Unit-5

Corporate Restructuring
Corporate restructuring becomes a buzzword during economic downturns. A company going
through tough financial scenario needs to understand the process of corporate restructuring
thoroughly. Although restructuring is a generic word for any changes in the company, this word is
generally associated with financial troubles.
Definition of Corporate Restructuring
Corporate restructuring is a corporate action taken to significantly modify the structure or the
operations of the company. This usually happens when a company is facing significant problems
and is in financial jeopardy. Often, the restructuring is referred to the ways to reduce the size of
the company and make it small. Corporate restructuring is essential to eliminate all the financial
troubles and improve the performance of the company.
The troubled company’s management hires legal and financial experts to assist and advise in the
negotiations and the transaction deals. The company can go as far as appointing a new CEO
specifically for making the controversial and difficult decisions to save or restructure the company.
Generally, the company may look at debt financing, operations reduction and sale of the
company’s portions to interested investors.
Reasons for Corporate Restructuring
Corporate restructuring is implemented under the following scenarios:
Change in the Strategy
The management of the troubled company attempts to improve the company’s performance by
eliminating certain subsidiaries or divisions which do not align with the core focus of the company.
The division may not seem to fit strategically with the long-term vision of the company. Thus, the
company decides to focus on its core strategy and sell such assets to the buyers that can use them
more effectively.
Lack of Profits
The division may not be profitable enough to cover the firm’s cost of capital and cause economic
losses to the firm. The poor performance of the division may be the result of the management
making a wrong decision to start the division or the decline in the profitability of the division due
to the increasing costs or changing customer needs.
Reverse Synergy
This concept is in contrast to the M&A principles of synergy, where a combined unit is worth more
than the individual parts together. According to reverse synergy, the individual parts may be worth
more than the combined unit. This is a common reasoning for divesting the assets. The company
may decide that more value can be unlocked from a division by divesting it off to a third party
rather than owning it.
Cash Flow Requirement
A sale of the division can help in creating a considerable cash inflow for the company. If the
company is facing some difficulty in obtaining finance, selling an asset is a quick approach to
raising money and reduce debt.
Types of Corporate Restructuring
Corporate Restructuring means any change in the business capacity or portfolio that is carried out
by inorganic route or any change in the capital structure of a company that is not in the ordinary
course of its business or any change in the ownership of a company or control over its management
or a combination of any two or all of the above.
Types of Corporate Restructuring
1. Mergers / Amalgamation
2. Acquisition and Takeover
3. Divestiture
4. Demerger (spin off / split up / split off)
5. Reduction of Capital
6. Joint Ventures
7. Buy back of Securities

1. Merger / Amalgamation: A merger is a combination of two or more businesses into one

business. Laws in India use the term ‘amalgamation’ for merger. Amalgamation is the
merger of one or more companies with another or the merger of two or more companies to
form a new company, in such a way that all assets and liabilities of the amalgamating
companies become assets and liabilities of the amalgamated company.

Merger through Absorption: - An absorption is a combination of two or more companies

into an ‘existing company’. All companies except one lose their identity in such a merger.
For example, absorption of Tata Fertilizers Ltd (TFL) by Tata Chemicals Ltd. (TCL).

Merger through Consolidation: - A consolidation is a combination of two or more

companies into a ‘new company’. In this form of merger, all companies are legally
dissolved and a new entity is created. Here, the acquired company transfers its assets,
liabilities and shares to the acquiring company for cash or exchange of shares. For example,
merger of Hindustan Computers Ltd, Hindustan Instruments Ltd, Indian Software
Company Ltd and Indian Reprographics Ltd into an entirely new company called HCL Ltd.
2. Acquisitions and Takeovers: An acquisition may be defined as an act of acquiring
effective control by one company over assets or management of another company without
any combination of companies. Thus, in an acquisition two or more companies may remain
independent, separate legal entities, but there may be a change in control of the companies.
When an acquisition is ‘forced’ or ‘unwilling’, it is called a takeover.

3. Divestiture: Divestiture means an out sale of all or substantially all the assets of the
company or any of its business undertakings / divisions, usually for cash (or for a
combination of cash and debt) and not against equity shares. In short, divestiture means
sale of assets, but not in a piecemeal manner. Divestiture is normally used to mobilize
resources for core business or businesses of the company by realizing value of non-core
business assets.

4. Demerger (spin off / split up / split off): Demerger is a form of corporate restructuring in
which an entity’s business operations are segregated into one or more components.

Demerger can take three forms:

 Spin-off
 Split-up
 Split-off

Definition: Demerger is the business strategy wherein company transfers one or more of
its business undertakings to another company. In other words, when a company splits off
its existing business activities into several components, with the intent to form a new
company that operates on its own or sell or dissolve the unit so separated, is called a
demerger.
A demerged company is said to be one whose undertakings are transferred to the other
company, and the company to which the undertakings are transferred is called the resulting
company. The demerger can take place in any of the following forms:

Demerger

Spin-off: It is the divestiture strategy wherein the company’s division or undertaking is

separated as an independent company. Once the undertakings are spun-off, both the parent
company and the resulting company act as a separate corporate entity.
Generally, the spin-off strategy is adopted when the company wants to dispose of the non-
core assets or feels that the potential of the business unit can be well explored when
operating under the independent management structure and possibly attracting more
outside investments.
Wipro’s information technology division is the best example of spin-off, which got
separated from its parent company long back in 1980’s.
 Split-up: A business strategy wherein a company splits-up into one or more independent
companies, such that the parent company ceases to exist. Once the company is split into
separate entities, the shares of the parent company is exchanged for the shares in the new
company and are distributed in the same proportion as held in the original company,
depending on the situation.

The company may go for a split-up if the government mandates it, in order to curtail the
monopoly practices. Also, if the company has several business lines and the management
is not able to control all at the same time, may separate it to focus on the core business
activity
5. Reduction of Capital: Reduction of Capital is a process by which a company is allowed
to extinguish or reduce liability on any of its shares in respect of share capital not paid up,
or is allowed to cancel any paid-up share capital which is post or is allowed to pay-off any
paid –up capital which is in excess of its requirements.

6. Joint Venture: Joint Venture is an arrangement in which two or more companies (called
joint venture partners) contribute to the equity capital of a new company (called joint
venture) in pre-decided proportion. For e.g. Maruti Suzuki.

7. Buy back of Securities: When a company is holding excess cash, which it does not require
in the medium term (say three to five years); it is prudent for the company to return this
excess cash to its shareholders. Buy-back of securities is one of the methods used to return
the excess cash to its shareholders.

What Is Project Finance?

Project finance is the funding (financing) of long-term infrastructure, industrial projects, and
public services using a non-recourse or limited recourse financial structure. The debt and equity
used to finance the project are paid back from the cash flow generated by the project.

Project financing is a loan structure that relies primarily on the project's cash flow for repayment,
with the project's assets, rights, and interests held as secondary collateral. Project finance is
especially attractive to the private sector because companies can fund major projects off-balance
sheet.

What is Project Financing?

If you are planning to start an industrial, infrastructure, or public services project and need funds
for the same, Project Financing might be the answer that you are looking for. Project Financing
is a long-term, zero or limited recourse financing solution that is available to a borrower against
the rights, assets, and interests related to the concerned project. The repayment of this loan can
be done using the cash flow generated once the project is complete instead of the balance sheets
of the sponsors. In case the borrower fails to comply with the terms of the loan, the lender is
entitled to take control of the project. Additionally, financial companies can earn better margins
if a company avails this scheme while partially shifting the associated project risks. Therefore,
this type loan scheme is highly favored by sponsors, companies, and lenders alike.

In order to bridge the gap between sponsors and lenders, an intermediary is formed namely
Special Purpose Vehicle (SPV). The main role of the SPV is to supervise the fund procurement
and management to ensure that the project assets do not succumb to the aftereffects of project
failure. Before a lender decides to finance a project, it is also important that all the risks that
might affect the project are identified and allocated to avoid any future complication.

What Is Special Purpose Vehicle (SPV) and Why Is It Necessary?

During Project Financing, a Special Purpose Vehicle (SPV) is appointed to ensure that the
project financials are managed properly to avoid non-performance of assets due to project
failure. Since this entity is established especially for the project, the only asset it has is the
project. The appointment of SPV guarantees the lenders of the sponsors’ commitment by
ensuring that the project is financially stable.

What Are the Various Stages of Project Financing?

1. Pre-Financing Stage

This stage further consists of the following segments:

Identification of the Project Plan - This process includes identifying the strategic plan of the
project and analyzing whether its plausible or not. In order to ensure that the project plan is in
line with the goals of the financial services company, it is crucial for the lender to perform this
step.

Recognizing and Minimizing the Risk - Risk management is one of the key steps that should
be focused on before the project financing venture begins. Before investing, the lender has every
right to check if the project has enough available resources to avoid any future risks.

Checking Project Feasibility - Before a lender decides to invest on a project, it is important to

check if the concerned project is financially and technically feasible by analyzing all the
associated factors.

2. Financing Stage

Being the most crucial part of Project Financing, this step is further sub-categorized into the
following:

Arrangement of Finances - In order to take care of the finances related to the project, the
sponsor needs to acquire equity or loan from a financial services organisation whose goals are
aligned to that of the project.
Loan or Equity Negotiation - During this step, the borrower and lender negotiate the loan
amount and come to a unanimous decision regarding the same.

Documentation and Verification - In this step, the terms of the loan are mutually decided and
documented keeping the policies of the project in mind.

Payment - Once the loan documentation is done, the borrower receives the funds as agreed
previously to carry out the operations of the project.

3. Post-Financing Stage

Timely Project Monitoring - As the project commences, it is the job of the project manager to
monitor the project at regular intervals.

Project Closure - This step signifies the end of the project.

Loan Repayment - After the project has ended, it is imperative to keep track of the cash flow
from its operations as these funds will be, then, utilized to repay the loan taken to finance the
project.

Key Features of Project Financing

Since a project deals with huge amount funds, it is important that you learn about this structured
financial scheme. Below mentioned are the key features of Project Financing:
1. Capital Intensive Financing Scheme Project Financing is ideal for ventures
requiring huge amount of equity and debt, and is usually implemented in developing
countries as it leads to economic growth of the country. Being more expensive than
corporate loans, this financing scheme drives costs higher while reducing liquidity.
Additionally, the projects under this plan commonly carry Emerging Market Risk and
Political Risk. To insure the project against these risks, the project also has to pay
expensive premiums.
2. Risk Allocation Under this financial plan, some of the risks associated with the
project is shifted towards the lender. Therefore, sponsors prefer to avail this financing
scheme since it helps them mitigate some of the risk. On the other hand, lenders can
receive better credit margin with Project Financing.
3. Multiple Participants Applicable As Project Financing often concerns a large-scale
project, it is possible to allocate numerous parties in the project to take care of its
various aspects. This helps in the seamless operation of the entire process.
4. Asset Ownership is Decided at the Completion of Project the Special Purpose
Vehicle is responsible to overview the proceedings of the project while monitoring the
assets related to the project. Once the project is completed, the project ownership goes
to the concerned entity as determined by the terms of the loan.
5. Zero or Limited Recourse Financing Solution Since the borrower does not have
ownership of the project until its completion, the lenders do not have to waste time or
 resources evaluating the assets and credibility of the borrower. Instead, the lender can
focus on the feasibility of the project. The financial services company can opt for
limited recourse from the sponsors if it deduces that the project might not be able to
generate enough cash flow to repay the loan after completion.
6. Loan Repayment with the Project Cash Flow According to the terms of the loan in
Project Financing, the excess cash flow received by the project should be used to pay
off the outstanding debt received by the borrower. As the debt is gradually paid off,
this will reduce the risk exposure of financial services company.
7. Better Tax Treatment If Project Financing is implemented, the project and/or the
sponsors can receive the benefit of better tax treatment. Therefore, this structured
financing solution is preferred by sponsors to receive funds for long-term projects.
8. Sponsor Credit Has No Impact on Project While this long-term financing plan
maximizes the leverage of a project, it also ensures that the credit standings of the
sponsor has no negative impact on the project. Due to this reason, the credit risk of the
project is often better than the credit standings of the sponsor.
Types of Sponsors in Project Financing
In order to determine the objective of the project and the risks related to it, it is important to know
the type of sponsor associated with the project. Broadly categorized, there are four types of project
sponsors involved in a Project Financing venture:
Industrial sponsor - This type of sponsors are usually aligned to an upstream or downstream
business in some way.
Public sponsor - The main motive of these sponsors is public service and are usually associated
with the government or a municipal corporation.
Contractual sponsor - The sponsors who are a key player in the development and running of
plants are Contractual sponsors.
Financial sponsor - This type of sponsors often partake in project finance initiatives and invest in
deals with a sizeable amount of return.