Changes at the top: exploring the corporate-restructuring landscape

September 17, 2020

Corporate restructuring has become mediaspeak for distressed companies looking to pull themselves out of adverse circumstances. While understandable, that perception only covers a small part of its true breadth and complexity.

Let us begin with a definition: corporate restructuring is a set of decisive measures to enhance a company’s value and increase its competitiveness. This interpretation avoids the common misconceptions surrounding corporate restructurings and gets to the core of its objectives.

But although its higher-level objectives are clear and straightforward, the ground-level details are anything but. The corporate restructuring landscape is vast and intricate, and there are far too many permutations and processes involved to cover in this article.

However, what we can do is to provide you with a foundational framework that can guide you through the major landmarks and highways that span this landscape. We will analyze the differences between the two main types of corporate restructurings, touch on the many reasons a firm may elect to undergo a reorganization (beyond just troubled conditions) and examine the key considerations it must ponder before embarking on a course of change.

The Two Primary Types of Corporate Restructurings

Although the reasons for corporate restructurings are diverse, the act of corporate reorganization can be split into two broad subcategories – financial and organizational.

Financial restructuring involves facility and security structuring and review, and capital restructuring of a firm. Within the debt structure, it can entail renegotiating borrowings to extend maturities and manage repayments. And within the equity structure, it can comprise capital contributions, reductions, consolidations, or share conversions. Financial restructuring also encompasses asset optimization, which may involve asset sales or transfers.

Organizational restructuring is “everything else” that needs to be done to enhance the firm’s competitiveness. This could include mergers and acquisitions, cost-cutting, or closing unprofitable divisions. Because organizational restructuring often involves changes that directly affect a firm’s employees, it requires a high degree of coordination and proper stakeholder communication.

There is also operational restructuring – the shifting of a firm’s business to enhance competitiveness. While some literature places this as a separate category, in practice, operational restructuring typically requires some combination of financial and organizational restructuring.

While there is a clear distinction between the financial and organizational restructuring, in practice, both types can (and usually are) carried out in parallel. Why a firm decides to change its structure will depend on its own specific objectives.

Why Organizations Undergo Corporate Restructuring

  1. To slim down the existing corporate structure. “Corporate bloat” describes the phenomenon whereby as a company grows, the cost of managing its business begins to accelerate faster than any sales and profits. The result? Steadily declining revenues or profits per employee. As such, restructuring provides a proven avenue for “trimming the fat” such as reducing operating costs, increasing management efficiency, and eventually restoring profitability metrics.
  1. For tax planning efficiency. Complex and varying global tax codes make tax planning a vital consideration for any multinational. Corporate restructurings can enable companies to realize significant tax savings through a combination of establishing appropriate capital and organizational structures.
  1. To prepare for an IPO. To maximize the chances of a successful IPO and shareholder value after IPO a company may need to undergo a pre-IPO transformation. Creating an efficient shareholding structure is of primary importance here, as the company may need to switch from an individual to corporate owner, inject relevant businesses into the group, or remove assets that are not planning to be listed. Further, a restructuring could also help enhance corporate governance and strengthen internal controls.
  1. To address commercial risk. Corporate restructuring is versatile in the sense that it can help both proactively mitigate a prospective risk or manage an existing one. When doing so, it is essential to create a systematic process for diagnosing if the corporate restructuring can successfully manage risk preferences.
  1. To restructure its debt. If a company is in distress, it may need to renegotiate and restructure its debt obligations to continue as a going concern or to reduce the interest burden. Successful debt restructurings such as creditors’ scheme of arrangement require astute creditor negotiations and in-depth knowledge of the legal regulations involved.
  1. For better succession planning. Many companies are still family owned, especially here in Asia, with EY estimating that almost 85% of businesses in the region are family run[1]. According to UBS’ 2019 Global Family Office Report, only 49% of Asian family offices have succession plans in place, which is below the global average. Succession planning is, therefore, a crucial issue – and one that proper corporate restructuring can help to address.
  1. To accommodate a new regulatory environment. Changes in the regulatory climate or statutory and legal compliance requirements often necessitate corporate restructuring. A prominent example was the repeal of the Glass-Steagall Act in the US in 1999, after which many banks consolidated their investment and retail banking divisions through holding companies[2]. This repeal was thought to be a significant contributing factor to the conditions that ultimately led to the 2008 global financial crisis.
  1. For planning business expansions. Inorganic expansions, such as through mergers and acquisitions, would typically require extensive corporate restructuring. However, a period of reorganization can also be beneficial for organic growth. One recent example is Disney, which, in 2018, made changes to better capitalize on the changing media landscape, particularly the rise of direct-to-consumer streaming[3].
  1. For share capital restructuring. Capital restructuring has become increasingly common given changing market conditions. Restructurings are often needed to balance allocations and rights between founders, employees, and investors. Companies may thus choose to reconstitute their share capital to optimize fundraising, even if it is in the form of debt.

While this list is extensive, it is far from exhaustive. As we have noted, corporate restructuring is a broad umbrella, which means that the considerations companies must factor in before proceeding are equally varied. However, based on our experience, they can also be distilled into several key aspects.

Aspects to Consider Before Restructuring

The interests of the shareholders and company are vital. While all corporate restructuring is ostensibly done for the best interests of the shareholders and company, outcome and intentions may not necessarily align. For example, not all shareholders may be happy with a rearrangement of the share capital structure. One crucial factor in overcoming this challenge is effective communication with all stakeholders.

Evaluating legal and regulatory risks is also paramount. Staff reductions, a common feature of corporate restructurings, open up the potential for retaliatory action if not carefully managed. The same goes for the alteration of contracts – whether with employees, suppliers, or customers – that may be required as part of a restructuring. And, of course, legal and regulatory risks are ever-present whenever insolvency is the primary reason behind a restructuring.

We also need to consider the risks to the company or directors. All corporate restructurings carry some level of risk – the key is understanding and mitigating them ahead of time. Beyond apparent risks such as regulatory or business, there are also other more subtle ones such as the potential of negative publicity and lowered employee morale which must also be examined.

Then there are the effects on tax liabilities. Standard restructuring items such as disposals or asset transfers can have considerable tax implications on the business – even if tax efficiency is not the primary intention behind the restructuring. A thorough review of tax implications is thus a prerequisite for almost all restructurings.

An important question to ask is whether the benefits are worth the costs. Corporate restructurings are complex processes that can entail high costs. As such, the simple truth is that not all reorganizations may be able to generate a justifiable return on investment. Being able to perform a comprehensive cost-benefit analysis on a potential restructuring (a challenge in and of itself) is crucial for a successful shakeup.

Finally, it is essential to decide what action to implement to and when to do it. There might be multiple options and approaches for restructuring – including how to handle any internal roadblocks before proceeding with any restructuring. With so many different possible actions falling under the corporate restructuring umbrella, thorough planning, assessment and understanding which action to implement – and when to do it – is harder than it seems on the surface.

 

[1] EY Family Business Yearbook, 2014

[2] https://www.thebalance.com/glass-steagall-act-definition-purpose-and-repeal-3305850

[3] https://dpep.disney.com/the-walt-disney-company-announces-strategic-reorganization/

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