan.
This may involve negotiating financing with existing or new lenders, working with vendors
to continue the supply of goods and services, renegotiating with creditors directly, initiating
formal insolvency proceedings, or other actions depending on the specific restructuring plan.

FUNCTIONS

Distress restructuring is a process of reorganizing a business to improve its financial

performance, operational efficiency, or strategic direction. It is a type of corporate action
taken to significantly modify the debt, operations, or structure of a company as a way of
limiting financial harm and improving the business.

1. Limiting financial harm: Restructuring is often undertaken when a company is facing a

financial crisis. By modifying the financial or operational aspect of its business, the company
can limit the financial harm it is experiencing.

2. Improving business operations: Following a restructuring, the company should be left

with smoother, more economically sound business operations.

3. Altering procedures: The results of restructuring may include alterations in procedures,

computer systems, networks, locations, and legal issues.

4. Eliminating jobs: Because positions may overlap, jobs may be eliminated, and employees
laid off.

5. Modifying debt: Restructuring debt gives companies the flexibility to negotiate different
types of terms with different creditors. For example, they can offer a key supplier terms that
align with their go-forward plan, while offering a different payout to another vendor they
don't plan to work with again.

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MERITS of Distress Restructuring

1. Performance optimization: Restructuring can optimize the performance of a company by

removing redundancies and bureaucracies, which can lead to smoother operations and
increased efficiency.

2. Financial advancement: Restructuring can help a company advance financially by

modifying its debt, which gives it the flexibility to negotiate different types of terms with
different creditors.

3. Competitive advantage: Restructuring can give a company a competitive advantage by

allowing it to adapt to changes in the market and stay ahead of its competitors.

4. Increased operational efficiency: Restructuring can increase operational efficiency by

introducing new technologies or processes that make it easier to access business records or
streamline operations.

5. Avoidance of costly court fees: Out-of-court restructuring can be a more efficient option
in terms of monetary expenditures, as it avoids costly court fees and regulatory filings.

DEMERITS of Distress Restructuring

1. Re-training: Restructuring requires that staff be trained on the changing processes and/or
new processes/methods, which can be time-consuming and costly.

2. Loss of key skilled workers: Restructuring can result in the loss of key skilled workers,
which could result in a reduction in productivity and expenses in training for new employees.

3. Drop in morale: Downsizing is a time of uncertainty for employees, and restructuring can
lead to a drop in morale, which can negatively impact productivity.

4. Creditor collection efforts: Out-of-court restructuring requires unanimous approval by all

creditors, which can be difficult to achieve and may result in creditor collection efforts.

5. Unclear strategy and plan: Restructuring can stall business growth if there is a weak,
ineffective, or incompetent management team in place, which can lead to an unclear strategy
and plan.

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 UNIT – 3

EVALUATION OF A MERGER AS A CAPITAL BUDGETING DECISION

When a firm plans to acquire any firm then it should consider the acquisition as a
capital budgeting decision. Hence, such a proposal must be evaluated as a capital budgeting
decision.

Framework for evaluating acquisition

It consists of the following steps –

Step 1 – Determine CF (X), the equity related post-tax cash flows of the acquiring firm, X,
without the merger, over the relevant planning horizon period.

Step 2 – Determine PV (X), the present value of CF (X) by applying a suitable discount rate,

Step 3 – Determine CF (X’), the equity-related post cash flows of the combined firm X’
which consists of the acquiring firm X and the acquired firm Y over the planning horizon.
These cash flows must reflect the post merger benefits.

Step 4 – Determine PV (X’), the present value of CF (X’)

Step 5 – Determine the ownership position (OP) of the shareholders of firm X in the
combined firm X’, with the help of the following formula –

OP = Nx/[Nx + ER (Ny)]

Where –

Nx = number of outstanding equity shares of firm X (the acquiring firm) before the merger.

Ny= number of outstanding equity shares of firm Y (the acquired firm) before the merger.

ER = exchange ratio representing the number of shares of firm X exchanged for every share
of firm Y.

Step 6 – Calculate NPV of the merger proposal from the point of view of X as follows –

NPV (X) = OP [PV (X’)] – PV (X)

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Where –

NPV (X) = NPV of the merger proposal from the point of view of shareholders of X

OP = ownership position of the shareholder of firm X

PV (X’) = PV of the cash flows of the combined firm X’.

PV (X) = PV of the cash flows of firm X, before the merger.

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