D2. Business re-organisation Flashcards
Unbundling:
Unbundling: involves restructuring a business by reorganising it into number of separate parts. The main forms of unbundling are:
• Divestment (sell off)
• Demergers (spin-off)
• Management buy-outs
The type of unbundling that is appropriate will depend on the motives for the strategy.
Divestment.
Divestment. Divestment is the process of selling an asset (business). This can be achieved either by:
• Selling the whole business to a third party
• Selling the assets piecemeal
The sale of a division to a third party will add value if the estimated sale price exceeds the present value of lost cash flows (including economies of scale lost as a result). A buyer may be prepared to pay an amount that is greater than the present value of the cash flows of the division because under their ownership the division is worth more (e.g. due to synergies). To value a division, a cost of capital that reflects the risk of the division will be required.
Reasons for divestment.
- The principal motive for divestment will be if they either do not conform to group or business unit strategy.
- A company may decide to abandon a particular product/activity because it fails to yield an adequate return.
- Allowing management to concentrate on core business.
- To raise more cash possibly to fund new acquisitions or to pay debts in order to reduce gearing and financial risk.
- The management lack the necessary skills for this business sector
- Protection from takeover possibly by disposing of the reasons for the takeover or producing sufficient cash to fight it effectively.
A Sell-Off
A Sell-Off is a form of unbundling which involves disposing the non-core parts of the company. It involves selling part of a company to a third party for an agreed amount of funds or value. This value may comprise of cash and non-cash-based assets. The most common reasons for a sell-off are:
• To divest of less profitable and/or non-core business units.
• To offset cash shortages.
The extreme form of sell-off is liquidation, where the owners of the company voluntarily dissolve the business, sell-off the assets piecemeal, and distribute the proceeds amongst themselves.
Management buy-out (MBO).
Is form of divestment involving selling a part of the business to its management team. It allows a division to be sold with the co-operation of divisional management and be less likely to attract the attention of the competition authorities than a sale to another company.
An MBO will add value if the estimated sale price exceeds the present value of lost cash flows (including economies of scale lost). The management team may be prepared to pay an amount that is greater than the present value of the cash flows of the division because under their ownership the division is worth more (e.g. due to personal motivation, quicker decision making and savings in overheads.). To value a division, a cost of capital that reflects the risk of the division will be required.
Reasons for MBOs
- A parent company wishes to divest itself of a business that no longer fits in with its corporate objectives and strategy.
- A company/group may need to improve its liquidity. In such circumstances a buy-out might be particularly attractive as it would normally be for cash.
- A company may decide to abandon a particular product/activity because it fails to yield an adequate return.
- In administration a buy-out may be the management’s only best alternative to redundancy.
Advantages of MBOs to disposing company
- To raise cash to improve liquidity.
- If the subsidiary is loss-making, sale to the management will often be better financially than liquidation and closure costs.
- There is a known buyer.
- Better publicity can be earned by preserving employer’s jobs rather than closing the business down.
- It is better for the existing management to acquire the company rather than it possibly falling into enemy hands.
Advantages of buy-out to acquiring management
- It preserves their jobs.
- It offers them the prospects of significant equity participation in their company.
- It is quicker than starting a similar business from scratch.
- They can carry out their own strategies, no longer having to seek approval from the head office.
Problems of MBOs
- Management may have little or no experience financial management and financial accounting.
- Difficulty in determining a fair price to be paid.
- Maintaining continuity of relationships with suppliers and customers.
- Accepting the board representation requirement that many sources of funding may insist on.
- Inadequate cash flow to finance the maintenance and replacement of assets.
Sources of finance for MBOs.
Several institutions specialise in providing funds for MBOs. These include:
• The clearing banks.
• Pension funds and insurance companies.
• Venture capital.
• Government agencies and local authorities, for example Scottish Development Agency.
Sources of finance for MBOs.
Venture capital/private equity finance.
Venture capital/private equity finance. Typically, an MBO will be mainly financed by a mixture of equity (private equity as MBO will be unlisted), debt and mezzanine (convertible debts and convertible preference shares) finance. If an MBO is mainly financed (80%+) by debt, this may be referred to as leveraged buy-out (LBO). The equity and mezzanine finance element will be mainly provided by a venture capital/private equity firm. An element of equity will be provided by managers (to show commitment). A private company that is concerned about the risk of an MBO will increase the proportion of their investment provided as mezzanine finance (loans/convertibles). In addition to providing finance, venture capitalists can also be source of strategic advice and business contacts. In order to make sure that an MBO is on track to deliver gain, venture capitalists will set demanding financial targets.
Factors a supplier of finance will consider before lending
- The purchase consideration. Is the purchase price right or high?
- The level of financial commitment of the buy-out team.
- The management experience and expertise of the buy-out team.
- The stability of the business’s cash flows and the prospects for future growth.
- The rate of technological change in the industry and the costs associated with the changing technologies.
- The level of actual and potential competition.
- The likely time required for the business to achieve a stock market flotation, (so as to provide an exit route for the venture capitalist).
- Availability of security.
Conditions attached to provision of finance
- Board representation for the venture capitalist.
- Equity options.
- A right to take a controlling equity stake and so replace the existing management if the company fails to achieve specified performance targets.
Management buy-in
Management buy-in is when a team of outside managers, as opposed to managers who are already running the business, mount takeover bid and then run the business themselves. An MBI might occur when a business venture is running into trouble, and a group of outside managers see an opportunity to take over the business and restore it to profitability. Also, often occur when the major shareholder of a small family company wishes to retire. Many features are common to MBOs and MBIs including financing. Buy-ins work best for companies, where the existing managers are being replaced by managers of much better quality. However, managers who come in from outside may take time to get used to the company and may encounter opposition from employees if they seek to introduce significant changes.
Demerger (spin off)
Demerger (spin off) is the opposite of a merger. It is splitting up of a corporate body into two or more separate and independent bodies, it does not rise finance.
This is where a new company is created and the shares in the new company are owned by the shareholders of the original company There is no change in ownership of assets, but the assets are transferred to the new company. The result is to create two or more companies whereas previously there was only one company. Each company now owns some of the assets of the original company and the shareholders own the same proportion of shares in the new company as in the original company.
An extreme form of spin-off is where the original company is split up into a number of separate companies and the original company broken up and it ceases to exist. This is commonly called demerger. Demerger involves splitting a company into two or more separate parts of roughly comparable size which are large enough to carry on independently after the split.
