Restructuring (sometimes referred to as reorganizing) is an action taken by corporations to change their ownership, capital, and operational structure, usually due to financial pressures. When a corporation can no longer meet its payment liabilities, it will either elect or be forced into a bankruptcy proceeding whereby a court will manage (through a trustee or administrator) the orderly repayment of its creditors. Most people are familiar with the liquidation form of bankruptcy (known as a "Chapter 7" in the United States), whereby the corporation is dissolved and the creditors form a line to receive their share of the proceeds. But in cases where the corporation's business would still be viable if not for the weight of its current liabilities, the corporation will instead be "restructured" so that it emerges from bankruptcy (known as a "Chapter 11"). The court will consider a plan in which employees and creditors will give up some or all of their rights so that the overall outcome will be as fair as possible.
The court has wide latitude during this process. For starters, because the corporation's assets cannot meet its liabilities, the stockholders will almost certainly have their shares delisted (if publicly traded), canceled, and declared worthless. Employees will also have their rights canceled or diminished. Their pensions and union contracts may be restricted or nullified; unpaid wages will be settled at some reduced amount.
Why do companies restructure?
Companies agree to restructure and thereby modify their capital structure or operations when they are in financial difficulties, such as Chapter 11 bankruptcy or because their debt load has become too large, which results in heavy interest expenses that are too large to cover using operational cash flows, but their underlying business model is solvent and could be operationally profitable if not for the pressure from debt. It is most often done to reduce its debt load or become more profitable.
A few more examples may be:
- Its new product or service may not have as much demand as expected, leading to earnings that are too low to pay off the debt acquired to finance the production of the said product or service.
- A financial crisis hurts it badly or reveals weaknesses in its business model. The 2008 financial crisis negatively affected many companies, which led to many companies having to restructure. The same was seen following the weak economic conditions due to the effects of the Covid-19 pandemic.
- It is confronted with an increasingly competitive market in an industry where it once held a substantially larger market share.
In truth, it would be impossible to cover every reason why a company may choose to restructure. There are countless reasons why a company's management may believe that a business model is no longer viable, that a different business model could yield greater profit or be more competitive, or why a company may find itself in financial trouble that management feels can be resolved through a different business strategy or capital structure.
Types of Corporate Restructuring
There are many ways a company may attempt to restructure its business. Most of these strategies can be sorted into two different categories: financial and organizational. Many times, if a company is really struggling they may attempt multiple different methods to restructure and have a competitive outlook for their business. While not all companies employing the following strategies are seriously indebted, all of these strategies are used to gain a competitive advantage and generate greater revenue for them.
Some methods are not exceptionally drastic and change very little about a company, whereas others may change its entire business. Indeed, some of the following strategies have the potential to even change the industries a company engages in.
As with any process, the best method depends on the company that is involved and the circumstances it finds itself in. In some situations, a company may employ a group of specialists to help navigate the reorganization process and give advice on what strategies may have the most benefit. In many cases, the company may not have full autonomy and must satisfy the wishes of its creditors.
It deals with a company's finances. Rather than changing a company's production process, it is concerned with the way a company is sourcing funds and how it may be able to use them more effectively. This includes rearranging a company's portfolio of investments and managing the equity issued. In fact, these two practices are of a particular type known as portfolio and equity restructuring.
Capital restructuring is the practice of a company changing its ratio of debt and equity to create an optimum balance between the two. Balancing the levels of equity and debt is a delicate process in a company and they frequently assess their balance sheet in order to see if they are using leverage effectively or if they are at risk of using it too much. This could be achieved by various measures such as issuing more stock or taking out a loan in order to perform an equity buyback.
A decision to restructure debt deals with a company's debt structure and involves making a plan to pay off debts with the consent of a company's creditors. It plays a very important role especially in companies undergoing Chapter 11 bankruptcy and is explained in detail below.
Equity or portfolio restructuring
Equity reorganization is when a company splits its stock or makes unilateral decisions concerning the per-share value of that equity. This includes a stock split, reverse stock split, or stock dividends.
Portfolio reorganization is when a company re-evaluates its portfolio in an attempt to create a better investment outlook in the future. This typically changes a company's cross-holding pattern - when a publicly-traded company invests in another publicly traded company, or can affect a company's investments in securities.
It is the process of reducing debt payments or lengthening the debt schedule. There are multiple ways a company may be able to reduce its debt burden.
- Debt for equity swap: A company may be able to issue equity to the lender in order to reduce the amount owed to them. In some circumstances, a lender may even accept equity for the entirety of the amount owed.
- Decrease in interest rates: A company may be able to have its interest rates decreased so that it can afford to pay its loan installments.
- Decrease in balance: A lender may agree to reduce the principal amount so that the debtor is able to afford its payments. This may be referred to as a haircut and is sometimes agreed upon by a company's bondholders.
- Lengthen debt schedule: A lender may agree to have the debt paid back over a longer period of time, making it easier for the debtor to meet its payment obligations on time. Similarly, if a company cannot afford to pay back its loan in full a lender may allow that company to pay in installments, effectively lengthening the debt schedule.
Lenders allow companies to restructure their debt because it is generally better for both the debtor and the lender. If a company still has reliable earnings then it is often more profitable for the lender to accept less or allow a longer repayment schedule than it would be to liquidate the company and accept a share of its assets which may amount to nothing or a loss of principal in the best case.
It is an effort to change the existing business structure of a company. This can include changing the process through which a company creates products or services in order to become more efficient or rearranging its different segments. Often, in this process, a company changes its Chief Executive Officer (CEO) or internal employment structure, hoping that new leadership will bring a fresh change to the company and be better equipped to deliver solvency. While not always the case, it tends to be a much larger process than its financial counterpart and creates much bigger changes within the company.
Companies sometimes will restructure their financial position to prepare for certain types of organizational changes. Creating a better financial position within a company can help to make transitions and big changes go a lot smoother than they otherwise would. Generally, these two are hardly exclusive events, and a company that is struggling may use all the tools in its arsenal in order to make itself more competitive.
There are many different ways to reconfigure a company organizationally, and below we focus on a few of the most common ways a business might change its operations.
A spin-off is when a company decides to relinquish its control of a segment of its business and create an independent company from that segment. A spin-off involves dividing a company into multiple independent companies or breaking off one unit of a company from its parent. In such events, the parent company usually retains a substantial share of equity in the newly formed company. This may be done when a company believes that a segment would be more profitable and valued higher independently from the parent company. Many companies find that they are balancing too many projects at once and it would be more efficient if they refocused their efforts on their original mission.
When spin-offs are created, the parent company typically owns a substantial portion of the stock of the spin-off, which it then gives to stockholders in the form of a dividend. In some cases, the parent company may offer stockholders shares of the spin-off company at a discounted rate in exchange for shares of the parent company.
Spin-offs have much more volatile stock valuations than their parent companies because of how newly independent they are and also because they generally are much smaller. These companies may perform well in strong markets but volatility can hurt them in weak markets.
Mergers & Acquisitions
A merger is when two companies combine operations in order to become a single company. There are a few different types of mergers, based on where in the supply chain the companies merge. A horizontal merger is when two companies that are in the same industry and share the same market merge to take over a greater market share. These types of mergers are often reviewed closely by officials in order to prevent monopolies. A vertical merger is when a company merges with one of its suppliers, generally to reduce its costs. These types of mergers come under much less scrutiny by regulatory agencies.
An acquisition is when a company purchases another company. In a simple acquisition, a company purchases the majority stake of another company but does not change its name or its business structure. In other cases, a company acquires another and assumes a management role. This is much more likely to happen if the company being acquired is struggling to overcome its debts. In some cases, an acquisition results in a company buying an indebted company's assets and liquidating them upon acquisition for a profit.
Usually, companies restructure their financial position before preparing for mergers and acquisitions to get the best deal possible for their company.
Downsizing is just about exactly what it sounds like. It is the significant decrease in the operations and production of a company and may occur when a business has grown larger than the demand for its products or has become so large that its operations have become inefficient and stretched thin. It may also occur if a company finds itself in a much more competitive market than it was initially, and is forced to share its market with many more competitors. In the process of downsizing a company attempts to shrink itself to a more manageable size, often firing many employees and attempting to cut its supply to a reasonable size. While many employees are fired in the process of downsizing, it can also increase the workload of employees that remain in the company. This can occur because a company is failing to scale properly and its marginal costs are increasing leading to reduced efficiency, or if demand for its products and services is not meeting supply. Unfortunately, downsizing has many negative effects on a business in the long run. It can put too much stress on the company's remaining employees and can result in the loss of productivity, departure of valuable employees as well as weaker worker morale.
Downscoping is a specific type of downsizing that focuses on reducing the scale of particular segments of a company. Downscoping is when a company finds itself spread thin among many different pursuits and decides to refocus its operations on its main business and shrink or cut other segments of its business. One of the ways a business might reduce its scope is by creating a spin-off.
It does not need to be a formal process. In many cases, companies will implement some form of it before their debt becomes overwhelming. The process for companies that are still solvent is decided by the management of the company and its stakeholders. Companies often undergo various types of reorganization before selling the company or other such large organizational changes.
When it is done due to insolvency, it is called Chapter 11 bankruptcy in the United States. This type of bankruptcy is more forgiving than Chapter 7 bankruptcy, which is when a company liquidates its assets and pays back creditors as much as possible before completely shutting down. There are two ways a Chapter 11 bankruptcy can be filed, either by the company, called a voluntary petition, or by a creditor that meets certain criteria, called an involuntary petition. Once a company has filed for bankruptcy, it must submit a number of financial documents and information to the courts, and must come up with a reorganization plan to be confirmed by the court, and is voted on by ballot by creditors who generally will make less money than original balances. In order to be approved by the banks, the plan must accommodate the creditors as well as be workable, however, it does not need to be guaranteed to work. In some cases, a court may overrule a creditor's disapproval and confirm the reorganization plan.
The process is overseen by a U.S. Trustee or a bankruptcy administrator that monitors the revenue and expenses of a business and may impose certain requirements on the company in regards to reporting financials and some other financial matters. In addition, a U.S. Trustee conducts a meeting with the creditors and may question the Company's officials under oath about its business operations and its debt burden.
The company also works with bankers, who lend help on the reorganization process and advice on how to go about it. Experienced bankers serve troubled businesses that are facing, coping with, or recovering from bankruptcy. They are expected to be well-versed with Bankruptcy Code. Large firms such as investment banks and Big4 professional service firms often have a specialized department within corporate finance/ investment banking divisions to help deal with the various nuances of this process. Divisions that help restructure the debt of a company may consist of a group representing it to negotiate with its creditors to obtain forgiveness of their debt balances and/or to avoid bankruptcy.
The video below from Khan Academy teaches gives a good overview of the Chapter 11 bankruptcy process.
Restructuring: Winners and losers
The decision to restructure typically favors debt and bondholders. "Typically" is used here because, in some extraordinary circumstances, such as the auto bailouts from a few years ago, the government may intervene to support employee rights at the expense of bondholders. However, in the majority of cases, the bondholders will either have their debt settled at a reduced amount, restructured as to tenor, principal amount, or interest rate, or subordinated to a new lender willing to infuse the corporation with fresh capital.
The company itself usually benefits greatly from the process than undergoing liquidation. If it is able to recover instead of closing its doors, it is to the great advantage of its employees, management, and shareholders. It can also benefit debt holders more than liquidation, as the division process from the liquidation of assets among lenders usually leads to higher losses as compared to when a company is able to continue its operations and generate revenue into the future. In essence, this process may be able to create a lot of winners, although as pointed out above some people "win" more than others.
While it can be an effective way to reorganize a business to run more effectively and improve revenue outlook, it is not always without pain. It has a number of noteworthy downsides that can hurt a business, although it is typically better for a company to take the risk of short-term pains in order to position itself for greater success in the future.
It can be expensive in terms of both money and time. The larger the shift in operation the more costly this process can be for a company. In the case of Chapter 11 bankruptcy, legal fees can add up quickly. The fees that accrue from a company helping with the process, such as creditors, can also be quite costly. Designing and implementing a newly organized way of business is a demanding process that requires lots of attention and can take resources away from other important things. At the same time, the confusion and rearrangement may reduce productivity and decrease income. All this can come at a time when a company needs income and stability more than ever, yet it is rarely that easy. To the better effect of the company, the news it generates can sometimes boost a company's stock price if investors welcome the news and are confident in the company's ability to recover.
Employees can become startled at the news however and may worry about the ways that the business might change. As mentioned above, employees may have their rights stripped away in favor of creditors and have a right to be concerned about what might happen to their own finances. In many cases, company reorganization will reduce certain ventures or outright retire certain branches within it, meaning considerable layoffs that employees are right to be worried about. While it may be somewhat unavoidable, concern among employees can be unhealthy for a company and transparency can be very valuable during such times.
In Russia, both creditors and debtors can petition for bankruptcy. Russian laws surrounding the process are not entirely dissimilar to the Chapter 11 bankruptcy in the United States. A creditor may file a petition for bankruptcy if a debtor has not paid their debts for three months. Like in the United States, a debtor may enter into financial rehabilitation, which is what the formal process is called in Russia. The debtor may be subject to asset seizure, a financial rehabilitation plan, a modified debt repayment schedule, supervision by an arbitrage administrator, and external supervision. In order to be eligible for financial rehabilitation creditors must vote in favor or else the indebted company will be liquidated. The creditors also must approve the financial rehabilitation plan.
The process in England is similar to America's and has recently made changes that even more closely resemble the United States' process. You do not need to be an English company in order to pursue it in England, but only prove a significant connection to the country. If the company is expected to have financial troubles in the future, work is carried out to create a plan of reorganization in order to minimize damages. The plan must receive approval from those who own at least 75% of the debt. The process in England involves two court hearings, one where the court decides if the company is eligible and another to confirm the plan. More recently, England implemented cross-class cram down, meaning that a viable plan may continue in certain circumstances even if a group of creditors refuses to agree to it. This process is already available in the United States.
In China, the process is not dissimilar to the process in the United States. Companies that are unable to pay their debts can apply for reorganization with the Chinese courts and petition to restructure the company. Reorganization often includes similar measures of canceling or reducing the debt load, extending the payment deadlines, debt for equity swaps, and reorganization of the company.
In India, the process similarly seeks to find a resolution between the creditor and the debtor that restabilizes the debtor company. While formal routes exist, India also allows companies to make informal agreements surrounding reorganizing and paying off debt. In the formal path, India must find that a company meets its definition of insolvency, and then the process of reorganization may commence. In this process, it is not necessary for a debtor company to agree to the process if the creditors' petition for the company to be restructured. The process puts an interim resolution professional in place who takes over the company, and the power of the board of directors is suspended. The plans must obtain 66% approval from the creditors' committee. If a resolution is not met within 330 days the debtor company is mandatorily liquidated.
Example: General Electric
On November 9, 2021, General Electric (GE) announced that the company would restructure into three separate units, spinning off their energy and healthcare units, with the main arm focusing on aviation. This should take effect in early 2023.
General Electric has been struggling for some time, with its problems stemming from the collapse of the housing market in 2008. This financial crisis revealed weaknesses in GE and the stock slipped 42% that year. After making poor acquisitions GE continued to struggle underneath the weight of its debt and was taken off of the Dow Jones Industrial Average (DJIA) in 2018. Covid-19 weakened GE after a positive year in 2019, with its aviation arm taking a heavy blow. Since 2008, GE has gone through a number of CEO changes in an attempt to garner strong leadership and gain a better position.
With its announcement to restructure GE emphasized its previously stated goal of paying off $75 billion in debt by the end of 2021, saying that they are on track to meet this objective. GE stated that it is now on track to bring its net debt to EBITDA ratio to less than 2.5x by 2023.
China's property sector had run into significant trouble in 2021, with the collapse of property giant Evergrande and the following debt troubles of Kaisa, another Chinese property giant. Evergrande is the largest issuer of U.S. dollar-denominated offshore high yield bonds and Kaisa is the second largest. In 2021 Kaisa missed a payment on a wealth management product during a time when investors had already begun to worry about their illiquidity and mounting debt.
Kaisa's plan relies heavily on debt reorganization. Kaisa announced that they had already restructured 1.1 billion yuan worth of debt for the wealth management products they had defaulted on earlier, and intend to repay the outstanding 397 million yuan debt, and are in negotiations. As for their U.S. dollar-denominated offshore bonds, Kaisa is reorganizing debt payments due in December to be due in 2023, and instead of being worth $400 million, they will be worth $380 million.
This news is being welcomed strongly by investors who seem to be optimistic about the property giant's plans to restructure its debt. The company's stock surged 20% before closing around 14% up by the end of the trading day following this announcement.
- Capital Structure
- Financial Institutions Group (FIG)
- Investment Bank (IB)
- Investment Banking Division (IBD)