Tag: Cost Control and Management Accounting Osmania University b.com Notes

Reconstruction is a process of the company’s reorganization, concerning legal, operational, ownership and other structures, by revaluing assets and reassessing the liabilities. There are two methods of reconstruction which are internal reconstruction and external reconstruction. The former is the method in which the reconstruction is undertaken without winding up the company and forming a new one, while the latter, is one whereby the existing company loses its existence, and a new company is set up to take over the business of the existing company.

Internal reconstruction is a method of corporate restructuring where an arrangement is made by the company of the organization where in changes in the assets and liabilities are made to improve the financial position without liquidating the company or transferring the ownership to external party, whereas external reconstruction is the one where an existing company is liquidated and taken over by another newly formed company and the transfer of assets and liabilities takes place, and the same is considered similar to amalgamation.

Internal Methods:

1. Authorization by Articles of Association: The company must be authorized by its articles of association to resort for capital reduction. Articles of association contains all the details regarding the internal affairs of the company and mention the clause containing manner of reduction of capital.
2. Passing of Special Resolution: The company must pass the special resolution before resorting to capital reduction. The special resolution can be passed only if the majority of the stakeholders are assenting to the internal reconstruction. This special resolution must be get signed by the tribunal and deposited to the registrar appointed under the Companies Act, 2013.
3. Permission of Tribunal: The company must get the due permission of the court or tribunal before starting the process of the capital reduction. The tribunal grants permission only it feels satisfied with the point that the company is going fair and there is positive consent of every stakeholder.
4. Payment of borrowings: As per Section 66 of the Companies Act, 2013, the company has to repay all the amounts it gets deposited and also the interest due thereon before going for capital reduction.
5. Consent of Creditors: The written consent of the creditors is required for the company which is going for capital reduction. The court requires the company to secure the interest of the dissenting creditors. The company gets the permission of the court after the court thinks fit that reduction of capital will not harm the interest of the creditors.
6. Public Notice: The company has to make a public notice as per the directions of the tribunal stating that the company is resorting to capital reduction. Also, the company has to state the valid reasons for the same.

Methods of Internal Reconstruction

Alteration of Share Capital:

Section 61 to 64 of Companies Act, 2013 deals with alteration of share capital. It may take the form of fresh issue of new shares, conversion of fully paid shares with stock, cancellation of unissued capital, consolidation of existing shares and subdivision of existing shares.

Memorandum of Association contains capital clause of a company. A company, limited by shares, can alter this capital clause, if is permitted by:

1. The Articles of Association of the company.
2. If a resolution to this effect is passed by the company in the general meeting.

A company can alter share capital in any of the following ways:

A) The company may increase its capital by issuing new shares.

B) It may consolidate the whole or any part of its share capital into shares of larger amount.

C) It may convert shares into stock or vice versa.

D) It may sub-divide the whole or any part of its share capital into shares of smaller amount.

E) It may cancel those shares which have not been taken up and reduce its capital accordingly.

Variation of Shareholders right:

Section 48 of the Companies Act 2013 states that where a share capital of the company is divided into different classes of shares, the rights attached to the shares of any class may be varied with the consent in writing of the holders of not less than three-fourths of the issued shares of that class or by means of a special resolution passed at a separate meeting of the holders of the issued shares of that class.

Reduction of Share Capital:

Section 66 of the Companies Act 2013 provides that subject to confirmation by the Tribunal on an application by the company, a company limited by shares or limited by guarantee and having a share capital may, by a special resolution, reduce the share capital in any manner and in particular, may:

(a) Extinguish or reduce the liability on any of its shares in respect of the share capital not paid-up; or

(b) Either with or without extinguishing or reducing liability on any of its shares:

(i) Cancel any paid-up share capital which is lost or is unrepresented by available assets.

(ii) Pay off any paid-up share capital which is in excess of the wants of the company.

Compromise/Arrangement:

A scheme of compromise and arrangement is an agreement between a company and its members and outside liabilities when the company faces financial problems. Such an arrangement, therefore, also involves sacrifices by shareholders, or creditors and debenture holders or by all.

Surrender of Shares:

In this method, shares are divided into shares of smaller denominations and then the shareholders are made to surrender their shares to the company. These shares are then allotted to debenture holders and creditors so that their liabilities are reduced. The unutilized surrendered shares are then cancelled by transferred to Reconstruction Account.

External Reconstruction

External Reconstruction is a process in which the company’s financial affairs are wound up, and a new company is formed to take over the assets and liabilities of the existing company, after the reorganization of the financial position. It requires the approval of shareholders, creditors and National Company Law Tribunal (NCLT).

In external reconstruction, the undertaking is being continued by the company but is in substance transferred to a company which is not an external one, but another entity that comprises of almost same shareholders, to be carried on by the transferee company. The accounting treatment of external reconstruction is same as the amalgamation in the nature of the purchase.

External reconstruction involves several activities which generally include:

• Liquidation of the existing company.
• Issue of shares in new company to shareholders of the existing company.
• Financial arrangement can be made for settlement of liabilities of the existing company by the new company. For example, debenture holders or creditors can be discharged by way of issue of equity or preference shares.
• Formation of a new company to take over the business (all assets and liabilities) of the existing company at agreed values.
• The new company may take over assets at reduced values which more accurately represent the true value.

Reconstruction is an exercise of restating assets & liabilities by a company/entity whose financial position as reflected by its balance sheet is not healthy but the future is promising. When a company is suffering loss for several past years and suffering from financial difficulties, it may go for reconstruction. It refers to the transfer of a company or several companies’ business to a new company. This exercise is done to gain the confidence of different stakeholders (creditors, lenders, customers, shareholders, etc) whose support is required for the revival of the operations. If any company is suffering loss and it closes its business and join with or without other company, it creates a new company.

Reconstruction is a process of the company’s reorganization, concerning legal, operational, ownership, and other structures, by revaluing assets and reassessing the liabilities.

In other words, when a company’s balance sheet shows huge accumulated losses, heavy fictitious and intangible assets or is in financial difficulties or is to overcapitalized, and then the process of reconstruction is restored. It is required when the company is incurring losses for many years, and the statement of account does not reflect the true and fair position of the business, as a higher net worth is depicted, than that of the real one.

Objectives:

• To resolve the problem of over-capitalization/huge accumulated losses/overvaluation of assets.
• To generate surplus for writing off accumulated losses & writing down overstated assets.
• To generate cash for working capital needs, replacement of assets, to add balancing equipment, modernize plant & machinery, etc.
• When the capital structure of a company is complex and is required to make it simple
• Raising fresh capital by issuing new shares.
• To generate surplus for writing off accumulated losses & writing down overstated assets.
• To generate cash for working capital needs, replacement of assets, to add balancing equipment, modernize plant & machinery, etc.

Internal Reconstruction is not always happened as it requires a lot of work and effort. It usually performs in the following condition:

• Complicate Capital Structure: The company may start from a family own which does not have a proper capital structure from the beginning. So, when the company getting bigger, the capital structure will be getting worst.
• Complex internal structure: The company may cover too many business functions which out of control of top management. It means top management does not have enough skill and competence to control all business functions.
• Mispresented financial statement: The financial statements are mispresented due to overstate of assets, undervalue of liabilities, and fictitious assets that exist on the balance sheet. The income statement does not reflect the actual business performance.
• Company overcapitalized: The company may build the asset but it capitalizes more than the actual cost.

Company Law provisions

Conditions/ Provisions Regarding Internal Reconstruction

Authorisation By Articles of Association

The company must be authorized by its articles of association to resort for capital reduction. Articles of association contains all the details regarding the internal affairs of the company and mention the clause containing manner of reduction of capital.

Passing of Special Resolution

The company must pass the special resolution before resorting to capital reduction. The special resolution can be passed only if the majority of the stakeholders are assenting to the internal reconstruction. This special resolution must be get signed by the tribunal and deposited to the registrar appointed under the Companies Act, 2013.

Permission of Tribunal

The company must get the due permission of the court or tribunal before starting the process of the capital reduction. The tribunal grants permission only it feels satisfied with the point that the company is going fair and there is positive consent of every stakeholder.

Payment of borrowings

As per Section 66 of the Companies Act, 2013, the company has to repay all the amounts it gets deposited and also the interest due thereon before going for capital reduction.

Consent of Creditors

The written consent of the creditors is required for the company which is going for capital reduction. The court requires the company to secure the interest of the dissenting creditors. The company gets the permission of the court after the court thinks fit that reduction of capital will not harm the interest of the creditors.

Public notice

The company has to make a public notice as per the directions of the tribunal stating that the company is resorting to capital reduction. Also, the company has to state the valid reasons for the same.

Ways of reduction of capital

The company limited by shares and limited by guarantee can go for internal reconstruction in three ways:

By reducing or extinguishing the liability: the company can repay its liability on account of uncalled amount on the shares issued. Under this method, the paid-up shares capital of the company would remain unchanged.

Reducing the capital by returning the excess capital: In case the company has availability of surplus cash, the company can use it to repay the excess capital if it finds it profitable. The capital can be refunded after complying with the proper procedure.

Reducing the paid-up share capital: When the company suffers losses continuously due to some reasons, it is quite common that the accumulated losses and deferred expenses will appear on the assets side of balance sheet. The fictitious assets on the balance sheet makes clear that the company is unable to discharge its liability. Under such circumstances, the capital which is unpresented by available assets should be cancelled.

Modes and Procedure of Reduction

The reduction of share capital, or the internal restructuring of a company can be done in various ways. The objective is to mitigate losses and restructuring of share capital in a way to balance out the assets and the liabilities.

Following are the ways to reduce capital under Section 66 of the Act:

• Cancellation of paid-up share capital that is not presented by the existing assets with or without reduction of liabilities on any of the shares.
• Extinguishment or reduction of unpaid share capital.
• Paying off any paid-up capital, which is surplus to the requirements of the company.

For a company to avail the provision of reduction of share capital, the company shall first make an application to the Tribunal (NCLT). After obtaining a sanction from the Tribunal, the restructuring shall come into force by a special resolution passed by the company.

The Tribunal shall make sure the following conditions are fulfilled before granting the sanction:

• There is no objection from the creditors.
• In case of objection by the creditors, their consent has been obtained by the company.
• The rights of the creditors have been secured or they have been paid off.

Section 66 read with the National Company Law Tribunal (Procedure for reduction of share capital) Rules, 2016 formulate the procedure of reduction of share capital. Rule 2(1) lays down the procedure of making an application to the Tribunal. An application to this effect has to be filed with the Tribunal in Form No. RSC-1 along with a fee of Rs. 5000/-.

The application above has to be supplemented with the following:

• A list of creditors in the order of their class, along with their names, address, and amount owed, duly signed by the managing director of the company.
• The auditor shall certify the above-mentioned list of creditors.
• A declaration to the effect that the company is not in arrears in the repayment of the deposits or the interest by one of the directors of the company and certified by the auditor.
• The certificate to the effect that such restructuring is in accordance with the other provisions of the Companies Act.

Corporate restructuring has been fueled by variety of forces such as global competition, regulatory changes, technological breakthroughs, managerial innovations, transformation and formerly centrally planned socialistic economies and expansion of international trade. It has led to dramatic improvement in corporate performance. Restructuring of a company involves an activity to make the organization more balanced, profitable and enable the company to achieve its objectives in a more simplified manner than previously. It may include the organizational restructuring such as merger, amalgamation, takeover, joint venture, divestment, expansion and so on or financial reorganization such as buy-back of shares, issue of sweat equity shares, redemption of shares, issues of convertible debenture/preference shares, issue of bonus shares, issue of deep discount bonds and so on. However, corporate restructurings fail if they are not in conformance with the strategic objectives.

Strategic Fit

The first step of the model is to check whether the restructuring fits in to the vision and strategy of both/all the parties involved. For example, A typical merger is one where two (or more) parties come together and form a new entity. Neither is taking over or acquiring the other. Even where company A takes over part or whole of company B, the result is a merger.

In either case, that is, whether coming together, or whether there is a sale and purchase, it is desirable that the top managements of both A and B have evolved their own respective perspective visions and come to the considered conclusion that a merger is the best strategy.

For A, takeover may be a useful strategy for entry into a new product, territory or segment; or a means for faster growth, in addition to internal, organic expansion; or access to resources like capacity, talent, technology, brands or funds. For B, selling out may be a good strategy to divest an unrelated business, focus on core businesses and release resources for such concentration.

1. Planning Phase

• SMART objectives, ROI

Restructuring makes sense only if profitability and market position are improved. The business objectives should be ambitious, but realistic, time bound, specific and clearly measured.  

• Budget for restructuring

Without a sufficient budget, any restructuring is “mission impossible”. 

• Internal communication to gain team’s support & give/get ongoing feedback

Incorrect/poor communication of the process creates chaos. 

• Project team creation: x-functional, x-country

The project team should include all key people who are needed to make the project successful. 

• One fully dedicated project manager/coordinator

“Shared” responsibility does not work in restructuring. 

• “Sponsor” from top management team who will support the process

Without support from the top management level, the process can get stacked easily. 

• Person responsible for each country

For multinational restructuring, the voice from the country level with first hand, local knowledge should be heard.    

• Project management tools and procedures in place

Project management tools should be used, especially in complex projects. A company can use existing procedures or create new ones. 

2. Implementation test phase

• Test phase for one country, area, division, function, head office, etc.

Small-scale tests are needed to avoid the risk of big and costly mistakes affecting the whole organisation.     

3. Measuring & analysis of test phase

• Measuring results against SMART objectives
• Corrections of initial plans, if necessary

This is the most important part of organisational restructuring process in its implementation phase. If a test is not successful, the whole organisational restructuring is in danger. 

4. Full rollout

• Measuring results against SMART objectives
• Corrections to implementation

From business units to category management

Nike started as a company selling footwear for runners. After some years, they added sneakers for other sports categories like soccer, sportswear (lifestyle), tennis, basketball, x-training, women’s fitness and American football. Nike quickly realised that its consumers need specialised apparel and equipment to practice their sports, so the two business units were added to the product portfolio. The company’s organisation reflected all these changes by including “business unit” departments: footwear, apparel and equipment for all sports to typical functional divisions. At a later stage, Nike’s top management decided to organise the company by sports categories. The main reason was that, for example, products for soccer differ significantly from products for running by product range, expertise needed, distribution channel, sports assets, product features, places where consumers play, etc.  Each category is a different “field of play”, where producers compete to win the hearts of each category consumers. It was much easier to respond to consumer needs and to grow distinctive category markets when the organisation reflected the category approach. Each sports category division includes footwear, apparel and equipment, but has also a team to manage category marketing, retail, visual merchandising, product development, and so on.  Nike’s organisational evolution from a business unit organisation to sports category set up is a great example of how a company can adjust to meet consumer needs better and grow business at a very fast pace. Such an approach helped Nike become number one globally and in each sport “field of play”. The transformation from footwear to BU divisions took several years, but the reorganisation from BU to categories was executed within 1 year.  Nike’s mission to serve and inspire athletes from all over the world (“if you have a body, you are an athlete”) helped the company make the right organisational decisions and redefine a service model in the industry. The competition followed by doing the same but was unable to regain strategic initiative.  

Geographic expansion: an example of CEMEA region

Nike was established in Oregon, USA. It soon expanded to all other states and then started the business in Western Europe and on other continents. For CEMEA region (Central Europe, Russia, Turkey, Israel, Middle East and Africa), Nike picked Poland as the first, test country for the region. With the help of shared services in Nike’s European headquarters in Holland and central warehouse for Europe in Belgium, Nike Poland was opened as their own, buy-sell subsidiary. After one year of tests, the country’s opening pattern was applied for other countries of CEMEA region, one after another. Poland was treated as a training and knowledge centre for other countries’ teams.  Before Nike’s rollout of its own subsidiaries, these markets were serviced by ineffective, exclusive distributors who were not able to promote Nike brand and grow revenues the Nike way. Each CEMEA country had its own customer service in the European headquarters, CEMEA functional and category teams and centralised supply chain model. With its own subsidiaries in each CEMEA county, Nike was able to offer better commercial terms to its retail partners, start marketing activities to position the brand properly, grow revenues (for example, with the impressive CARG of 19% during 13 years in Poland). The big organisational restructuring innovation was the European headquarters as a service centre for all European countries which enable countries to be less staffed, more focused on sales and with less headcount needed to cover all functional departments in each country. Nike worked as a matrix, where all functional and category positions are represented at all levels (global, geography, country). Marketing activities were integrated across all departments (sales, marketing and retail) and executed in each country, according to global guidelines, and with local adjustments.       

Supply chain: centralization of deliveries

After Nike expanded to Europe and started in some countries with traditional logistics in the first couple of years, instead of having warehouses in each country, one central warehouse was built in Laakdal, Belgium, to supply all European customers from one place. All Nike global factories shipped their products to Laakdal, and then, outsourced logistics companies delivered seasonal orders to the doors of Nike European customers. In the 90s, opening a huge warehouse facility in the middle of nowhere in Belgium, but close to the sea ports was a huge supply chain innovation, which simplified logistics and was a labour and operational cost saving compared to having warehouses in each country. The system did not work perfectly from day one, but gradually, Nike made it very functional and partly automated.

From “prop” to “futures” orders

In the early stage of its development, Nike met the demand by collecting orders from customers, ordering production at factories and delivering products to customers. The idea of making customers order products, with the help of product samples and catalogues, 6 months before each of 4 seasons was revolutionary. It enabled better demand-based, supply planning, with less cash and logistics constraints. This system called “futures” ordering, as opposed to on-demand “prop” system, has changed Nike’s organisation dramatically. Instead of collecting orders by Nike’s sales force during visits to customers, Nike built a network of unified showrooms in each country. Nike’s sales force presented new seasonal collections to customers in a similar way, with similar visual merchandising support, and well ahead of their delivery to the market. 

From a wholesale model to direct-to-consumer

Any success in business depends on good interaction with consumers and a high gross margin. As the founder of Nike, Phil Knight, used to say: “Once gross margin is good, everything else can be fixed”. In the past, the main business partners for Nike were: key accounts like Footlocker, Intersport, Decathlon, El Corte Ingles, Sports Direct, JD Sport, Go Sport, Bata, mid-size “field” accounts and Small Value Accounts. Nike sales departments clearly reflected that approach. In a way, Nike was partly dependent on the customer experience that their partners offered. Many of them were far from being brand enhancers and frequently decreased prices through aggressive discounting. The company did not have its own retail, except for a few Nike Towns or factory outlet stores. With the growing role of e-commerce and periodic market overstocking due to the aggressive strategic goals, Nike decided to strengthen its direct-to-consumer presence on the global market by opening Nike-only stores, its own online store www.nike.com, its own factory outlet stores and by introducing category shop-in-shop concept with key accounts. These actions required considerable restructuring of Nike organisation to cope with new tasks like channel and space planning, category directive assortments for its own stores, product differentiation in retail, return logistics, among a number of other challenges. Although the direct-to-consumer approach is continuous learning for Nike, earning double wholesale and retail margins from their own, a brand-enhancing retail stores network was a huge gain for Nike’s P&L.

Selected cost optimisation restructuring initiatives

“Shared services” is a concept introduced by Nike to reduce employment by offering 1 central or regional service centre for many countries. It was applied for a group of smaller countries or the whole Nike regions. The shared services were applied to HR, customer service, logistics, IT, procurement, etc. It is nothing new these days, but 20 years ago, it was a very innovative solution. Global or regional headcount reduction is a bit primitive type of reorganisation to reduce labour cost. Nike executed it when the organisation gained excessive “fat” while revenues and gross margin did not grow as planned. When the top line went back to normal and headcount limits were eased, the total number of headcount usually came back to the number from the previous level or more. “10 per cent cut in costs” was Nike’s initiative to reduce excessive operational costs at country’s or regional level. This task was surprisingly easy to execute by Nike countries, despite their initial resistance, as long as the exercise was not repeated in the following year.

Corporate restructuring is an action taken by the corporate entity to modify its capital structure or its operations significantly. Generally, corporate restructuring happens when a corporate entity is experiencing significant problems and is in financial jeopardy.

Corporate restructuring is implemented in the following situations:

Change in the Strategy: The management of the distressed entity attempts to improve its performance by eliminating certain divisions and subsidiaries which do not align with the core strategy of the company. The division or subsidiaries may not appear to fit strategically with the company’s long-term vision. Thus, the corporate entity decides to focus on its core strategy and dispose of such assets to the potential buyers.

Lack of Profits: The undertaking may not be enough profit-making to cover the cost of capital of the company and may cause economic losses. The poor performance of the undertaking may be the result of a wrong decision taken by the management to start the division or the decline in the profitability of the undertaking due to the change in customer needs or increasing costs.

Reverse Synergy: This concept is in contrast to the principles of synergy, where the value of a merged unit is more than the value of individual units collectively. According to reverse synergy, the value of an individual unit may be more than the merged unit. This is one of the common reasons for divesting the assets of the company. The concerned entity may decide that by divesting a division to a third party can fetch more value rather than owning it.

Cash Flow Requirement: Disposing of an unproductive undertaking can provide a considerable cash inflow to the company. If the concerned corporate entity is facing some complexity in obtaining finance, disposing of an asset is an approach in order to raise money and to reduce debt.

Steps:

1. Start with your business strategy

The first component of company reorganization strategy is finding out why upper management wants to reorganize in the first place. Without understanding the new direction, the company’s heading or defining the problem the company is hoping to solve, there is nothing to guide the reorganization process and no way to measure its success.

The business strategy will arm you with the goals or criteria you’ll need to meet with this company reorganization plan if such a plan is even practical.

2. Identify strengths and weaknesses in the current organizational structure

With the strategy in mind, you need to consider where your current organizational structure is failing to meet company goals and where it’s working. If you haven’t already, create an org chart to get an elevated perspective on where your company structure stands now.

Part of this org structure evaluation process should be to gather feedback. Too many companies undergo reorganization planning without taking into consideration the people who will be affected by both departmental and company restructuring plans. Your employees often have valuable insights on what isn’t working and what you should continue doing it’s up to you to gather those insights and include them throughout your company reorganization process.

It’s easier said than done, though. Without feeling that their concerns and ideas are taken seriously and are truly anonymous, your employees will be reluctant to divulge any feedback regarding a company restructure. It’s up to you to foster a safe environment in which employees feel their thoughts are valued. Consider sending out an anonymous survey to ask what they would change and how they would approach a company reorganization.

3. Consider your options and design a new structure

After determining the problem with the current company organizational structure, gathering feedback from employees and key stakeholders, and considering all the existing job functions, it’s time to create a new organization model.

Bear in mind that this newly restructured model is only a first draft: It will and should change before being implemented. This new organizational structure should include:

• The vertical and horizontal lines of authority.
• An indication of who will be making formal decisions within departments.
• Attributes of employees, including skills and experience.
• The definition and distribution of functions throughout the organization and the relationships among those functions.

4. Communicate the reorganization

Once you’ve weighed various options in your reorganization planning and determined your best path forward, it’s time to show the rest of the company with a reorganization announcement.

Don’t spring the change on your employees. Make communication and transparency the highest priority throughout your company reorganization process again, an org chart can help create clarity in this situation, especially paired with details about each role’s responsibilities. You might need to communicate separately with managers or anyone with a direct report to ensure that they’ll be able to answer questions and help with execution.

5. Launch your company restructure and adjust as necessary

The moment has finally arrived to execute the company or department restructuring. Remember that change can be difficult give employees some time to adjust to the restructuring to accurately gauge its effects. Think back to your business strategy, and make adjustments if the new organizational structure still doesn’t meet your ultimate goals.

Implementing a New Business Plan

When a corporate restructuring plan is developed and approved, the resulting plan effectively supersedes the company’s original business plan. This is likely to be more detailed and time-sensitive than a traditional plan. One key to success is how effective business owners and managers are in adapting to changes during the implementation phase. As a business owner contemplating even the most basic restructuring plan, you should be prepared for the challenges ahead.

Demerger

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:

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.

Advantages of Demerger

Helpful in Fixing Accountability

Another benefit is that it helps in fixing the accountability of the top management because when company is big and there are many departments then each department and top management blame each other for the failure but when company is demerged than each company’s top management will be separately accountable and responsible for any failure or loss happening in the company. In simple words if there are 4 sections of 100 students having 25 students each and if students of 3 sections do well but students of 1 section perform poorly than it is easy to fix accountability of class teacher of that section rather than finding fault if there is only one class of 100 students.

Management Accountability:

When companies are split off, the management of each company has its own balance sheet. As a result, it is not possible for certain entities in the group to live as parasites off the earnings of other entities. The management of each company becomes accountable for its own financial results. Also, management tends to have more control over their operations. They have the right to make their own investments and even raise funds from the market on their own account.

Smooth Operations:

The first and foremost advantage of demerger is that it results in smooth operations because when company is big than it is not possible to take area of all areas but when company is split into 2 or 3 companies then each company will have separate top management which ensures that all areas of operations of the company run smoothly. Hence for example, if in a school there are 100 students in one class than it is very difficult to manage all students but if those 100 students are divided into 4 classes of 25 students each than it is very easy to manage all the students same is the case with the company doing demerging.

Unlocking of Value:

It results in the unlocking of the value of the company as a whole because when demerger happens separate companies achieve efficiency due to the specialization of operations which results in greater overall profits for the group of companies as a whole.

Disadvantages:

Employees Problem

The internal factors also get affected by the demerger example i.e employees. When the split-up takes place then the employees also have to split. That explains few in the parent company and the rest in the newly formed company. However, if the shift is according to their consent then it works. But if they are ordered then the employees might feel demotivated or wish to leave the job.

A Decrease In Economies Of Scale

One of the disadvantages of demerger example is that the company loses its economies of scale. That was enjoyed due to the large size company and does not prevail during the process of split-up.

Clashing Of Interests

A conflict among the recognition or reputation of top-level management may occur since a split-up increase the number of top-level managers. The decisions or views might contradict which can lead to delay in work or detrimental to the performance of the organisation.

Reverse Merger:

A merger wherein a publicly listed company is taken over by a privately held company and provides an opportunity, to the private company to go public, without going through the complex and lengthy process of getting listed on the stock exchange. In this type of amalgamation, the unlisted company acquires majority shares in the listed company. The decision of merger is taken with great planning and analysis considering all the positives and negatives.

The sole aim is to accelerate growth and build a good image in the market. It also enhances company’s profitability through economies of scale, synergy, operating economies, entry to new product lines, etc. Further, it removes financial constraints and also minimizes financial cost. However, there are certain restrictions, like high employee turnover, culture conflicts, etc. which might hit the efficiency and effectiveness.

Advantages:

• The private company becomes a public company at a lesser cost and gets listed on the exchange without IPO.
• This type of merger does not create a negative impact on the competition in the market. The chances of reverse mergers being put on hold due to negative impact are very less.
• It helps in saving of taxes of private companies.

Disadvantages:

Equity Dilution:

There is definitely a cost for acquiring a shell. The private company is putting up its assets, reputation, and business to acquire the shell, but the shell’s owners want a continuing equity interest in the restructured company. This means that the private company owner’s equity and voting power are diluted as a result of the merger. The amount of dilution will depend on the value of what the two parties are bringing to the table and their negotiating skills. As discussed previously, a shell with significant loss carry forwards adds value to the transaction, and this will come at a cost to the private company.

Shell’s History:

The shell company is a “shell” for a reason. Most shells are companies that have wound down or sold off their operating business, while some were formed for the sole purpose of being available for reverse merger opportunities. The latter does not have a long or dangerous history and should have significantly fewer pitfalls.

Frequently a company is a shell because it’s a failed company. As a result, remaining shareholders may have grievances with the company and its management. They may be reluctant to get into a reverse merger because they see it as a significant dilution of their equity in the company. Of course, a prudent investor would normally prefer a small piece of a valuable company to a large piece of a worthless company. Yet even when shareholders are convinced to sell most of their shares, or perhaps even invest additional funds, they may want to quickly recoup their investment and get out of the restructured company. To avoid this situation, the reverse merger agreement should contain some timing restrictions on the sale of stock. Another problem with a shell that has a history is the possibility of unknown liabilities. Efforts should be made to contact previous suppliers to make sure there are no outstanding claims against the company. Investigations also need to be made regarding any pending lawsuits, and the shell’s legal counsel needs to provide all relevant information.

Under SEBI Purview:

In a reverse merger, the purchasing company avoids the full IPO process. But not surprisingly, the SEBI is very skeptical of such mergers and may judge individual cases to be illegal, so it’s essential that the purchasing and subsequently the combined company strictly adhere to SEBI rules to avoid sanctions or even prosecution.

Disinvestment is the action of an organization or government selling or liquidating an asset or subsidiary. Absent the sale of an asset, disinvestment also refers to capital expenditure (CapEx) reductions, which can facilitate the re-allocation of resources to more productive areas within an organization or government-funded project.

Whether disinvestment results in the divestiture or the reduction of funding, the primary objective is to maximize the return on investment (ROI) related to capital goods, labor, and infrastructure.

From a government point of view, the disinvestment strategy can be of the following types:

• Minority Disinvestment: The Government wishes to retain managerial control over the company by maintaining the majority stake (equal to or more than 51%). Because public sector enterprises cater to the citizens, the Government needs to be able to influence company policies to further the interests of the general public. The Government generally auctions the minority stake to potential institutional investors or announces an offer for sale (OFS) inviting participation by the public.
• Majority Disinvestment: The Government gives up the majority stake in a government-held company. After the disinvestment, the government is left holding a minority stake in the company. Such a decision is based on strategic grounds and policies of the Government. Typically, majority disinvestments are done in the favor of other public sector enterprises. For example, Chennai Petroleum Corporation Limited, formerly known as Madras Refineries Limited is a group company of Indian Oil Corporation after disinvestment by the Government. The idea is the consolidation of resources in a company which ultimately leads to operational efficiency.
• Strategic Disinvestment: The government sells off a PSU to usually a non-government, private entity. The intention is to transfer the ownership of a non-performing organization to more efficient private players in the market and reduce on the financial burden on the government balance sheet.
• Complete Disinvestment/Privatization: 100 percent sale of Government stake in a PSU leads to the privatization of the company, wherein complete ownership and control are passed onto the buyer.

From a general point of view, the disinvestment in India can be categorized in the following manner:

• Organizing the market segment: A company may disinvest in one of its underperforming divisions, as other divisions continue to deliver higher profitability while demanding similar resources and expenditure. Such a disinvestment strategy is to shift the focus of the company on the divisions performing well and to scale them up.
• Offloading unnecessary assets: A company is cornered into adopting this strategy when the acquisition of an asset does not fit its long-term strategy. Companies’ post-merger are stuck with assets they do not intend to use. A company may choose to disinvest in acquired assets and instead focus on their competitive abilities.
• Social and legal considerations: A company may have to disinvest if they cross a certain threshold limit in the market holding to enable fair competition. Another example is of an endowment fund pulling out of investments in energy companies given environmental concerns.

Advantages

• Privatization would help stemming further outflows of the scarce public resources of sustaining the unviable non-strategic public sector unit.
• To obtain release of the large number of public resources locked up in non-strategic public sector units for re-employment in areas that are much higher on the social priority e.g. health, family, welfare etc. and to reduce the public debt that is assuming threatening proportions.
• Privatisation would facilitate transferring the commercial risk to which the tax payer’s money locked up in the public sector is exposed to the private sector wherever the private sector is willing to step in.
• Privatisation would release tangible and intangible resources such as large manpower locked up in managing PSU’s and release them for deployment in high priority social sector.
• Disinvestment would expose privatized companies to market disciplines and help them become self-reliant.
• Disinvestment would result in wider distribution of wealth by offering shares of privatized companies to small investors and employees.
• Disinvestment would have a beneficial effect on the capital market. The increase in floating stock would give the market more depth and liquidity, give investors early exit options, help establish more accurate benchmarks for valuation and raising of funds by privatized companies for their projects and expansion.
• Opening up the public sector to private investment will increase economic activity and have an overall beneficial effect on economy, employment and tax revenues in the medium to long term.
• Bring relief to consumers by way of more choices and better quality of products and services, e.g. Telecom sector.

Disadvantages

• The loss of PSU’s is rising. It was 9305 crores in 1998 and 10060 crores in 2000.
• This is welcome but disinvestment of profit-making public-sector units will rob the government of good returns. Further, if department of disinvestment wants to get away with commercial risks, why should it retain equity in disinvested PSU’s, e.g. Balco (49%), Modern Foods (26%) etc.
• The amount raised through disinvestment from 1991-2001 was Rs. 2051 crores per year which is too meagre. Further, the way money released by disinvestment is being used, remaining undisclosed.
• This is true but only when the govt, ensures that the market system regulates and disciplines privatized firms taking care of public’s interest.
• Privatization programme is generally not been affected through the public sales of shares. Earlier, sale of shares (1991-96) attracted the employees to a limited extent and was not friendly to small investors and employees.
• The growth in social sector is not in any way hindered by non-availability of manpower.
• In most cases, shares of disinvested PSU’s are by and large in the hands of institutions with little floating stock. The present policy of privatization through the strategic partner route would also not achieve these objectives.
• Hindustan Lever has categorically stated that it has no plans for any capital infusion in Modern food industries acquired by it in January, 2002. The supporter of disinvestment had thought that tax payer’s money would be saved through private sector investment.
• No monopoly is good. Only fair and full competition can bring relief to consumers.