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The main objective of both private and public business organisations has traditionally been and continues to be the maximisation and growth of shareholder value (Blatz & Others, 2006). Increasing revenues and profitability, consistently, year after year, in dynamic environmental conditions and fiercely competitive markets is however an enormous challenge and few are the business organisations that can achieve such progress on a consistent basis (Blatz & Others, 2006). Growth and expansion through external means like acquisition is an attractive option but can lead to periods of significant underperformance and challenging integration problems (Blatz & Others, 2006). The acquisition of Compaq by HP for example represents a case where the difficulties associated with the acquisition led to the termination of the services of the Chief Executive of the acquiring organisation (Blatz & Others, 2006).
Most companies can as such be expected to experience periods that will be difficult and require refocusing of business objectives and restructuring of corporate finances (Davis, 2004). Such restructuring, when applied in the financial sense refers to the bringing about of fundamental alterations in the financial structure of business firms with the objective of increasing the value of the business to shareholders or to creditors (Davis, 2004). Financial restructuring relates to the restructuring of assets and liabilities of business corporations in order to align them with their cash flow requirements (Davis, 2004).
It is important that the senior managements of companies recognise and appreciate the requirement for financial restructuring, develop an appropriate and practicable plan, and, if required, negotiate with shareholders and creditors (Davis, 2004). In certain circumstances, where financing difficulties become obvious, acceptance of the need for financial restructuring and the execution of appropriate changes can lead to avoidance of legal solutions like administration, receivership or even insolvency (Davis, 2004).
Causes of Financial Restructuring
A number of causes can explain why business firms arrive at situations that need restructuring or refocusing (Gilson, 2001). Some of the most important reasons for financial restructuring arise either out of alterations in the competitive environments of business firms or because of the need to correct unsuitable capital or cost structures (Gilson, 2001).
Recent years have witnessed a number of changes in the business environments of business firms, not just in the Anglo-American context, but across the world (Gilson, 2001). Economic liberalisation, the breakdown of economic and physical barriers between countries, the emergence of good quality and low cost production and service centres in the developing and emerging nations, and business globalisation have resulted in enormous enhancement in the number of business variables and in the competitive environment (Gilson, 2001). Some companies have been able to meet these challenges by the application of carefully planned and appropriately implemented strategies that have enabled them to reduce their costs, improve their quality and expand their operations (Gilson, 2001). Tesco, the largest food retailer in the UK, has for example been able to successfully meet these challenges, not only by sourcing material at cheaper rates from overseas locations but also by expanding its operations in numerous new countries (Gilson, 2001). Companies like Marks and Spencer and Sainsbury on the other hand were unable to respond swiftly to the changing environment and in the process lost out on profitability, market share and time (Gilson, 2001).
There is also a tendency for companies that work in low interest rate environs to leverage their balance sheets through increase of debt, firstly because the cost of debt is substantially lesser than cost of equity, and secondly because availability of finance enables managements to work with greater comfort and pursue fresh business opportunities (Hartman, 2003). Financial theory also stresses upon the advantages of engaging in a certain amount of the borrowing in order to profit from the tax shield that is available on interest on borrowings (Hartman, 2003). Specialists in leverage buyout have also found that substantial amount of borrowings on the balance sheets of business firms, when matched with appropriate incentives, can motivate managements to engage in ruthless cost reduction, strong market expansion and rapid debt repayment (Hartman, 2003).
However such debt can become a difficult liability in circumstances associated with economic downturn or with difficult market conditions (Hartman, 2003). In such circumstances, when business firms experience strong declines in revenues and profitability, managements of companies with high amounts of debt need to take rapid action in order to establish stronger and more competitive financial bases for their firms (Hartman, 2003). Large business organisations like Deutsche Telecom or France Telecom have had to sell assets or merge with competitors in order to deal with the challenges arising out of high leverage (Hartman, 2003). The recent collapse of Lehman Brothers underlines the risks of excessive leverage.
Business organisations that are incapable of reducing their costs in comparison with other market players will essentially be hurt by the market and rapidly lose their profitability (Slatter & Others, 2006). The maintenance of a flexible cost base in swiftly altering market conditions is a business imperative for most companies (Slatter & Others, 2006). Whilst adopting outsourcing alternatives for both production and services provides organisations with options to convert fixed costs into variable costs, such options are limited, especially in key or core areas where organisations are required to maintain and develop their competitive advantage (Slatter & Others, 2006).
Methods of Financial Restructuring
Financial restructuring can occur in many ways like internal reorganisation, elimination of departments and manpower, reduction or elimination of costs, restructuring of debt, share buybacks, mergers and acquisitions, demergers, court related procedures and finally liquidation and insolvency (Davis, 2004).
Whilst financial restructuring is essentially an undesirable business alternative for most senior managements and, (except when arising out of hostile mergers or acquisitions), possibly indicates the occurrence of grave errors in the running of businesses, it is necessary for the board of directors to accept the need to financially restructure their businesses as and when such need arises (Davis, 2004). Private equity firms, because of their effective monitoring of managerial actions, are often in a position to force alterations and accelerate restructuring (Davis, 2004). Whilst some businesses require changes at senior management levels for effective refocusing and restructuring, early senior management commitment towards financial restructuring always helps in improving the effectiveness of the process (Davis, 2004).
Most financial restructuring processes start with cutting of unnecessary costs and redeployment of inefficiently used resources as swiftly as possible (Blatz & Others, 2006). Once the direction of such restructuring is decided by the senior managements of business firms, assets that have been determined to be surplus need to be disposed efficiently (Blatz & Others, 2006). Whilst swiftly conducted sales are by and large known to reduce sale proceeds, the conduct of structured auctions and the build up of adequate competitive tension ensures that such assets are sold at the best possible prices (Blatz & Others, 2006). In certain situations, where such assets are required for future businesses, business organisations often opt to take them off the balance sheet, either through sale and leaseback arrangements, or through the construction of alliances and joint ventures (Blatz & Others, 2006). Such cost reduction or asset divestment plans also incorporate avenues for deployment of unlocked funds; it is equally important that management of such free cash is done with adequate care and responsibility (Blatz & Others, 2006).
Financial restructuring that essentially aims to tackle falling profitability or over-leveraged balance sheets require early communication and discussion with shareholders and creditors for the development of an achievable and practicable workout plan (Hartman, 2003). Shareholders may well be unwilling to bring in additional funds into businesses that are doing badly, even as creditors will wish to avoid options like court based administration or legal insolvency procedures, because of the associated delays and costs (Hartman, 2003). The preparation of a credible financial restructuring plan can help in making creditors agree to accepting of significant modifications in their repayments, as well as in the terms of such repayment (Hartman, 2003). Financial restructuring, with regard to debt, can be carried out so as to include short term payment reliefs or ballooned repayments after business transformation (Hartman, 2003). Many restructuring exercises involve conversions of some part of debt into equity in return for extension of the repayment period, provisioning of additional debt and/or lowering of liabilities (Hartman, 2003). Much of such debt restructuring depends upon the confidence of creditors in the achievability of the restructuring plans (Hartman, 2003). Business organisations negotiate a number of alternative financial structures to arrive at the optimal restructuring plan (Hartman, 2003).
Other methods of restructuring include mergers, de-mergers and share buybacks. It often becomes evident during the conduct of a restructuring process that it would be best for the business to be sold to a financial investor, merged with another business, or broken up into different units (Gilson, 2001). In some cases mergers, even though painful for the acquired company, give rise to important and valuable synergies (Gilson, 2001). The breaking up of a business into different units can on the other hand lead to better operational autonomies, improved direction and enhanced abilities of the de-merged businesses (Gilson, 2001). Companies, in share buyback programmes, distribute the excess cash in their possession to shareholders. The shareholders in such circumstances often get exit opportunities at premium prices, even as companies are able to reduce their liabilities on account of equity capital (Gilson, 2001). Such share buybacks are often done to improve market perceptions, show healthy financials, obtain tax advantages and improve promoter stakes (Gilson, 2001).
In situations where financial distress is high and more drastic measures are needed, administration or chapter 11 provide opportunities in the UK and the US for a formal and supervised modification of business claims (Slatter & Others, 2006). In such situations the objective is to sell the business or to preserve it as a going concern (Slatter & Others, 2006). Creditor claims in these circumstances are often frozen, even as radical restructuring plans are on occasion put into place (Slatter & Others, 2006). Such supervised processes aim to preserve creditor value to the greatest extent possible, often to the disadvantage of shareholders (Slatter & Others, 2006). Whilst the administration / chapter 11 process has often helped managements to reduce their creditor liabilities, such actions can also lead to apprehensive suppliers and customers renegotiating their business dealings with such forms negative impact on their future viability (Slatter & Others, 2006).
The last and most drastic recourse in financial restructuring pertains to insolvency or liquidation, where the business ceases to run and an appointed liquidator disposes the various assets and distributes them to creditors in line with their security levels (Slatter & Others, 2006). In such circumstances unsecured creditors and shareholders are the last to receive their money and often receive little payment (Slatter & Others, 2006).
The need for financial restructuring, more often than not, arises out of financial distress and can prove to be extremely costly, both for shareholders and for creditors, until and unless prompt action is taken at an early stage.
The ongoing economic crisis has led to numerous cases for financial restructuring, many of which have resulted in failure, with both banks and creditors being too hard pressed to provide the required support. With regard to big corporations, the survival of Morgan Stanley and Citibank and the collapse of Lehman Brothers in the aftermath of the sub-prime crisis reveal the effectiveness of external help in financial restructuring situations.
Experts state that close and transparent communication between three interested stakeholders, namely the senior management, key shareholders and creditors, is essential in order to avoid the likelihood of legal procedures, with consequently detrimental effect on business activities.
It has often been seen that managements wait till it is too late to effect financial restructuring that could have earlier provided good results. The obtaining of expert legal and financial counsel at early stages can well help managements in formulating and developing restructuring plans that are SMART (specific, measurable, achievable, realistic and time bound) in nature and provide stockholders and important creditors with required confidence.