Understanding Corporate Restructuring and why it is rampant in the current business environment?

Ramkumar Raja Chidambaram

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5 min read

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Jul 21, 2019

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Introduction

• In the current age, volatility in business conditions are high due to the technology disruption which makes the existing business models irrelevant. Changes in customer preferences along with changing regulatory landscape add further uncertainty. With digital disruption, every company is facing an impending threat of getting extinct, as its business operations as well as its business portfolios are no longer aligned to the market demands.
• The investors, creditors and shareholders are equally putting pressure on company management to deliver superior shareholder returns.With rising of activist investors, more and more companies are compelled to review their business models and operations to ensure they continue to be profitable.
• Hence corporate restructuring has become rampant in companies where the management and board are involved in restructuring activities to ensure companies focus on their core competencies and strategic strengths.Previously corporate restructuring would reactive and are done when companies suffer from revenue declines or not able to generate enough cash to repay its liabilities.
• Now, Corporate restructuring activity are proactive and takes places every 2-3 years to review the current business performance and if the companies provide services that operate in high growth markets.This is because the business processes, systems and the model continue to get disrupted and companies need to adapt themselves to these changes.

Different levels of Corporate Restructuring

• Corporate restructuring can involve Financial restructuring and Organizational restructuring.
• Financial restructuring is more focused on evaluating the company capital structure and decide if this is efficient to generate high cash.For any business, Cashflows is the king and all efforts are done to improve cash flows as this would improve shareholder returns.
• When a company has more debt in its capitalization structure compared to equity, then at distressed/tough environments, the companies may not generate enough cashflows to repay the interest payments of its creditors.In such a case, companies can restructure its debt either by refinancing their debt at lower interest rates or negotiate with its creditors to either extend their repayment dates or convert a part of its outstanding debt to equity.If creditors feel that the current situation faced by the company is temporary and are convinced that the interest repayments are blocking their current growth, then the creditors can free the company from the cash crunch, allowing them to reinvest this cash in growth initiatives. The creditors also have a better chance to recover its outstanding payments when the distressed companies turnaround and becomes profitable.
• The companies generally engage the services of bankers and attorneys in financial restructuring activities.
• Some of the other ways of restructuring would be, company looking to sell its business or a part of its business through spin offs, split offs and divestitures. In these situations, the company can raise money by selling a part of its business that is no longer profitable or strategic and can use these proceeds to either repay it's debt or invest in strategic investments.
• In this digital age, most of the current business models are not relevant, which inturn has made the assets owned by companies no longer profitable.For instance, with the advent of cloud, companies that have huge data centers operations have assets that no longer generate high cashflows.So divesting this assets would help company to raise proceeds.The divestment should also take into account the revenues and customers relationships that the companies lose when they divest a part of their business.In addition, there will be restructuring expenses that the company needs to undertake which includes engaging bankers to search for clients who would be interested to buy these assets.
• The company needs to have an excellent forecasting capability on when to divest their businesses.A company should look to divest when their divested business are profitable so that the company can get a good price and also be able to complete the process fast.In the case of a distressed sale, valuations are very low and the time taken to find a buyer is also high.

Organizational Restructuring

• This happens more regularly where the companies generally do reorganization to reallocate resources and investments to businesses which are profitable and operate in high growth markets.For businesses that are no longer profitable or which is no longer in demand, companies resort to cost cutting initiatives by either automating the processes or use low cost resources to realize margins.Parallely, companies would also start looking at buyers for divestments.In such cases, companies would also ensure not to lose customer relationships as result of divesting the business.Hence companies would start to cross sell its profitable services to the customers so that they continue to retain customer relationships after divestments.
• Companies would also look at their talent base to examine if they have the correct skillsets to operate the business profitably.It would look at retraining their existing employees to align them to the current market demand.In addition, companies would also look at hiring new skills from market and also aggressively manage its attrition rate to prevent churn of high skilled talent.
• Change management is a crucial part in restructuring as people are resistant to change.Hence clear communication to the employees on the reason behind the restructuring activity, what they are trying to accomplish from this exercise and how this will be implemented will go a long way in making the employees understand and garner their support for the program.Change management is extremely critical when integrating a target company post acquisitions, as there will be more emotions and anxiety in employees about their future role in the organization.

Restructuring expense and how it is accounted

• Restructuring costs are non recurring expenses and are entered as expenses in Income statement.These are generally reflected in the footnotes of the accounting statements as well as in management commentary in the audited report.
• Companies generally try to inflate the restructuring expenses to adjust even the operating losses.Sometimes companies tries to reduce their earnings in order to show a high growth in the next fiscal.To identify if the company has adjusted its losses in restructuring expenses, investors should look at split of restructuring expenses to identify the scope of restructuring.
• Investors generally perceive the restructuring activity as positive development as they would be confident that companies would become profitable post restructuring exercise.

Conclusion

• Corporate restructuring is becoming more frequent in companies as more companies are facing pressure to operate profitably to generate shareholder returns.
• Financial restructuring in case of distressed companies pose a serious risk to their shareholders and creditors.This might involve debt restructuring, spinoff and divestitures to raise cash to repay liabilities.
• Business restructuring mainly focuses on reorganization and reallocating resources/investments in businesses that are profitable and operate in high growth markets.This development is generally perceived as positive by the investors as they feel that companies are focusing on their core competencies and strategic growth areas.
• Restructuring activity is an expense that companies need to incur for engaging consultants, banker and attorneys. In case of layoffs, severance costs are factored in and in case of strategic investments like market expansion, investments costs are taken as part of restructuring expenses.
• In most of the cases, restructuring generally yields a positive outcome for companies post completion.This is evident by high revenues and earnings numbers that companies exhibit in their future results.