Restructuring is defined as actions taken by an organization when facing difficulties due to wrong management decisions or changes in demographic conditions and therefore tries to align its business with the current profitable trend by a) restructuring its finances by debt issuance/closures, issuance of new equities, selling assets or b) organizational restructuring which includes shifting locations, layoffs, etc.
Types of Restructuring
#1 – Financial Restructuring
It happens mostly when the company’s sales start declining. So if earlier the company was mostly structured with debts, then with sales taking a hit, it will be difficult for the company to pay its fixed interest every year. In that scenario, the company’s try to reduce debt and increase equity as inequities; no fixed payments are required.
Similarly, if an organization is planning to take up a project and they are quite sure about the profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance. of the project, then they will go for debt financing as they know that they can repay the debt from profit and will be able to enjoy the extra profit.
#2 – Organisational Restructuring
It is done to reduce the operational cost of the business internally. If the hierarchical chain in an organization is very long, then that is not cost-effective as too many promotions will be involved, which in turn will lead to more salary to employees. So in organizational restructuring, the organization tries to find loops inside the organizational structure and starts to act on it by cutting down inefficient employees, removing unwanted positions, reducing the salary of top management, and so on.
Examples of Restructuring
Company ABC sees that the interest rate is decreasing in the market. So it will be cheaper to raise debts now. So if company ABC has more equity in capital structure, then it should opt to change the capital structure now. It should reduce its equity position by buying back shares and increase debt position by issuing new debts in the market. It, in return, will decrease the weighted average cost of capital for the company.
The salary of the CEO mostly depends on the size of the organization. So if the board of directors finds that the company in the past has acquired unrelated businesses just to increase the size of the company so that the salary of the CEO gets increased, then the board of directors may decide for a capital restructuring which will sell of the unrelated businesses, making the company cash-rich and decreasing the CEO’s salary. These restructure are very important in the long run of any organization.
How Does Restructuring Work?
- It is a decision that needs to be taken by the board of directors. Once the decision is taken, then mostly external advisors are hired to find the most effective restructuring scheme.
- If an organization has got several businesses, and out of all the businesses, few are really loss-making. Then the organization may decide to sell off that business.
- You need to hire advisors, structure your financing either by raising more debt or more equity, which also involves a cost to underwriters and many more. So the main motive is after restructuring when the organization will start to perform again, it will be easy for the organization to run normal business and be profitable in the long run.
Restructuring is mostly done to increase the valuation of the company, and there are two situations when valuation –
#1 – Synergy
- During the mergerMergerA merger is a voluntary fusion of two existing entities equal in size, operations, and customers deciding to amalgamate to form a new entity, expand its reach into new territories, lower operational costs, increase revenues, and earn greater control over market share., the most important thing that determines whether the merger is going to add value to the newly formed organization is synergy.
- Company A is planning to merge with Company B, and a new company AB will be formed. Say Company A’s valuation now is $5 million, and Company’s B valuation now is $4 million. So together, they should be $9 million, but in most cases, the value is more than $9 million, which is the result of synergy.
- It may happen due to many reasons. Say Company A is a rubber company, and Company B is a Tyre company, so earlier company B used to buy rubber at a higher cost, but now they will be getting them at a much cheaper rate.
- So this restructuring helped to increase the valuation of newly formed companies. So always, before doing so, the valuation should be done, which will show a clear picture between before and after the restructuring process.
#2 – Reverse Synergy
- This concept is the reverse of synergy. In synergy, the combined part’s value is more than individual valuation, but in reverse synergy, the value of the individual parts is more than the combined parts.
- So say if an organization’s value is $10 million and its management, after doing valuation of individual businesses, finds that if individual business values are added together, then the value will be more than $10 million.
- Then it may sell off the business, which is not adding extra operational value to the organization but can be sold for significant cash in the market.
- So due to restructuring, the business is able to add extra value to the company’s wealth by selling off the non-related business and getting cash in exchange, which will help to pay off the debts.
Characteristics of Restructuring
- Unrelated business is sold off to improve the valuation of the company.
- Downsizing of business by closing down or selling of businesses that are no longer profitable;
- Concentrating business in few locations possible rather than spreading it all over and increasing the cost;
- Taking advantage of the change in the interest rate in the market by reissuing debts with lesser interest rates;
Restructuring is an important step taken by organizations to help them sustain in the long run. It is beneficial as the new organization after the restructuring is more efficient and cost-friendly. It also helps to increase the value of an organization.
This article has been a guide to what is restructuring and its meaning. Here we discuss two types (Financial and Organizational) of restructuring along with its characteristics, valuations, and examples. You can learn more about accounting from the following articles –