Private Equity & Corporate Restructuring.pdf

Private Equity & Corporate Restructuring

Jasmee S. Johnson

School of Business, Liberty University

BUSI 536 –Mergers & Acquisitions

Dr. Darville

December 5, 2021

Author Note

Jasmee S. Johnson

I have no known conflict of interest to disclose. Correspondence concerning this article

the shares remain with the parent company’s shareholders. Although the spin-off company has

separated from its parent company, it has no tax implications. Spin-off companies are becoming

more and more critical in the business world: it is a phenomenon relative to the entry into a

market by a firm [ CITATION Mol19 \l 1033 ].

An equity carve-out is a variation of a divestiture that involves the sale of an equity

interest in a subsidiary to outsiders [ CITATION Gau181 \l 1033 ]. An equity carve-out

establishes new shareholders and generates a positive cash flow. Larger, less-leveraged parents

more often choose to divest through carve-outs because carve-outs are larger, have less debt in

their capital structure, and are less risky, all of which makes them more attractive to an outside

investor [ CITATION Sha95 \l 1033 ].

Divestitures are commonly used business practices that may take place for various

reasons. Companies divest to help markets evaluate units separately from the parent company.

Divestitures, understood as the parent company’s disposal and sale of assets, facilities, product

lines, subsidiaries, divisions, and business units, are emerging as a central research topic in

several areas [ CITATION Mos08 \l 1033 ]. Divestitures can be viewed as a reflection of the

economic patterns, reverse previous strategic decisions, and be proactive. A spin-off is a type of

divestiture, and an equity carve-out is a partial divestiture. Divestitures and spin-offs can create

Increase in Divestitures During the 1970s

Divestitures have been used to rebuild the economy in the United States since the mid-

1970s. Divestitures help to create value for companies during the mergers and acquisitions

process. Companies increased their presence within the stock market in the 1960s, and they did

this through mergers and acquisitions with publicly traded companies. The stock market

performance seemed to play a determining role in the volume of divestitures, and when the

market performed well, the number of divestitures increased [ CITATION Gau181 \l 1033 ]. In

the late 1960s and early 1970s, companies targeted smaller private and public companies outside

their firm’s primary business line, resulting in diversification and conglomeration of larger

companies [ CITATION But13 \l 1033 ]. During this time, acquisitions became a way to

conserve corporate wealth. In the 1970s, the Securities Exchange was the deciding factor in the

volume of divestitures. The formation of conglomerates caused a decline in the stock market and

led to the divesture of underperforming departments and previously merged companies

[CITATION Kle01 \l 1033 ]. Under the pressure of weaker economic demand, firms were forced

to sell off divisions to raise funds and improve cash flow, and divestitures jumped to 42% of total

transactions in 1975, and the trend peaked in 1975 [ CITATION Gau181 \l 1033 ].

The Bible helps us understand patience and timing and that everything happens for a

by upper management to improve the company’s financial state or move the company in a new

strategic direction. One primary reason for voluntary divestiture is to move a company out of a

particular line of business that it feels no longer fits into its overall strategic plans [ CITATION

Gau181 \l 1033 ]. So, the company chooses to divest the part that no longer fits into the strategic

plan. Voluntary divestiture can create alterations in the firm’s life cycle [CITATION Pas06 \l

1033 ].

Another reason for voluntary divestiture is reverse synergy. Reverse synergy means that

the parts are worth more separately than they are within the parent company’s corporate structure

[ CITATION Gau181 \l 1033 ]. A reverse synergy is a non-traditional approach to gaining a

competitive advantage, and management can implement new management within the divested

divisions [ CITATION And12 \l 1033 ].

The Bible teaches us that we can work hard to implement change that can lead us on a

better path for the future. These changes can also include parting ways with things or people

hindering us from growing. “If your right eye causes you to sin, pluck it out and cast it from you,

for it is more profitable for you that one of your members perish than for your whole body to be

cast into hell. And if your right hand causes you to sin, cut it off and cast it from you; for it is

more profitable for you that one of your members perish than for your whole body to be cast into

an outstanding debt of $1 billion and maintain its annual dividend of $2.20 [ CITATION Jon15 \l

1033 ]. Darden used the spin-off method and spun off some of its land and real estate into a Four

Corners Property Trust. Darden Restaurant’s spin-off method is unique, although the company

exclusively sold off profitable resources. The overall goal of any spin-off is to part ways with

parts of the business that is not creating value and bringing success to a company. “Therefore, if

anyone is in Christ, he is a new creation; old things have passed away; behold, all things have

become new” (King James Bible, 1769/2017, 2 Corinthians 5:17).

The Six Step Divestiture and Spin-off Process

The divestiture and spin-off process is an extensive planning process. Divestitures focus

on driving positive corporate change by selling rather than buying assets, lines of business, or

subsidiaries [ CITATION Fel14 \l 1033 ]. To ensure that the results are successful, firms must

utilize and follow the six-step process.

The first step in the divestiture and spin-off process is the decision-making step. In this

step, the parent company must decide whether divestiture is an appropriate direction. The

company can only decide after a thorough financial analysis of various alternatives has been

completed [ CITATION Gau181 \l 1033 ].

According to Gaughan (2018), the second step is to develop a restructuring plan. The

The third step is the actual selling of the business. During this step, the seller must find a

buyer for the asset. To ensure the successful completion of this step, an investment banker

facilitates this transaction. They will usually prepare a confidential memorandum featuring

relevant information that would pique the interest of potential buyers [ CITATION Gau181 \l

1033 ].

The fourth step requires that the shareholders approve the plan that has been developed in

the first three steps. The plan is submitted to the shareholders at a meeting, which may be the

customarily scheduled shareholders’ meeting or a special meeting to consider only this issue

[ CITATION Gau181 \l 1033 ]. Lastly, the shareholders will decide if the plan needs further

improvement or agree to the developed plan.

The fifth step is the registration of the shares with the Securities and Exchange

Commission (SEC) if the transaction requires the issuance of shares. During this step, a

prospectus must be produced. A prospectus is a part of the registration statement and must be

delivered to all the shareholders who will receive stock in the spin-off entity [ CITATION

Gau181 \l 1033 ].

The final step is the finalization of the deal. Consideration is exchanged, and the division

is separated from the parent company according to a prearranged timetable [ CITATION

Wealth Effects

There has been much debate regarding the stock market and divestitures. According to

Gaughan (2018), shareholders benefit significantly from divestitures. Divested or spun-off

entities must remain economically viable so that the smaller entity can provide a higher

economic value standing alone than when it was part of the parent corporation [ CITATION

Gau181 \l 1033 ]. Numerous studies have investigated the impact of divestitures on shareholder

wealth. Some studies have concluded that divestitures positively affect the parent company’s

stock return and that shareholders have positive economic gain from selloffs [ CITATION

Tes20 \l 1033 ]. Although upon the announcement of the takeover, there can be a negative wealth

effect for the firm, there is no significant effect of the wealth effect and spin-off combined.

Tax Consequences of a Spin-off

One of the significant advantages of a spin-off over an outright divestiture is that the

spin-off may qualify for tax-free treatment, and this can be done if the transaction meets certain

Internal Revenue Code requirements (Sections 354 and 355) [ CITATION Gau181 \l 1033 ]. One

requirement of Section 355 is that the parent company distribute “control” of shares in the spun-

off company, which is defined as shares representing at least 80% of the total combined voting

power and at least 80% of any non-voting shares, and the spin-off must be carried out for a

because of this, you also pay taxes, for they are God’s ministers attending continually to this very

thing. 7 Render therefore to all their due: taxes to whom taxes are due, customs to whom

customs, fear to whom fear, honor to whom honor” (King James Bible, 1769/2017, Romans

13:6-7).

Differences Between a Liquidation and a Reorganization

Numerous options are available to a company that faces financial and profitability issues.

Divestment is an option for a company seeking to regain financial stability. A company may also

seek bankruptcy as an option. Management can also choose to liquidate assets to satisfy

liabilities or enter reorganization negotiations to increase the company’s profitability.

A reorganization plan is a flexible option that allows a company to continue to operate

while implementing changes to help the company become a more profitable organization

[ CITATION Gau181 \l 1033 ]. During a reorganization plan, debtors renegotiate the terms of the

debts. If a company is financially unstable, reorganization can assist with consolidating debts and

regulating the agreements to get the company back in the right direction. The reorganization

plan: (1) divides the creditors into classes based on the nature of their claims; (2) proposes

treatment of each class of claims; and (3) provides the means for the execution of the plan, the

goal of which is to repay the creditors, at least in part ultimately, and to have the successor entity

the liquidation of the companies assets to repay the creditors. Once the company has liquidated

its assets, the company no longer exists.

The significant difference between a reorganization and liquidation is its future and

whether or not it continues to operate. Management that can agree on a reorganization plan can

continue operating and find ways to become more profitable while companies that liquidate their

assets cease to exist. Another difference is the repayment of the creditor. In a liquidation

proceeding, creditors can only retrieve a limited amount of the owed debt. In contrast, a creditor

that agrees to a reorganization plan can retrieve the total amount of the owed debt. The Bible

teaches us that we should always weigh our options, and the same thing should be applied to

business. In the case of reorganization and liquidation, does a business want to figure out a more

profitable plan, or does it just want to sell its assets and close, but with whichever choice, God

should guide the final decision. “Trust in the Lord with all thine heart, and lean not unto thine

own understanding. In all thy ways, acknowledge him, and he shall direct thy paths” (King

James Bible, 1769/2017, Proverbs 3:5-6).

Advantages and Disadvantages of Chapter 11 Bankruptcy

Chapter 11 bankruptcy is a plan that helps a financially unstable company reorganize

without liquidating assets and stopping operations (Fisher et al., 2019). Chapter 11 helps a