A corporate reorganization clause is a provision contained in a company’s charter. The provision guides mergers and acquisitions, changes in assets or ownership structure, as well as changes in corporate control. The most common forms of corporate reorganization include mergers and amalgamations, financial restructuring, corporate buyouts, divestitures, etc.
While many companies reorganize to improve efficiency and increase profits, others also pursue reorganization as a way of reviving a financially troubled business. The management of a company facing liquidation may make certain changes to its operations.
The changes may include entering into an agreement with creditors on debt repayments and restructuring the company’s capital structure or its assets and liabilities. The measures are part of the company’s reorganization geared toward extending the life of the financially-troubled company.
Reasons for Corporate Reorganization
The following are some of the reasons that may prompt a company to consider restructuring its capital structure or assets:
1. Focus on core operations
A company that is facing financial difficulties may choose to eliminate certain divisions that do not align with its long-term vision. The company may be spending a lot of resources on non-core activities that derail the achievement of its main objectives. It can sell the non-core divisions or their assets to buyers who can derive greater value from them. The revenues obtained can then be used to strengthen core operations.
2. Generate cash flows to pay off debts
A company may be facing financial difficulties due to huge debts. The management can sell less important assets and use the generated cash flows to salvage the company from going into liquidation. The company can pay off its maturing debts first and negotiate credit terms with creditors so that the repayment period can be extended for other debts.
Types of Corporate Reorganization
The following are the main types of corporate reorganizations:
1. Mergers and consolidations
A statutory merger is based on the acquisition of a company’s assets by another company, either in the same or different industry. The desired effect of a merger transaction is the accumulation of assets and liabilities of the two entities involved in the transaction. The entities will also derive other benefits such as rapid growth, diversification, economies of scale, synergy, etc.
After the completion of the merger and consolidation, the merging entities cease to exist and start operating as a single combined entity. The transaction must be approved by the board of directors of the respective companies. Also, their shareholders must vote and approve the transaction. The transaction is also governed by federal and state laws such as antitrust laws.
2. Corporate buyouts
Corporate buyouts are a form of corporate reorganization where an entity acquires a controlling interest in another company. Usually, the buyer acquires more than 50% of the target company in order to gain the upper hand in decision making for the company.
The target companies for buyouts are mostly undervalued or underperforming companies that can be turned around before going public in later years. They can also include family-owned businesses whose owners wish to retire.
Corporate buyouts are financed by wealthy individuals, institutional investors, etc. The buyers use a high proportion of debt, with the assets of the target company used as collateral.
3. Corporate takeovers
Corporate takeovers occur when a company attempts to assume a controlling interest in another company by acquiring a majority stake in the company. Usually, takeovers involve a larger company acquiring a smaller entity, either through a voluntary or hostile takeover.
A voluntary takeover occurs when the acquirer and target entity mutually agree to the transaction, and the board of directors of the target company willingly approves the transaction. Voluntary corporate takeovers are initiated because the companies find value in each other, and the transaction will bring about operational efficiencies and improvements in revenues.
A hostile takeover is usually a forced acquisition, where an acquirer initiates a takeover attempt without the knowledge of the target company. The acquirer can implement a hostile takeover by purchasing a substantial stake in the target company when the markets open before the management realizes what is happening.
A recapitalization transaction is a form of corporate reorganization where a company attempts to stabilize its capital structure by exchanging one form of financing for another. For example, the company can exchange the preferred stock or equity in the capital structure and replace it with debt.
A company can implement recapitalization when there is a threat of hostile takeover from its larger competitors or to prevent bankruptcy. Adding more debt to the capital structure would make the company less attractive to investors. During a financial crisis, governments pursue recapitalization in order to keep themselves solvent and protect the financial system from insolvency.
5. Divestiture (Spinoffs and split-offs)
Divestiture involves selling off a business unit of the company to another company. Companies use divestitures in order to focus on the core units of the company that earn the most revenues. A company can also divest as a way of solving financial issues resulting from non-core areas of the business.
Divestiture can take multiple forms, including as sell-offs, spin-offs, split-offs, split-ups, etc. The main forms of divestiture are spin-offs and split-offs. Spin-offs refer to a business division that is carved out of the parent company and operates as an independent entity. The acquirer allocates shares of the new subsidiary to its stockholders on a pro-rata basis.
On the other hand, a split-off is a subsidiary of the parent company that is split off from the parent company. Shareholders of the latter are allocated shares in the new subsidiary in exchange for shares in the parent company.
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