MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Editorial Board
Mr. Amit Kumar
Assistant Professor, Shaheed Sukhdev College of Business Studies,
University of Delhi
Dr. Rishi Taparia
Associate Professor, Amity College of Commerce & Finance,
Amity University, Noida, Uttar Pradesh

Content Writers
Subhash Manda, Gurdeep Singh, Dr. Rooplata,
Dr. Rupesh Sharma, Mr. Ranjeet Kumar Ambast
Academic Coordinator
Mr. Deekshant Awasthi

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

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Ms. Anjali Sain

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L E S S O N

1
Corporate Restructuring
Subhash Manda
Assistant Professor
University of Delhi
Email-Id: subhashchoudhary98732@gmail.com

STRUCTURE
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1.1 Learning Objectives

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1.2 Introduction
1.3 Meaning of Corporate Restructuring
1.4 Needs of Corporate Restructuring
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1.5 Scope of Corporate Restructuring
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1.6 Modes of Restructuring
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1.7 Strategies Mergers & Acquisitions
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1.8 Global Scenario
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1.9 Indian Scenario
O L
S
1.10 Summary

L /
1.11 Answers to In-Text Questions

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1.12 Self-Assessment Questions
C
1.13 References
E /
D C
1.1 Learning Objectives
‹
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To understand the different kinds of things that fall under the term “corporate
restructuring.”
‹ To comprehend the goals or purposes underlying these corporate restructuring
exercises.
‹ To understand present scenario of corporate restructuring - Global and Indian.
‹ To understand the structure of each form of corporate restructuring.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 1.2 Introduction

The two main methods of growth for business organisations are organic
growth and inorganic expansion.
Internal initiatives, such as business or financial restructuring, that increase
the organization’s customer base, sales, and revenue without altering the
company’s legal status are what lead to organic growth. An organisation

i
can achieve faster growth through inorganic growth, allowing it to skip

l
a few steps on the growth ladder. One of the most crucial strategies for
h
etc.
D e
ensuring inorganic growth is restructuring through mergers, amalgamations,

of
The term “corporate restructuring” refers to a restructuring process carried
out by a company enterprise. Redesigning one or more business-related

i ty
components is what it entails. Corporate restructuring, then, is a thorough

r s
process that a firm can use to streamline its operations and improve its

e
position for accomplishing both short and long-term corporate goals. A

v
n i
company may expand over time as the value of its goods and services is
understood, but this is a lengthy procedure. It may also expand through
U
an inorganic process, represented by a sudden increase in the workforce,
,
L
clients, and infrastructure resources, which will improve the entity’s

O
overall revenues and profits.

S
L /
The business environment is evolving quickly in terms of technology,
competition, goods, people, places, markets, and customers. Companies are
O
expected to innovate and outperform the competition in order to consistently
C
E /
maximise shareholder value; thus, simply keeping up with these changes is
not enough. Inorganic growth tactics like mergers, acquisitions, takeovers,

D C and spinoffs are viewed as crucial engines that help businesses enter new

©D
markets, expand their customer base, cut competition, consolidate and
grow in size quickly, and utilise new technology with respect to products,
people, and processes. Inorganic growth techniques are therefore seen as
rapid business restructuring options for growth.

1.3 Meaning of Corporate Restructuring

Corporate restructuring is the process of making big changes to a
company’s business model, management team, or financial structure in

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 C C

order to deal with problems and improve the value of the company’s Notes
shares. Restructuring can lead to big layoffs or even bankruptcy, but
the goal is generally to minimise the effects on employees as much as
possible. Restructuring might involve selling the company or merging it
with another one. Restructuring is a business plan that companies use for
long-term sustainability and success. Shareholders or creditors could force
a restructuring if they think the company’s current business plans aren’t
enough and make them lose money on their investments. The nature of
these dangers can vary, but companies often opt for restructuring when
h i
they lose market share, their profit margins go down, or the power of
e l
D
their brand goes down. Other reasons for corporate restructuring include

of
not being able to keep talented employees and big changes in the market
that directly affect the business plan of the company.

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It refers to the process of making significant changes to a company’s

s i
business model, management team, or financial structure. The purpose of

r
this is to address challenges and increase shareholder value. Corporate
e
v
restructuring is indeed an example of an inorganic growth strategy.
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1.4 eeds of Corporate estructuring n
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Corporate restructuring is the process of reorganising a company’s operations
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to improve productivity and profitability. Restructuring is a strategy for
S
L /
altering the organisational structure to help the company reach its strategic
objectives. It includes significant adjustments to an organisation.

C O
/
The purpose or aims of the organisation will determine which strategy is

C E
chosen, and since different businesses have distinct purposes and goals, each
business will need a unique strategy. Corporate restructuring attempts to

D
accomplish different things at different times for different firms. However,

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the one purpose that remains consistent across all corporate restructuring
efforts is to remove the disadvantages and combine the benefits.
There are several reasons why a Corporate Restructuring process needs
to be done:
u Focus on core competence, operational synergy, cost reduction and
efficient allocation of managerial capabilities.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes ‹ Strike a balance in the utilisation of the infrastructure and resources

that are available.
‹ The ability to take advantage of economies of scale by expanding
into domestic and foreign markets.
‹ The rejuvenation and rehabilitation of a sick department by offsetting
the department’s losses with the profits of a flourishing business.
‹ Acquiring access to ongoing scientific research and technical
advancements, as well as a steady supply of raw materials.
h i
‹

e l
Enhance the performance of the company in order to gain a competitive

D
edge by embracing the fundamental shifts brought about by advances

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in information technology.
‹ Capital restructuring through the use of an appropriate mix of loan

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and equity funds with the goal of lowering the cost of repaying

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debt and increasing the return on capital utilised.

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i v
1.5 Scope of Corporate Restructuring

U n
Corporate restructuring is the process of arranging the business activities

L ,
of a company as a whole so that the company can reach certain goals
that have already been set. Among these goals are the following:

S O
/
‹ Orderly revamping of the company’s activities;
‹

O L
Using extra cash from one business to finance profitable growth in
another;

/ CReducing risk; and

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‹

‹ Developing the company’s core strengths.

DD
When we say “corporate level,” we could be talking about a single

©
company that does one thing or an enterprise that does many things. It
could also mean a group of companies that do things that are related
or unrelated. When these kinds of businesses think about restructuring
their activities, they have to look at the whole picture in order to come
up with a plan that will work at all levels. But a plan like this could be
presented and put into place in stages.

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 Corporate restruCturing

In addition to enhancing the competitive position of an individual Notes

company, the primary objective of corporate restructuring is to maximise
the contribution of that company to the overall corporate goals. Enhancing
one’s competitive advantages also involves capitalising on the strategic
assets that a company has built up over time, such as natural monopolies,
goodwill, and exclusive rights obtained through licencing, among other
things. As a result, restructuring could assist in gaining a competitive
advantage over other companies.
Technology advances because of competition. Cross-country competition is
h i
different from competition that takes place within a country. Innovations
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and inventions don’t happen just because people want to be creative
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of
or because they get tired of the things that are already around them.
Innovations and inventions happen because people have to in order to

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keep up with the competition. In a world with a lot of competition, people

s i
talk a lot about cutting costs and adding value. Money flows into the

r
production stream so that companies can compete with each other and
e
v
offer the best goods at prices that buyers can afford. People are pushed
i
U n
to think big by global competition, and this makes them ready to face
global challenges. In other words, global competition pushes businesses

L ,
and individuals to get fit around the world. So, competition is an important
factor. Corporate restructuring is a process that could be used to make a

S
company and business more competitive.O
L /
Corporate restructuring’s scope involves improving the economy (cost

O
reduction) and increasing effectiveness (profitability). A business must

C
/
restructure itself and focus on its competitive advantage if it is to expand

C E
or survive in a highly competitive market. Companies in this environment
must be able to combine all of their resources and use them effectively if

D
they want to survive and expand. By merging smaller companies, a larger

©D
corporation can benefit from economies of scale. A larger size results
in a greater corporate status. Because of its prominence, it can use the
same to its own benefit by being able to raise more money at a lower
cost. Profits result when the cost of capital is reduced. The company can
expand on all levels and consequently become more and more competitive
when funds are available.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 1.6 Modes of Restructuring

Modes of Restructuring

Financial Organizational
Market &

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Portfolio
i
Restructuring Restructuring
Technological
Restructuring
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Restructuring

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1. Financial Restructuring

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The word “financial structure” refers to the allocation of the corporate

i
flow of funds, whether in the form of cash or credit, as well as the

s
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strategic or contractual decision rules that control the flow and determine

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the value contributed as well as its distribution among the many corporate
v
n i
constituencies. It encompasses substantial changes in a company’s capital
structure, such as leveraged buyouts, leveraged recapitalizations, and debt-

, U
for-equity swaps, as well as mergers, acquisitions, joint ventures, strategic

O L
alliances, and other similar transactions. The scale of the investment base,
the ratio between active investment and defensive reserves, the focus

/ S
of investment (choice of revenue source), the rate at which earnings

O L
are reinvested, the ratio between debt and equity contracts, the nature,
degree, and cost of corporate oversight (overhead), the distribution of

/ C
expenditures between current and future revenue potential, and the nature

C Eand duration of wage and benefit plans are the elements that make up the
corporate financial structure. Financial restructuring provides economic
D
©D
value. Restructuring the capital base and obtaining funding for
new projects are both aspects of financial restructuring. Financial
restructuring enables a company to emerge from a difficult financial
condition without having to liquidate.
Financial restructuring is carried out for a variety of business purposes:
‹ Poor financial results,
‹ External competition,

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 CORPORATE RESTRUCTURING

‹ Market share erosion or loss, and Notes

‹ Emerging market prospects.
2. Organisational Restructuring
A change in the organisational structure of a concerned entity is referred to
as organisational restructuring. It entails changes to the firm’s organisational
structure such as lowering the hierarchical level, decreasing staff, revising
job profiles, and changing reporting relationships. These improvements
require the collaboration of employees at all levels. Some businesses
h i
change their organisational structure in order to develop and create
new departments to serve markets that are expanding. Other businesses
e l
D
of
restructure their organisational structures to reduce or eliminate departments
in order to save money. As a result, organisational restructuring assists

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in reducing expenses and settling outstanding debts in order to continue
with commercial activity.

s i
3. Market and Technological Restructuring
e r
i v
Market restructuring involves decisions with respect to the product market

U n
segments where the company plans to operate on its core competencies.
On the other hand, technical restructuring takes place whenever a new

L ,
technology is discovered that changes the way an industry performs.
This kind of restructuring typically has an impact on employees because

S O
it leads to new training initiatives and occasionally even layoffs as the

L /
business works to increase its efficiency. Alliances with third parties that

O
either possess the necessary technical knowledge or resources are also

C
required for this form of restructuring.
/
C E
Tata Consultancy Services Limited, a technology major from India, has
initiated a restructuring process with a focus on three core areas: Cloud,

D
Agile, and Automation. The company’s restructuring plan concentrates

©D
on various aspects such as manufacturing capacity, product, technical
and technological improvements, financial restructuring, employment
restructuring, organisational restructuring, purchasing restructuring, and
management restructuring.
Disney’s global technology group within the parks-and-resorts division
is currently undergoing a reorganisation that has unfortunately resulted
in some employees being let go from their positions. The company is

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes implementing a strategy to eliminate certain positions and replace them

with others that align with their long-term technology goals.
4. Portfolio Restructuring
It refers to the significant changes made by a firm in terms of the assets
it owns or the lines of business it operates in. These changes may include
liquidations, divestitures, asset sales, and spin-offs. It is important to
understand that a company may decide to restructure its business for

i
various reasons. One reason could be to sharpen their focus by disposing

l h
of a unit that is not central to their core business. Another reason could

D e
be to raise capital or get rid of an operation that is not performing well
by selling off a division. Additionally, a company may engage in a

of
vigorous strategy of acquisitions and divestitures in order to restructure
its portfolio.

i ty
1.7 Strategies Mergers & Acquisitions
r s
v e
i
Various types of Mergers & Acquisitions strategies are:
1. Takeovers
U n
2. Mergers
3. Disinvestments
L ,
S O
/
4. Strategic Alliances

L
5. Joint Ventures

O
C
6. Demerger & Hive offs

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7. Reverse Merger

D C 8. Slump sale

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1.7.1 Takeovers/Acquisitions
An acquisition is when one company gains effective control over the
assets or management of another company without any combination of
the two companies. In the process of acquisition, it is possible for two or
more companies to maintain their independence as separate legal entities.
However, there may be a shift in the control of these companies.

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 CORPORATE RESTRUCTURING

It’s important to note that there are two types of acquisitions: Friendly Notes
and hostile. In the first scenario, the companies engage in collaborative
discussions, while in the second scenario, the acquisition target is resistant
to being purchased or the target’s board is unaware of the proposal.
The term “acquisition” typically denotes the act of a larger company
purchasing a smaller one. It is possible for a smaller firm to gain
management control of a larger or more established company and choose
to retain the latter’s name for the newly merged entity. The term we use
to describe this situation is a reverse takeover.
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Types of Acquisitions:
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‹ As the buyer, you will acquire the shares of the target company that
is being purchased, which will give you control over it. It’s important

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to understand that when a person or entity gains ownership control

i
of a company, they also gain effective control over the company’s

s
r
assets. However, it’s important to note that when a company is

e
acquired as a going concern, this type of transaction also carries
v
n i
with it all of the liabilities that the business has accrued in the past,
as well as all of the risks that the company faces in its commercial
environment.
, U
‹

O L
It can be stated that the assets of the target company are purchased
by the buyer. The cash that the target receives from the sell-off is

/ S
distributed to its shareholders either in the form of dividends or
L
through liquidation. When a buyer acquires all of the assets of a
O
C
target company, it can result in the target company being left with

/
no assets and essentially becoming an empty shell. It’s important
E
C
to note that buyers frequently opt for an asset purchase structure in

D
order to selectively choose the assets they desire while excluding any

©D
unwanted liabilities. It is crucial to consider potential liabilities that
may arise in the future, especially when they involve unquantifiable
damage awards. Examples of such liabilities include litigation
related to defective products, employee benefits or terminations, and
environmental damage. One drawback of this particular structure
pertains to the tax that several jurisdictions levy on the transfer of
individual assets. In contrast, stock transactions can often be organised
as similar kind exchanges or other agreements that are either tax-

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes free or tax-neutral for both the purchaser and the shareholders of
the seller.

1.7.2 Mergers
A merger is a process in which two or more companies are combined
together. This can be done through amalgamation, absorption, or by
forming a new company. When two or more companies come together,
they typically offer the stockholders of one company securities in the
h i
acquiring company in exchange for giving up their stock.
e l
Types of Mergers
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of
A horizontal merger refers to the consolidation of two or more companies
that operate in the same industry. This is an example of a merger with

i ty
a direct competitor that results in the expansion of the firm’s operations

s
within the same industry. It’s important to understand that horizontal
r
e
mergers are strategic business moves aimed at achieving economies of

i v
scale. This is done by reducing the number of competitors in the industry.

n
A vertical merger occurs when two companies operating in the same
U
,
industry but at different stages of production or distribution combine.

O L
When a company acquires its supplier or producers of raw materials, it
can lead to a form of vertical integration known as backward integration.

/ S
On the other hand, it is important to note that forward integration can

O L
occur when a company chooses to acquire a retailer or customer company.
“A vertical merger is a strategy that enables firms to achieve complete

/ C
integration by owning all stages of the production process as well as the

C Emarketing network.”

D
A co-generic merger is a merger between two companies that operate

©D
in the same or related industries, but do not offer the same products.
Instead, they offer related products and may share similar distribution
channels. This type of merger can provide synergies for the companies
involved. The potential benefit that can be derived from these mergers is
quite significant. This is because such transactions provide opportunities
for diversification around a common case of strategic resources.
A conglomerate merger refers to the combination of two companies
that operate in different and unrelated industries. In other words, the

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 CORPORATE RESTRUCTURING

businesses of the two companies are not related to each other either Notes
horizontally or vertically. It’s important to understand that in a pure
conglomerate, there are no significant shared characteristics between the
companies in terms of production, marketing, research and development,
or technology. A conglomerate merger refers to the merging of various
types of businesses under a single parent company. The purpose of a
merger is to utilise financial resources, increase debt capacity, and achieve
synergy in managerial functions.

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1.7.3 Disinvestments/Divestiture
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of
This refers to a complete sale of all or a significant portion of a company’s
assets or business divisions, typically for cash or a combination of

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cash and debt, and not in exchange for equity shares. To put it briefly,

i
divestiture refers to the process of selling assets as a whole rather than
s
r
in separate pieces. In the process of divestiture, a company disposes of

e
v
all or a significant portion of the assets belonging to one or more of its

i
undertakings or divisions or to the company as a whole.
n
subsidiary division:
, U
There exist several reasons why a company may choose to divest a

O L
It is possible for a subsidiary to be efficiently managed and generate

/ S
a profit upon sale, which can then be utilised to fund the operations
of the parent company.

O L
It is possible that the subsidiary may not align with the strategic
C
‹

E /
direction of the parent company. When a company sells its subsidiary,
it can prevent valuable business resources from being redirected
C
towards the subsidiary. This, in turn, can increase the likelihood
D
©D
of success for the parent company.
‹ It appears that the subsidiary is not meeting the expected performance
standards. It is possible for a parent company to sell its subsidiary
in order to prevent a bigger loss in the future or to avoid the costs
involved in a complete liquidation.
‹ It is possible that changes in regulations could lead the parent
company to divest its subsidiaries.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 1.7.4 Strategic Alliances

A strategic alliance is a formal agreement between two or more parties that
allows them to collaborate together towards specific commercial goals. In
a strategic alliance, it is important to note that each participating company
maintains its own independent existence. To clarify, the concept being
conveyed is that there is no formation of an individual distinct entity
from the existing entities. A strategic alliance refers to a collaboration

i
between businesses that aims to achieve mutual benefits, such as reducing
h
new markets.
e l
costs, sharing technology, developing products, and gaining access to

D
of
The fundamental concept is to combine resources and promote creative
concepts and methods with a common objective of sharing benefits.

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Examples of e-commerce websites are Flipkart and OLX. It’s important to

i
understand that strategic alliances can be a valuable tool for organisations
s
r
to accelerate their pursuit of opportunities. By engaging in a collaborative
e
v
effort with another individual or group, you can gain access to a wealth

n i
of knowledge and resources that they possess.

1.7.5 Joint Ventures

, U
O L
A Joint Venture is an independent organisation established by two or

/ S
more businesses to engage in business operations jointly. It involves the

O L
creation of a new business entity that is jointly owned, controlled, and
managed by two or more parties.
/ C
E
In this case, both parties have agreed to contribute equity and share the

D C revenues, expenses, and capital of the company. Vistara Airlines is a joint

venture between Tata and Singapore Airlines.

©D
There are two types of joint ventures:
u A project-based joint venture is an agreement between businesses
to collaborate on specific tasks.
u Companies enter into functional-based joint ventures to attain mutual
benefits.
A joint venture is a business arrangement where two or more companies
come together to share their assets, knowledge, and funds. This allows

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 CORPORATE RESTRUCTURING

them to combine their strengths and create a new entity without changing Notes
the original companies.

1.7.6 Demerger & Hive offs

A demerger is a type of corporate restructuring that involves separating
a company’s business operations into one or more distinct parts. A
demerger is a corporate strategy that is commonly employed to enhance
the efficiency of each segment. Following a demerger, each segment can
h i
concentrate on a more specialised task, resulting in smoother operations.
e l
Demerger can take these forms:
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1. Spin-off

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2. Split-up
3. Split-off
s i
e r
A spin-off is a process where one of the business divisions or undertakings

i v
transfers all or most of its assets, liabilities, loans, and business to another

U n
company. This transfer is done on a going-concern basis, and the shares
of the new company are allotted to the shareholders of the transferor
company in a proportionate manner.
L ,
O
Split-up involves the transfer of all or substantially all assets, liabilities,

/ S
loans, and businesses of a company to two or more companies on an

O L
ongoing basis. Similar to a spin-off, the shares in each of the new
companies are allotted to the original shareholders of the company on a

/ C
proportionate basis. However, unlike a spin-off, the transferor company
ceases to exist.

C E
As you can observe from the earlier statement, in a spin-off, the company
D
©D
that transfers its assets continues to operate at least one of its businesses.
If a company were to transfer all of its businesses to different companies
and become a shell company or cease to exist through liquidation without
winding up, this process would be referred to as a split-up.
In a split-off, it is important to note that the shareholders of the transferor
company do not receive shares of the transferee company in the same
proportion as they held in the transferor company. This distinguishes it
from a spin-off.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Typically, in a split-off, a portion of the shareholders receive shares in

the transferee company as compensation for their shares in the transferor
company.

1.7.7 Reverse Merger

A reverse merger is a type of merger where private companies acquire
a public company by exchanging the majority of its shares with a public
company. This results in the private company becoming a subsidiary of
h i
the publicly-traded company. This term is commonly referred to as a
e l
D
reverse IPO or a reverse takeover (RTO). The procedure mentioned earlier

of
enables the business’s owners to exercise greater control and command
over the recently acquired business.

ty
The process through which a privately held corporation obtains a controlling

s i
interest in a publicly traded one is referred to as a “reverse merger.” By

r
completing this acquisition, the private company will be able to save
e
v
both time and money compared to the typical path of completing an IPO.
i
U n
In order to gain a better understanding of the reverse merger process,
it is important to examine the various forms in which it can be found
within the market:
L ,
‹

S O
A public corporation may acquire a sizeable portion of a privately

L /
held business, giving the private business a majority stake in the
public business (typically greater than 50%). It is now possible to

C O
refer to the previously private company as public because it has

/ become a subsidiary of the formerly public company.

CE
‹ The merger of a public corporation with a privately held firm

D
typically takes the form of an exchange of stocks, and under these

© D circumstances, the privately held company maintains a large degree

of control over the public company.

1.7.8 Slump Sale

A slump sale refers to the transfer of one or more business undertakings
through a sale where a lump sum payment is made without assigning
specific values to the individual assets and liabilities involved in the

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 CORPORATE RESTRUCTURING

transaction. If a company decides to sell or dispose of its entire business Notes

operations, or a significant portion thereof, for a pre-determined amount or
under pre-determined conditions, when there is a lump sum consideration
involved, it leads to what is known as a slump sale.

1.8 Global Scenario

Over the course of the previous decade, corporate restructuring has
progressively emerged as a fundamental aspect of managerial practices and
h i
a widespread occurrence on a global scale. An unprecedented number of
e l
D
companies worldwide have undertaken various organizational changes, such

of
as division reorganization, asset restructuring, operational streamlining, and
division spin-offs, all with the aim of enhancing their overall performance.

ty
The utilization of this kind of equipment has facilitated the quick and

i
efficient response of numerous organizations to unforeseen challenges and
s
r
emerging prospects, thereby allowing them to regain their competitive

e
v
edge. Suppliers, customers, and competitors play an equally significant
role when working with a restructured company.
n i
, U
Globalisation provides consumers with a wide array of choices. This is
due to ever-evolving technologies, which are constantly changing market
L
dynamics. Additionally, established brands are facing challenges from
O
S
new value-driven competitors. Moreover, there is a noticeable increase

L /
in the movement of goods across different countries, contributing to

O
the globalised nature of trade. Furthermore, entry barriers to various

C
markets are gradually being reduced, allowing for more opportunities for

E /
businesses to expand internationally. As markets consolidate into fewer

D C
and larger entities, it can be observed that economies tend to become
more concentrated. In this international scenario, it is crucial to emphasise

©D
the importance of quality, range, cost, and reliability when it comes to
products and services. Companies worldwide have been engaging in
reshaping and repositioning strategies in order to effectively address the
challenges and capitalise on the opportunities presented by globalisation.
In turbulent times, it is important to adopt a management strategy that
centres around core competencies. This involves the strategic decision to
divest from loss-making companies and instead acquire those that have
the potential to contribute to the profit and growth of the group. The

PAGE 15
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes primary goal is to attain and maintain exceptional levels of performance.

Indeed, it is true that a significant number of companies worldwide are
engaging in mergers in order to attain a larger economic scale as a strategy
for both survival and expansion within the highly competitive global
economy. There has been a significant rise in the amount of funds that
are being transferred between nations in order to find potential candidates
for restructuring and takeovers.
In the last few years, there have been several notable developments. Firstly,

h i
it is worth mentioning that the rate of inflation has been slowing down.

e l
Additionally, there is speculation that interest rates may have reached

D
their highest point. Furthermore, it is unfortunate to note that certain

of
banks have experienced failures. However, it is important to highlight
that the crisis surrounding the US debt ceiling has been successfully

ty
resolved. Due to various factors such as digitalization, decarbonization,

s i
and a focus on value creation, there is a lot of activity happening in the

r
market. These dynamic conditions are expected to bring about opportunities
e
v
for transformation and contribute to a more active M&A market in the
i
upcoming years.

U n
The M&A activity in the future may not consist solely of attention-
,
grabbing megadeals, as we have seen a decline in such deals since
L
O
their peak in 2021. Instead, we can expect to observe a more balanced

S
number of mid-market deals, as companies actively pursue their strategic
/
O L
growth objectives. These smaller deals, in addition, have the potential to
facilitate transformation and foster growth. In the upcoming months, it

/ C
is expected that mid-market transactions will be prevalent in the market.

C EThis is because CEOs are utilising a combination of strategic acquisitions

and selective divestitures to reshape their portfolios for future growth.

D Although cash-rich corporates have the advantage of making larger moves,

©D
the focus will primarily be on mid-market transactions.
In the year 2023, we commenced with a prudent perspective on mergers
and acquisitions. The global economy was affected by concerns of recession
and the increase in interest rates, as central bankers worked to control the
high levels of inflation observed in various regions. It is undisputed that
the initial six months of this year have presented numerous challenges for
dealmakers. Deal volumes have experienced an 8% decline from already
low levels observed in the latter half of 2022. However, it is important

16 PAGE
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 CORPORATE RESTRUCTURING

to note that the volumes of deals are still higher than the levels observed Notes
before the pandemic in 2019.

1.9 Indian Scenario

Over the past few years, India has been observing and adopting the global
patterns of consolidation among companies by means of mergers and
acquisitions. Companies are experiencing takeovers, where one company
acquires another. Units are being separated and formed into separate
h i
entities, a process known as hiving off. Additionally, joint ventures are
e l
D
being established, which can be seen as similar to acquisitions. It can be

of
reasonably argued that the number of corporate restructurings in recent
years is likely greater than the number of restructurings in the six decades

ty
following independence.

s i
During the initial period of M&A transactions in India, it was the

r
government agencies and financial institutions that were responsible
e
v
for organising and facilitating these mergers and acquisitions within a
i
n
regulated framework. However, it is important to note that, starting from

, U
the beginning of the 1990s, Indian industries have experienced a growing
level of exposure to both domestic and international competition. As a
L
result, the ability to compete effectively has become absolutely necessary
O
S
for these industries to survive in the current economic landscape. As a

L /
result of heightened competition among domestic companies in both the

O
domestic and international markets, a significant number of corporations

C
in India have chosen to pursue Mergers and Acquisitions (M&A) as a

E /
strategic approach to expand and thrive in the current business landscape.

D C
The primary objective of the majority of corporations is to generate
global consumer engagement and derive benefits from it. This can

©D
be accomplished by forming partnerships with existing enterprises or
establishing new ones, both domestically and internationally. Mergers
and Acquisitions (M&A) have demonstrated their effectiveness in various
aspects of business expansion. They serve as a comprehensive strategy
for diversifying portfolios, venturing into new markets, acquiring valuable
knowledge, broadening access to research and development, and obtaining
the necessary assets to operate on a global level.

PAGE 17
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Here now, we will discuss or explore the new flexibility requirements
that Corporate India is currently facing as a result of restructuring.
Jobs: The scope of jobs is being broadened to include a wider range of
tasks.
Employment: Companies are transitioning away from their dependence on
workers with open-ended, full-time contracts. Instead, they are increasingly
opting to utilise part-time, temporary, contingent, and contract workers.

i
Skills: Skills are abilities or competencies that individuals possess, which
h
e l
enable them to perform specific tasks or activities effectively. They
are developed through learning, practise, and experience. Skills can be
D
of
categorised the implementation of new work practises has resulted in
an increase in skill levels and requirements. Consequently, workers are

ty
now expected to consistently enhance their skills in order to effectively
handle these changes.

s i
r
Workplace, including home and tele-working, is experiencing significant
e
v
growth due to the advancements in information and communication
technologies.
n i
, U
Increases in demand can be addressed through two methods: Overtime
work or adopting a more flexible approach to working hours. By
L
implementing these strategies, operating hours can be extended without
O
S
incurring additional costs associated with overtime rates.

L /
Remuneration: It seems that profit sharing, Employee Stock Ownership

O
Plans (ESOPs), and different types of bonuses are increasingly prevalent

C
/
in today’s workplace.

C EThe management philosophy of Indians is gradually evolving as they

recognise the need for adaptability in an increasingly flexible world.
D
©D
In terms of organisation, it is important to note that there is currently
a growing inclination towards adopting flatter organisational structures.
Corporate restructuring is a significant and far-reaching occurrence that
is observed extensively throughout India. One of the clearest and most
readily measurable manifestations of restructuring is the increasing trend
of mergers and acquisitions.

18 PAGE
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CORPORATE RESTRUCTURING

IN-TEXT QUESTIONS Notes

1. Which of the following are commonly cited reasons for M&As?

(a) Synergy
(b) Market power
(c) Strategic realignment
(d) All of the above
2. A merger is a combination of businesses in which:
h i
(a) Two businesses combine to form a new business
e l
(b) The participants are necessarily comparable in size,
D
of
competitive position, profitability, and market capitalization
(c) One of the two firms becomes a wholly owned subsidiary
of the other firm
i ty
(d) None of the above
r s
v e
3. Vertical mergers are those in which the participants are:
(a) In the same industry
n i
(b) In different industries
, U
L
(c) In different phases of the value chain

O
S
(d) None of the above

L /
4. All of the following are common motives for a merger or

O
acquisition except for:

C
E /
(a) Operating synergy
(b) Financial synergy

D C
(c) Raising the cost of capital

©D
(d) Buying undervalued assets
5. If two firms in the same line of business merge together, it is
called ________ merger.
(a) Horizontal
(b) Vertical
(c) Straight
(d) Conglomerate

PAGE 19
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School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 6. If two firms in unrelated line of business merge together, it is

called ________ merger.
(a) Horizontal
(b) Vertical
(c) Straight
(d) Conglomerate

i
7. The sale of a portion of a firm’s assets, operations, or divisions

h
to a third party is referred to as a:

e l
D
(a) Liquidation

of
(b) Divestiture
(c) Merger
(d) Restructuring
i ty
r s
8. An agreement between firms to create a separate, co-owned

v e
entity established to pursue a joint goal is called a:
(a) Consolidation
n i
U
(b) Strategic alliance

,
L
(c) Joint venture

O
(d) Merged alliance
S
/
9. An agreement between firms to cooperate in pursuit of a joint
L
O
goal is called a:

/ C (a) Consolidation

CE
(b) Joint venture

D
(c) Takeover project

© D (d) Strategic alliance

10. The restructuring of a corporation should be undertaken if:
(a) The restructuring can prevent an unwanted takeover
(b) The restructuring is expected to create value for shareholders
(c) The restructuring is expected to increase the firm’s revenue
(d) The interests of bondholders are not negatively affected

20 PAGE
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CORPORATE RESTRUCTURING

1.10 Summary Notes

‹ Corporate restructuring refers to a significant modification in the

strategic approach of a company, which aims to enhance its long-term
profitability. This may involve various actions such as diversification
or the closure of certain parts of the business.
‹ Either external causes that require a change in the organisational
structure or business model of a company might be the driving
force behind it, or it can be motivated by the necessity to make
h i
financial changes to the company’s assets and liabilities.
e l
‹ Corporate restructuring is an example of an inorganic business strategy
D
of
that can result in a faster pace of expansion, effective utilisation
of resources, fulfilment of increasing expectations of stakeholders,
effective management of competition, etc.
i ty
‹

r s
There are many different types of restructuring, including organisational

e
restructuring, technology restructuring, market restructuring, and

v
financial restructuring.

n i
U
‹ The terms “merger,” “demerger,” “acquisition,” “joint venture,”

,
“disinvestments,” “takeovers,” “strategic alliances,” and “slump

utilised the most frequently.

O L
sale” are among the corporate restructuring instruments that are

/ S
Corporate financial restructuring refers to any considerable change in
L
‹

O
a company’s financial structure, or ownership or control, or business

C
portfolio, with the goal of increasing the value of the organisation;

E /
this includes the restructuring of both debt and equity.

D C
1.11 Answers to In-Text Questions

©D
1. (d) All of the above
2. (d) None of the above
3. (c) In different phases of the value chain
4. (c) Raising the cost of capital
5. (a) Horizontal
6. (d) Conglomerate

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School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 7. (b) Divestiture

8. (c) Joint venture
9. (d) Strategic alliance
10. (b) The restructuring is expected to create value for shareholders

1.12 Self-Assessment Questions

h i
1. What is corporate restructuring? Discuss the significance of corporate
restructuring.
e l
D
2. What are the three forms of demerger? How do they differ from

of
each other?
3. List and explain the most common reasons why a company might
need to change its structure.
i ty
r s
4. Write a critical note about how business restructuring is going right

e
now, both from a global and an Indian point of view.
v
n i
U
1.13 References
‹
L ,
Prasad G. Godbole, “Mergers, Acquisitions and Corporate Restructuring”,

O
2nd Edition, Vikas Publishing House Pvt. Ltd.

S
‹

L /
Pradeep Kumar Sinha, “Merger, Acquisitions and Corporate Restructuring”,
3rd Edition (2019), Himalaya Publishing House.

C O
Weston, Fred; Chung, Kwang S. and Siu, Jon A.: Takeovers,
/
‹

E
Restructuring and Corporate Governance, Pearson Education.

D C ‹ Sundarsanam (2006); Creating Value from Mergers and Acquisitions,

(1st Edition) Pearson Education.

©D

22 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
L E S S O N

2
Merger and Amalgamation
Gurdeep Singh
Assistant Professor
Department of Finance and Business Economics
University of Delhi
Email-Id: g.swork@yahoo.com

h i
STRUCTURE
e l
D
of
2.1 Learning Objectives
2.2 Introduction
2.3 Merger and Amalgamation - Meaning
i ty
r
2.4 Accounting Standard-14 Accounting for Amalgamations
s
2.5 Methods of Accounting for Amalgamation
v e
2.6 Purchase Consideration
n i
U
2.7 Treatment of Reserves on Amalgamation
,
2.8 Goodwill on Amalgamation

O L
2.9 Taxation Aspects of Merger and Amalgamation
S and Amalgamation
2.10 Stamp Duty Aspects of /Merger

O L
2.11 Inter-Companies Holdings

/ C
2.12 Reasons for Merger and Amalgamation
E
C Procedure in the Books of Purchasing Company
2.13 Some Important Ratios for Analysing Merger and Amalgamation Deal

D
2.14 Accounting
D
2.16©Summary
2.15 Accounting Procedure in the Books of Vendor Company

2.17 Answers to In-Text Questions

2.18 Self-Assessment Questions
2.19 Suggested Readings

PAGE 23
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 2.1 Learning Objectives

‹ Describe the concept of Merger and Amalgamation.
‹ Understand the need of studying the concept of Merger and Amalgamation.
‹ Explain the Methods of Accounting for Amalgamation.
‹ Understand the Reasons for Mergers and Amalgamation.

2.2 Introduction
h i
e
In the competitive world of business and economics, companies often l
D
of
explore different strategies to improve their position in the market,
increase their size, or grow their operations. Two popular strategies they

ty
use are mergers and amalgamations. While these terms are sometimes

i
used interchangeably, they have different meanings and consequences.

s
r
Mergers and amalgamations can bring many benefits. They help companies

e
gain a larger share of the market, reach new customers, and save money
v
i
by working together. These strategic moves can make companies more
n
U
competitive and successful. However, there are also challenges. Combining

,
different companies can be difficult. They may have different ways of

O L
doing things or different rules. It’s important to make sure everyone works
well together. There are also rules and laws to follow to make sure the

/ S
merger or amalgamation is fair. In recent years, we’ve seen many big

O L
mergers and amalgamations. These happen because companies want to
grow and beat their competitors. It’s important for us to understand why

/ C
companies merge and amalgamate, and what it means for the business

C Eworld. In this lesson, we’ll explore mergers and amalgamations in detail.

D
We’ll look at what they are, why they happen, the challenges involved, and

©D
the impact they have on businesses and the economy. By understanding
these strategic moves, we can learn more about how businesses work and
the decisions they make.

2.3 Merger and Amalgamation - Meaning

Merger and amalgamation are strategic approaches employed by companies
to unify and establish a larger, more influential entity. Amalgamation, the
process of merging businesses, brings together multiple entities to create

24 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MERGER AND AMALGAMATION

a powerful, unified organization. This transformative journey entails the Notes

creation of a completely new company, formed by the seamless integration
of separate units. By combining their strengths, expertise, and resources,
these entities forge a self-sustaining entity, eliminating the need for third-
party services and resulting in significant cost savings. Amalgamation
manifests when like-minded companies in related industries opt to form a
fresh corporate entity, embodying a new legal existence. This harmonious
union can take two primary forms: merger, involving the convergence
of companies, or purchase, where one company acquires another. While
h i
amalgamation effectively mitigates competition among similar industry
e l
D
players, it must be carefully navigated to prevent the creation of a

of
monopolistic market. The amalgamation process unifies entities, establishing
a symbiotic support system that fosters collaborative work and reduces

ty
reliance on external service providers. In the realm of corporate finance,

i
amalgamation represents the fusion of multiple business units, whereas, in
s
r
accounting, it entails the consolidation of diverse financial statements. To
e
v
embark on the amalgamation journey, at least two akin companies must

n i
dissolve, paving the way for the emergence of a new entity that assumes

U
their operations. The dissolving companies are termed “vendor companies,”

L ,
while the newly established entity assumes the role of the “purchasing
company.” Typically, the purchasing company issues equity shares to

O
secure investment and fuel its growth. Amalgamation unlocks various tax
S
L /
benefits and capitalizes on the economies of scale, bolstering the value
of the merged entities. The newly formed entities herald opportunities for

C O
financial growth, capital development, and enhanced synergies. Synergy

/
signifies the collective benefits derived from the union, as the entities
E
C
seamlessly blend their resources and expertise. Amalgamation serves as

D
a pivotal strategy for astute tax planning and stands as a monumental

©D
milestone in the evolution and prosperity of businesses.
A merger takes place when two or more companies opt to merge their
operations and resources, amalgamating into a single, more substantial
organization. It is a voluntary agreement wherein all participating parties
willingly unite to form a cohesive entity. The primary objective of a
merger is to capitalize on the strengths, expertise, and market presence
of each company, with the aim of accomplishing shared goals and
aspirations. For instance, let’s imagine Company A, a prominent clothing

PAGE 25
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes manufacturer, elects to merge with Company B, a well-established fashion

retailer. By engaging in a merger, they can achieve vertical integration,
seamlessly integrating their operations from the manufacturing stage to
the retail aspect. Consequently, this consolidation enables them to enhance
efficiency, reduce costs, and exercise superior control over the entire
supply chain. The ultimate outcome is the formation of a robust and all-
encompassing fashion brand, empowering them to provide high-quality
products directly to discerning consumers. It is important to recognize

h
that mergers can manifest in various forms. They can take the shape of
i
e l
horizontal mergers, occurring between companies operating in the same

D
industry, vertical mergers that unite companies operating at different stages

of
of the supply chain, or conglomerate mergers, bringing together entities
from unrelated industries. The specific type of merger or amalgamation

ty
undertaken depends on the strategic goals and prevailing circumstances
surrounding the participating companies.
s i
Types of Mergers with Examples:
e r
‹
i v
Horizontal Merger: A horizontal merger happens when two or more

U n
companies in the same industry and at the same level of the supply
chain join forces to become one larger company. It allows them to

L ,
increase their market share and stay competitive.

O
For example, imagine two big smartphone makers, Company A and

S
L /
Company B, decide to merge. By combining their operations, they can
bring together their resources, technologies, and market presence to

C O
dominate the smartphone market. This horizontal merger strengthens

/ their position and offers customers a wider range of products.

CE
‹ Vertical Merger: A vertical merger occurs when companies at different

D
stages of the supply chain, like a manufacturer and a distributor or

© D a supplier and a retailer, merge to make operations smoother and

more efficient.
For instance, think of Company X, a clothing manufacturer, merging
with Company Y, a retail chain. By joining forces, Company X
gains better control over how its products are distributed and sold.
This vertical merger integrates their production and distribution
processes, leading to cost savings, better coordination, and happier
customers.

26 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MERGER AND AMALGAMATION

‹ Conglomerate Merger: A conglomerate merger happens when Notes

companies from unrelated industries merge to diversify their business
interests and expand into new markets.
For example, let’s say Company A, a major car manufacturer, decides
to merge with Company B, a well-known food processing company.
Through this conglomerate merger, they diversify their operations
and enter different sectors. By combining their strengths, they can
explore multiple markets, reduce risks, and discover new growth
opportunities.
h i
‹ Market Extension Merger: A market extension merger takes place
e l
when two companies in the same industry merge to access new
D
of
markets or geographic regions.

ty
For instance, imagine Company X, a successful software company
in one country, decides to merge with Company Y, a software

s i
r
company with a strong presence in another country. By combining

e
their market reach, they can expand their customer base and enter
v
n i
new markets. This market extension merger helps them establish
an international presence and increase their global market share.
‹
, U
Product Extension Merger: A product extension merger occurs

O L
when companies in the same industry merge to expand their product
offerings and diversify their business.

/ S
L
For example, consider Company A, a leading electronics manufacturer

O
known for its smartphones, merging with Company B, a renowned audio

C
equipment manufacturer. Through this merger, they can complement their
/
E
product lines and offer a wider range of electronic devices to customers.

D C
This product extension merger allows them to meet a broader range of
customer needs and enhance their competitive position.

©D
2.4 Accounting Standard-14 Accounting for Amalgamations
Accounting Standard-14 (AS-14) deals with how companies handle
amalgamations and the treatment of goodwill or reserves that result from
them. AS-14 primarily applies to companies, but some of its requirements
also affect the financial statements of other businesses.
It’s important to note that AS-14 does not cover cases of acquisitions. In
acquisitions, the acquiring company buys either all or part of the shares
PAGE 27
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes or assets of the company being acquired. These acquisitions can be made
through cash payments, issuing shares or other securities in the acquiring
company, or a combination of different forms of payment.
Distinguishing between an acquisition and an amalgamation lies in the
fact that in an acquisition, the acquired company continues to exist as
a separate legal entity. In contrast, in an amalgamation, the acquired
company is not preserved and becomes part of another company.

i
Amalgamations can be categorized into two main types:
Amalgamation in the Nature of Merger
l h
e
‹

D
‹ Amalgamation in the Nature of Purchase

of
For an amalgamation to be considered a in the nature of merger, the
following conditions must be met:
‹

i ty
All the assets and liabilities of the vendor/transferor company should

s
be taken over by the purchasing company/transferee company. The
r
e
vendor/transferor company is the one being amalgamated into another

v
n i
company, known as the purchasing company/transferee company.
Shareholders holding at least 90% of the face value of the equity
U
‹

,
shares of the vendor company/transferor company excluding shares

O L
held by the purchasing company/transferee company, its subsidiaries,
or nominees before the amalgamation become equity shareholders

/ S
of the purchasing company/transferee company as a result of the

L
amalgamation.

O
C
Shareholders of the vendor/transferor company who agree to become
/
‹
equity shareholders of the vendor company/transferor company

C E receive consideration in the form of equity shares in the purchasing

D
company/transferee company except, some cash may be given for

©D
any fractional shares.
‹ Business of vendor company/transferor company should be intended
to be carried on by purchasing company/transferee company.
‹ All the assets and liabilities of the vendor/transferor company should
be taken over at balance sheet value. Some difference may be
there due to change in the accounting policy (Depreciation method,
Inventory Valuation method, etc).

28 PAGE
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 MERGER AND AMALGAMATION

In this type of amalgamation, there is a genuine pooling of assets, liabilities, Notes

shareholders’ interests, and businesses of the amalgamating companies.
If any of the conditions mentioned earlier are not met, then the
amalgamation should be regarded as an amalgamation in the nature of
purchase. In such cases, one company is essentially acquiring another
company. Consequently, the equity shareholders of the combining entities
do not retain a proportionate share in the equity of the resulting entity.
Moreover, the business of the acquired company may not be intended to
continue after the amalgamation takes place.
h i
e l
2.5 Methods of Accounting for Amalgamation
D
The pooling of interest method & the purchase method are the two main
of
ty
methods used for accounting of amalgamations. For amalgamations that

s i
are in the nature of mergers, the pooling of interest method is employed,

r
whereas for amalgamations that are in the nature of purchase, the purchase
e
method is employed.
i v
U n
Pooling of Interest Method: There is no need to figure out the carrying
amounts of assets and liabilities because a merger involves the amalgamation

L ,
of two or more separate businesses. The separate financial accounts of

O
the merging entities are therefore aggregated with little modification.

/ S
The assets, liabilities, and reserves of the transferor company should be

O L
reported at their current carrying amounts and in an identical manner as
at the date of amalgamation when producing the financial statements of

/ C
the transferee company. These reserves can be capital or revenue-based

C E
or arise from revaluations. It is necessary to combine the balance of
the transferor company’s profit and loss account with the corresponding

D
balance of the transferee company or, if applicable, transfer the balance

©D
to the general reserve. If the transferor and the transferee company have
different accounting practices at the time of the merger, a standard set
of accounting policies will need to be implemented after the merger. It
is appropriate to treat as capital reserve the difference between the total
number of shares issued by the transferee company and the total share
capital of the transferor company. It is stated that this variation can be
compared with a share premium. Additionally, the reserve made during
the amalgamation cannot be distributed to shareholders as dividends or
bonus shares. The unadjusted amount represents a capital loss if the

PAGE 29
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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes value of the consideration outnumbers the share capital of the transferor
company, and adjustment needs to be done firstly from the capital reserves
and, when these reserves are not enough, from the revenue reserves. If
both capital reserves, as well as revenue reserves, are not enough, the
unadjusted difference can be adjusted from revenue reserves by appropriating
additional funds through the profit and loss account. The profit and loss
account shouldn’t be debited directly. When the profit and loss account
have an inadequate balance as well, the difference must be shown on the
assets side of the balance sheet.
h i
e
Purchase Method: In the purchase method, the transferee company
l
D
handles the amalgamation by either including the assets and liabilities at

of
their existing values or assigning the consideration to individual assets
and liabilities of the transferor company based on their fair values at the

ty
time of amalgamation. This process may involve considering assets and

s i
liabilities that were not previously mentioned in the transferor company’s
financial statements.
e r
i v
When determining the fair values of assets and liabilities, the intentions

U n
of the transferee company can influence the assessment. For instance,
the transferee company might have specific plans for certain assets or

,
anticipate expenses related to employee terminations or relocating facilities
L
O
due to changes in operations.

/ S
The books of account of the transferee company shall recognize the

O L
excess of consideration over the worth of the transferor company’s net
assets taken by the transferee company as goodwill which results from

/ C
amalgamation in the nature of the purchase. The difference should be

C Eaccounted for as capital reserve if the consideration is less than the

negotiated value of the net assets acquired.
D
©D
IN-TEXT QUESTIONS
1. What is amalgamation?
(a) The process of separating a mixture into its individual
components
(b) The process of combining two or more entities into a
single entity
(c) The process of converting a solid into a liquid state
(d) The process of heating a substance to its boiling point

30 PAGE
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MERGER AND AMALGAMATION

2. Why do companies often choose to undergo amalgamation? Notes

(a) To increase competition in the market

(b) To diversify their product offerings
(c) To reduce costs and improve efficiency
(d) To eliminate competition from other companies
3. Which of the following statements is true about amalgamation?
(a) It only occurs in the financial sector
h i
(b) It involves the physical combination of two or more
e l
substances
D
of
(c) It always results in a loss of value for the entities involved
(d) None of the above

i ty
4. What are the potential benefits of amalgamation for companies?
(a) Increased market share and economies of scale
r s
v e
i
(b) Higher taxes and regulatory burdens

n
(c) Decreased access to capital and resources
U
,
(d) Reduced customer base and brand dilution

L
5. Which of the following is a potential drawback of amalgamation?
O
S
(a) Improved market position and competitive advantage
/
entity
O L
(b) Increased risk and complexity in managing the combined

/ C
(c) Greater access to capital and investment opportunities

C E
(d) Enhanced product innovation and development

D
6. Which of the following best defines a merger?

©D
(a) The process of converting a public company into a private
company
(b) The purchase of one company by another, resulting in the
acquiring company controlling the acquired company
(c) The process of separating a company into multiple smaller
entities
(d) None of the above

PAGE 31
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School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 2.6 Purchase Consideration

The value of the shares, stocks, cash, as well as other assets that the
transferee company gives to the transferor company’s shareholders is the
Purchase consideration for amalgamation. The agreed-upon or negotiated
value of each of the consideration’s different parts is used to determine
the total value of the consideration.

i
Any non-cash items should be considered in the calculation of the

l h
Purchase consideration at their fair market value. There are several ways

D e
to figure out the fair value. When securities are issued, for instance, the
price determined by the appropriate authorities may be regarded as fair

of
value. Examining the market value of the items being exchanged will help
to evaluate the fair worth of other assets. The assets can be appraised

ty
using their net book value if the market value cannot be determined with
i
s
sufficient accuracy.

e r
If the amalgamation scheme calls for a consideration adjustment based

i v
on future events, the additional payment should be accounted for in the

U n
consideration if it is anticipated to be made and a reasonable estimate
of its amount can be established. In all other situations, the adjustment

L ,
must be made as soon as the amount can be determined.

O
Purchase Consideration is the business selling price that the transferor/
S
agreed upon.
L /
vendor company and the transferee/Purchasing Company have mutually

C O
Methods of calculating Purchase Consideration:

E ‹/ Lump-Sum Method: The lump sum method is used when the

D C purchasing company agrees to pay a fixed specific amount in

exchange for acquiring the seller company. For example, XYZ Ltd.

©D
agrees to acquire ABC Ltd. for a cost of $ 25 lakhs. The cost of
winding up and payments paid to third parties are not to be factored
into the acquisition consideration.
‹ Net Payment Method: With this method, the purchase consideration
is equal to the sum of all payments made by the transferee business
in cash, shares, and debentures.
‹ Exchange of Shares Method/Intrinsic Value Method: In this method,
the transferor company issues share to the transferee company

32 PAGE
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 MERGER AND AMALGAMATION

based on the intrinsic value of the shares of both companies after Notes
calculating these values. The realisable value of Total Net Assets
is divided by the number of Shares Outstanding to determine the
intrinsic value of each share.
‹ Net Assets Method: The sum of the assets acquired at agreed-upon
valuations less the agreed-upon acquisition of liabilities is the net
asset. If agreed upon valuations for assets and liabilities are not
available, book values must be used. It will not be included as part
of the purchase consideration if a specific asset is not acquired by
h i
the transferee company.
e l
Example: XYZ Ltd. acquired AB Ltd. on 1st April 2023 and paid the
D
of
consideration for the business as follows:

ty
(a) Issued 58,000 fully paid equity shares with a face value of Rs.10
each to the equity shareholders of AB Ltd.

s i
r
(b) Issued fully paid 11% preference shares with a face value of Rs.100
e
v
each to the preference shareholders of AB Ltd., discharging an

n i
amount of Rs.1,60,000. These preference shares were issued at a

U
premium of 10%.

L ,
(c) It was agreed that the debentures of AB Ltd. amounting to Rs.80,000
will be converted into an equal number and amount of 12% debentures
of XYZ Ltd.
S O
L /
Solution: To calculate the total purchase consideration, we need to

O
determine the value of each component:

C
E /
(a) The value of the equity shares issued to the equity shareholders of
AB Ltd. is 58,000 shares × Rs.10 = Rs. 5,80,000.

D C
(b) The value of the preference shares issued to the preference shareholders

©D
of AB Ltd. is Rs.1,60,000 plus a 10% premium. The premium is
calculated as 10% of Rs.1,60,000, which is Rs.16,000. Therefore,
the total value of the preference shares is Rs.1,60,000 + Rs.16,000
= Rs.1,76,000.
(c) The debentures of AB Ltd. amounting to Rs.80,000 are being
converted into debentures of XYZ Ltd. with the same amount. As
it is a payment to debenture holders, this shall not be included in
the calculation of purchase consideration.

PAGE 33
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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes The total purchase consideration:

Rs.5,80,000 (equity shares) + Rs.1,76,000 (preference shares issued at a
premium) = Rs.7,56,000.
Therefore, the amount of purchase consideration is Rs.7,56,000.

2.7 Treatment of Reserves on Amalgamation

In the event that the amalgamation is an amalgamation in the nature

h i
of merger

e l
In the event of a merger, the reserves of the transferor company remain
D
of
unchanged and are reflected in the financial statements of the transferee
company just as they appeared in the transferor company’s financial

ty
statements. This implies that the General Reserve, Capital Reserve, and

i
Revaluation Reserve of the transferor company become the corresponding
s
r
reserves of the transferee company. In the event of a merger-type
e
v
amalgamation, the reserves of the transferor company remain unchanged

n i
and are reflected in the financial statements of the transferee company

, U
just as they appeared in the transferor company’s financial statements. By
maintaining the identity of the reserves, any reserves that were eligible
L
for distribution as dividends prior to the amalgamation will retain their
O
S
eligibility for dividend distribution after the amalgamation. The difference
/
between the recorded amount of issued share capital, which includes any
L
O
additional consideration in the form of cash as well as other assets, and

C
the share capital of the transferor company is adjusted within the reserves
/
C Eof the transferee company’s financial statements.
In the event that the amalgamation is a amalgamation in the nature
D of purchase

©D In the event of an amalgamation classified as a in the nature of purchase,

the identity of reserves, except for statutory reserves, are not preserved,
except in specific circumstances mentioned below:
The transferor company may have created reserves to comply with the
requirements or take advantage of the benefits provided by the Income-

34 PAGE
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 MERGER AND AMALGAMATION

tax Act, 1961. These reserves, such as Development Allowance Reserve Notes
or Investment Allowance Reserve, are required to maintain their identity
for a specific period as per the Act.
Additionally, certain reserves may have been established in the transferor
company’s financial statements to meet the requirements of other statutes.
In general, reserves are not preserved in the event of an amalgamation
classified as a in the nature of purchase. However, an exception is made

i
for reserves of a statutory nature. These reserves retain their identity in
the financial statements of the transferee company, in the similar manner
l h
as they appeared in the transferor company’s financial statements, as long
as their identity is required to comply with the relevant statute.
D e
The net assets acquired by the transferee company are reduced by
of
ty
the consideration paid for the transferor company. If the result of this

i
calculation is negative, the shortfall is recorded as goodwill arising from

s
r
the amalgamation. Conversely, if the outcome is positive, the excess is
credited to the Capital Reserve.
v e
2.8 Goodwill on Amalgamation n i
, U
O L
Goodwill, which arises as a result of an amalgamation, signifies an initial
payment made in anticipation of future earnings. It is recognized as an

/ S
asset that necessitates systematic amortization over its useful life. However,

O L
determining the precise duration of goodwill’s utility is complex due to
its inherent characteristics, though a cautious estimation is undertaken.

/ C
Generally, it is deemed suitable to spread the amortization of goodwill

C E
over a maximum of five years, unless substantiated justifications warrant
a more extended period.
D
©D
When appraising the useful life of goodwill, various factors come into
play, including:
(i) The foreseeable longevity of the business or industry.
(ii) The influence exerted by product obsolescence, shifts in demand,
and prevailing economic dynamics.
(iii) The projected tenure of service for pivotal individuals or specific
groups of employees.
(iv) Envisaged actions implemented by competitors or potential rivals.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes (v) Legal, regulatory, or contractual provisions capable of affecting the

duration for which goodwill remains beneficial.

2.9 Taxation aspects of Merger and Amalgamation

The Companies Act of 2013 does not define the terms “Amalgamation”
or “Demerger” precisely, but it does shed light on their fundamental
meanings. A “merger” is the combination of two or more entities into a

i
single business with the primary goals of combining assets, and liabilities,
h
l
and creating a unified organizational structure. The following definition
e
D
of “amalgamation” in relation to companies is provided by Section 2(1B)

of
of the Income-tax Act of 1961: “Amalgamation” in relation to companies
is defined as the fusion of one or more companies with another company

ty
or the convergence of two or more companies to create an entirely

i
new entity. The companies that are amalgamating are referred to as the
s
r
“amalgamating company/companies,” and the new entity created as a

e
v
consequence of the merger is known as the “amalgamated company.” The

i
following conditions must be met for the merger to take place:
n
, U
(i) The newly formed entity takes ownership of all assets that belonged
to the amalgamating company or companies immediately prior to
the merger.
O L
/ S
(ii) The newly formed entity is now responsible for the full spectrum

O L
of liabilities related to the amalgamating company or companies
before the amalgamation.

/ C
(iii) Following the merger, shareholders in the amalgamating company or

C E companies who own at least three-fourths of the total value of their

shares excluding any shares currently held by the amalgamating
D
©D
company or any of its subsidiaries before the amalgamation become
shareholders in the amalgamated company.
Some of the Tax benefits and relief in the event of an amalgamation
are given below:
(a) Pursuant to section 47(vi) of the Income-tax Act, any gain arising
from the transfer of assets by the amalgamating companies to the
Indian Amalgamated Company is absolved from taxation. This
favourable treatment arises because such a transfer is not deemed
as transfer for the purpose of Capital Gains.

36 PAGE
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 MERGER AND AMALGAMATION

Exemption from Capital Gains Tax in International Restructuring [Sec. Notes

47(via)]: In the context of amalgamation involving foreign entities, the
transfer of shares held by the amalgamating foreign company to the
amalgamated foreign company, both having stakes in an Indian company, is
exempt from taxation under Section 47(via). Nevertheless, this exemption
applies only if two conditions are fulfilled:
(1) A minimum of twenty-five per cent of the shareholders of
the amalgamating foreign company retain their status as
shareholders in the amalgamated foreign company, and
h i
(2) The transfer which does not attract capital gains tax in the
e l
country where the amalgamating company is registered.
D
of
(b) Pursuant to Section 47(vii) of the Income-tax Act, any gains derived

ty
from the transfer of shares by a shareholder of the merging entities
are immune to taxation. This exemption is granted when such

s i
r
transactions are not treated as transfers for the purpose of capital
gain taxation, provided that:
v e
n i
(1) The transfer occurs as a result of being allocated shares in

U
the merged enterprise, and

,
(2) The new formed entity is an Indian entity.
L
IN-TEXT QUESTIONS
S O
/
7. Which of the following is true about a friendly merger or
L
O
acquisition?

/ C
(a) It occurs when the target company resists the acquisition

C E
attempt
(b) It occurs when both companies mutually agree to merge
D
©D
or acquire
(c) It involves a hostile takeover by force or against the will
of the target company
(d) It is a term used to describe a merger between competitors
in the same industry
8. What is a horizontal merger?
(a) A merger between companies at different stages of the
supply chain

PAGE 37
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School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes (b) A merger between companies in the same industry and

at the same stage of the supply chain
(c) A merger between companies in different industries
(d) A merger between companies with similar financial
performance
9. Which of the following statements is true about synergy in
mergers and acquisitions?

h i
l
(a) Synergy refers to the negative impact of the merger or

D e
acquisition on the performance of the companies involved
(b) Synergy refers to the combined value created by the merger

of
or acquisition that is greater than the sum of the individual
companies

i ty
(c) Synergy refers to the legal and regulatory challenges faced

r s
during the merger or acquisition process

v e
(d) Synergy refers to the financial analysis conducted to evaluate

n i
the profitability of the merger or acquisition

U
10. Which of the following is an example of a conglomerate merger?

,
L
(a) A merger between two competing airlines

O
(b) A merger between a car manufacturer and a steel mill
S
/
(c) A merger between two software companies
L
C O (d) A merger between a company and its supplier

E / Stamp Duty Aspects of Merger and Amalgamation

2.10
C
DD
The consideration of stamp duty holds significant importance in the strategic
planning of mergers. In fact, the selection of the merger structure itself
© is often influenced by potential savings in stamp duty. The imposition
of stamp duty, particularly on the transfer of immovable property, can
be substantial, warranting careful deliberation. Given that stamp duty is
primarily levied by the states in India, there exists ample opportunity for
minimizing this tax burden.
Typically, mergers involve the execution of various additional documents,
agreements, indemnity bonds, and the like, tailored to the specific

38 PAGE
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 MERGER AND AMALGAMATION

circumstances and needs of the parties involved. Stamp duty is applicable Notes
to these instruments based on their nature and contents.
The Central Government has granted an exemption from the payment
of stamp duty on instruments that evidence property transfers between
companies limited by shares, as defined in the Indian Companies Act of
1913, under certain conditions. These conditions include:
(i) The transferee company’s beneficial ownership of at least 90 per

i
cent of the issued share capital is held by the transferor company.
(ii) The transfer occurs between a parent company and a subsidiary
l h
company, with one of them being the beneficial owner of no less
D e
of
than 90 per cent of the issued share capital of the other.
(iii) The transfer occurs between two subsidiary companies, each of which

ty
has a common parent company that holds beneficial ownership of
no less than 90 per cent of their respective share capital.
s i
e r
Therefore, if property is transferred as per the High Court’s order

i v
concerning the Scheme of Arrangement/Amalgamation between companies

U n
satisfying any of the aforementioned conditions, no stamp duty will be
levied, provided that a certificate certifying the relationship between the

,
companies is obtained from the appropriate officer.
L
S O
2.11 Inter-Companies Holdings

L /
O
In the context of amalgamation and merger, intercompany holding refers

C
to a situation where one company holds a significant ownership stake
/
E
in another company. This ownership relationship plays a crucial role

D C
in the process. During an amalgamation, when companies combine to
form a new entity, intercompany holding occurs if one company already

©D
has a substantial ownership interest in another. The presence of this
intercompany holding affects decision-making and the structure of the
newly formed entity. Similarly, in a merger, when two companies merge
into one, intercompany holding happens if one of the merging companies
already holds a significant stake in the other. This intercompany holding
influences the integration process, decision-making, and the distribution
of responsibilities in the merged entity. Intercompany holding has
financial and legal implications in amalgamation and merger. Valuation,

PAGE 39
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes share exchange ratios, accounting treatment, regulatory compliance, and

shareholder agreements need careful consideration. Intercompany holding
brings both advantages and challenges. It can facilitate smoother integration
and coordination between the entities. However, it can also raise concerns
about conflicts of interest and fair treatment of minority shareholders.
Transparency and disclosure are essential when intercompany holding
is involved. Clear communication with shareholders and stakeholders is
necessary to ensure fairness, address conflicts, and protect everyone’s
interests. Intercompany holding in amalgamation and merger refers to
h i
e l
the ownership relationship between companies involved in the process.

D
It affects various aspects that require careful consideration and proper

of
measures to ensure fairness, transparency, and compliance with legal
requirements.

ty
Three categories of inter company holdings exist:

s i
(i) Purchasing (Transferee) Company holding shares in Vendor (Transferor)
company
e r
i v
(ii) Vendor (Transferor) company holding shares in Purchasing (Transferee)

U n
(iii) Purchasing (Transferee) and Vendor (Transferor) company hold shares
in each other.

L ,
Due to the fact that the purchasing (Transferee) company already owns

S O
some shares of the Vendor (Transferor) company, Purchase consideration

L /
should only be determined in terms of external shareholders.

O
Example: Let’s say the fair value of the Vendor (Transferor) business’s

C
/
net assets is Rs. 90 lakhs and the purchasing (Transferee) company owns

C E20% of the shares. Calculate the percentage of net assets owned by

external shareholders.

D
©D
Solution: Since the purchasing company holds 20%, the external shareholders
hold 80% of the assets, net assets owned by external shareholders = Rs.
72 lakhs (Rs. 90 lakhs × 80%).

2.12 Reasons for Merger and Amalgamation

Synergy: The amalgamation of firms results in a synergistic effect where
the combined value exceeds the sum of individual values. This is often
achieved through operational efficiencies, making the merged firm more

40 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MERGER AND AMALGAMATION

effective than its individual components. The scale of operations allows Notes
for lower average production costs, further enhancing efficiency.
Growth: Mergers and acquisitions can accelerate the growth of a company.
By pursuing forward and backward integration, a company can achieve
complete control over its supply chain and distribution channels, leading
to greater operational efficiency and improved customer satisfaction.
Adopting an end-to-end business model provides comprehensive control
over the entire business process, reducing inefficiencies and enhancing
overall growth potential.
h i
Tax Benefits: Mergers and acquisitions can offer advantages in terms of
e l
tax planning. The ability to set off and carry forward losses as per the
D
of
Income-tax Act can result in tax savings or a reduction in the tax liability
of the merged firm. Similarly, in the case of an acquisition, the losses

i ty
of the target company can be offset against the profits of the acquiring
company.
r s
e
Diversification: In certain cases, unrelated entities come together to form
v
n i
a new firm, expanding the company’s product or service portfolio. This
diversification can enhance the market value of the company, providing

,
a broader range of offerings to customers. U
O L
2.13 Some Important Ratios for Analysing Merger and
Amalgamation Deal
/ S
O L
Some of the important exchange ratios calculated for Merger and

/ C
Amalgamation deals:

C E
Earnings per share: One can compute the EPS of both companies and

D
apply the formula below to obtain the exchange ratio:

©D
Exchange ratio = Earnings Per Share of the target company divided by
Earnings Per Share of acquiring company
The main goal is to make the exchange in such a way that the merger
won’t have an impact on the Earnings Per Share of either company’s
shareholders.
Market price per share: One can calculate the exchange ratio using the
following formula with the help of the current market price per share of
the amalgamating companies:

PAGE 41
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Exchange rate: Market Price Per Share of the Target Company divided
by the Market Per Share of the Acquiring Company.
When shareholders of the target firm require the exact value of shares
from the acquiring company in relation to existing market holdings, this
exchange ratio is used.
Book Value per share: To obtain the exchange ratio, one must compute
the book value per share for the amalgamating companies and use the

i
formula below for determining the exchange ratio:

l
Exchange rate = Book value per share of the target company divided by
h
book value per share of the Acquiring Company.
D e
of
In accordance with this ratio, shares can be exchanged according to their
worth per share, regardless of the market price and earnings. When market

ty
shares are not priced accurately, this strategy is employed.

s i
Swap Ratio: The swap ratio is the rate at which the acquiring company

e r
exchanges its own shares for the shares of the target company during a

i v
merger or acquisition. The exchange of shares is not limited to a cash

U n
purchase of the target company’s equity shares, as the acquiring company
can choose to pay in cash or convert the target company’s stock into its

L ,
own shares, or use a combination of cash and stock. However, for the
conversion of stock from one company to another, both companies must

S O
agree on a specific exchange rate, known as the swap ratio. Determining

L /
the swap ratio requires significant effort and careful consideration before

O
executing the Merger and Acquisition transaction, as there is no universal

C
formula for calculating it. The share swap ratio formula involves analysing
/
E
various financial ratios of the companies, such as earnings per share, book

D C value, as well as other factors including size of the company, strategic

motives for the merger or acquisition, and also include long-term debts.

©D
If the target company is publicly listed, the share market value is also a
crucial factor to consider. The final swap ratio may incorporate additional
elements like the size of the companies and the target company’s long-
term debts, as well as subjective factors such as the rationale behind the
Merger and Acquisition transaction.
Price Earnings Ratio: It is usual practice to compare the target company
with deals that have recently closed in the same sector when attempting
to determine the worth of a deal. This kind of study is well suited to

42 PAGE
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 MERGER AND AMALGAMATION

the Price Earnings Ratio. Traders can determine whether the valuation is Notes
high or low by comparing the price-earnings ratio across deals.
Example: ABC Ltd. has been considering merging with XYZ Ltd. Both of
the Boards of Directors have access to the information below. The issue
at hand is the amount of many ABC Ltd. shares that should be exchanged
to merge with XYZ Ltd. Both of the boards are discussing whether to
approve 40,000, 50,000, or 60,000 shares. You are required to develop a
table outlining the possible effects of each of them on the shareholders.
ABC Ltd. XYZ Ltd. Combined
h i
Post merger
e l
D
Firm

of
1. Current earnings per year 4,00,000 2,00,000 7,00,000
2. Shares outstanding 1,00,000 20,000 ?

ty
3. Earnings per share (Rs.) 4 10 ?

i
(1 ÷ 2)
4. Price per share (Rs.) 40 100
r s ?
5. Price-earnings ratio [4 ÷ 3] 10

v e
10 10

i
6. Value of firm (Rs.) 40,00,000 20,00,000 70,00,000
7. Expected Annual growth
rate in earnings in fore-
0

U n 0 0

seeable future
L ,
O
Solution: The following table outlining the possible effects of each of

S
the three possible options on the shareholders: -
/
Number Exchange
of ABC ratio
Number of

O
ABC Ltd.’s L Fraction
of ABC
Value of
shares
Fraction
of ABC
Value of
shares

/ C
Ltd.’s [(1)/20,000 shares out- Ltd. (Post owned Ltd. owned

E
shares shares standing merger) by XYZ (Com- by ABC

C
issued to of XYZ after merg- owned Ltd.’s bined Ltd.’s
share- Ltd.] er [1,00,000 by XYZ sharehold- Post-merg- share-
holder of
D + (1)] Ltd.’s ers [(4) × er) owned holder

©D
XYZ Ltd. sharehold- 70,00,000] by ABC [(6) ×
ers [(1)/ Ltd.’s 70,00,000]
(3)] share-
holders
[50,000/
(3)]
(1) (2) (3) (4) (5) (6) (7)
40,000 2 1,40,000 2/7 20,00,000 5/7 50,00,000
50,000 2.5 1,50,000 1/3 23,33,333 2/3 46,66,667
60,000 3 1,60,000 3/8 26,25,000 5/8 43,75,000

PAGE 43
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 2.14 Accounting Procedure in the Books of Purchasing

Company
When two companies amalgamate, the assets and liabilities of the transferor
company are transferred to the transferee business and are shown in the
financial statements of the transferee company that were created after
the date of the merger.

i
Two forms of amalgamations, namely amalgamations in the nature of
mergers (using the pooling of interest Method) and amalgamations in
l h
e
the nature of purchases (using the purchase Method), would have distinct
accounting treatments in the accounts of the transferee company.
D
of
In case of Amalgamation in the nature of Purchase (using the Purchase
Method)

i ty
Calculation of the Value of Goodwill/Capital Reserve - To determine the value

r s
of Goodwill/Capital Reserve in an amalgamation, the purchase consideration

e
is subtracted from the transferor company’s net assets that the transferee
v
company acquires.
n i
U
Following is a concise explanation of it:

Goodwill (Debit)
L ,
In the event when Purchase Consideration > Net Assets Acquired =

S O
/
In the event when Purchase Consideration < Net Assets Acquired =

O L
Capital Reserve (Credit)
Accounting Entries in the books of Purchasing (Transferee) Company

/ C
(Using the Purchase Method)

C E 1. When the purchase consideration becomes due

D Business Purchase A/c (Debit)

©D
To Liquidator of Vendor (Transferor) Company A/c
2. In order to take over the liabilities and assets of the trans-
feror company
Sundry Assets A/c (Debit) [fair/agreed value if
given]
Goodwill A/c (Debit)
[Purchase Consid-
To Sundry Liabilities A/c (Individually)
eration]
To Business Purchase A/c
To Capital Reserve A/c

44 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MERGER AND AMALGAMATION

3. To pay the vendor company the purchase consideration Notes

Liquidator of Vendor (Transferor) Company A/c
(Debit)
To Equity Share Capital A/c [Purchase Consid-
eration]
To Preference Share Capital A/c
To Securities Premium A/c
To Bank A/c
4. Accounting for liquidation expenses
h i
(i) If borne and paid by the transferee (purchasing) com-
e l
D
pany

of
Goodwill A/c (Debit)
To Cash/Bank A/c
(ii) If borne and paid by the transferor/vendor company
i
No Entry
ty
(iii) If the transferee (purchasing) company reimburses the
r s
transferor company for liquidation expenses after the transferor

v e
i
company pays them (same entry as above, that is (ii) above).

n
U
Goodwill A/c (Debit)
To Cash/Bank A/c

L ,
Note: As an alternative, we may pass the subsequent two
items in place of above entry no.
S
(iii)
O
(a) Goodwill A/c
L / (Debit)

O
To Liquidator of Vendor (Transferor) Company A/c

C
E
To Cash/Bank A/c/
(b) Liquidator of Vendor (Transferor) Company A/c (Debit)

D C
5. For the purpose of discharging debt holders’ obligations,

©D
debentures may be issued [Debentures in Pur-
Debentures in Vendor (Transferor) Company A/c (Debit) chasing Company]
To % Debentures A/c
6. In order to record Statutory Reserves
Amalgamation Adjustment Reserve A/c (Debit)
To Statutory Reserve A/c [Individually]
Note: Amalgamation Adjustment A/c will be shown under the
Sub-heading “Other Non-Current Assets” in the Balance sheet.

PAGE 45
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 7. For the transferee company’s formation expenses

Preliminary Expenses A/c (Debit)
To Bank A/c
8. Cancellation of Mutual Asset and Liability in between
Vendor (Transferor) Company and Purchasing (Transferee)
Company
Bills Payable A/c (Debit)
Creditor A/c (Debit)

h i
Loan A/c (Debit)
e l
D
To Debtor A/c

of
To Bills Receivable A/c
To Advances A/c

i ty
Accounting Entries in the books of Purchasing (Transferee) Company
(Using the Pooling of Interest Method)
r s
v e
i
1. When the purchase consideration becomes due
Business Merger A/c

U n (Debit)
To Liquidator of Vendor (Transferor) Com-
pany A/c
L ,
O
2. In order to take over the liabilities and assets of

/ S
the transferor company

L
Sundry Assets A/c (Individually) (Debit)

CO
To Sundry Liabilities A/c (Individually) [at book value]

E/
To Securities Premium A/c [at book value]

C
To Statutory Reserves A/c (Individually) [at book value]

D D To Other Reserves and Provisions A/c (In- [at book value]

dividually)

© To Profit and Loss or Surplus A/c

To General Reserve A/c
To Business Merger A/c [Purchase Consideration]

46 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MERGER AND AMALGAMATION

3. To pay the vendor company the purchase con- Notes

sideration
Liquidator of Vendor (Transferor) Company A/c [Purchase Consideration]
(Debit)
To Equity Share Capital A/c
To Preference Share Capital A/c
To Securities Premium A/c
To Bank A/c
h i
4. Accounting for liquidation expenses
e l
D
(i) If borne and paid by the transferee (purchasing)

of
company
Liquidation Expenses A/c (Debit)
To Cash/Bank A/c
i ty
(For Paying the liquidation expenses)
r s
General Reserve/Profit and Loss/Surplus A/c

v e
(Debit)

n i
U
To Liquidation Expenses A/c

L ,
(To adjust liquidation expenses through general
reserves, statements of profits and loss/surplus
accounts)

S O
company
L /
(ii) If borne and paid by the transferor/vendor No Entry

C O
5. For the purpose of discharging debt holders’

E /
obligations, debentures may be issued
[Debentures in Purchasing

C
Debentures in Vendor (Transferor) Company A/c
Company]

D
(Debit)

©D
To % Debentures A/c
6. For the transferee company’s formation expenses
Preliminary Expenses A/c (Debit)
To Bank A/c
7. Cancellation of Mutual Asset and Liability in be-
tween Vendor (Transferor) Company and Purchasing
(Transferee) Company
Bills Payable A/c (Debit)

PAGE 47
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Creditor A/c (Debit)

Loan A/c (Debit)
To Debtor A/c
To Bills Receivable A/c
To Advances A/c

2.15 Accounting Procedure in the Books of Vendor Company

h i
1. Transferring all assets to the Realisation Account
e l
D
Realisation A/c [Individually] (Debit)

of
To Sundry Assets A/c
2. For the purpose of transferring all external liabilities

ty
to the Realisation Account
Sundry Liabilities A/c [Individually]
s i
(Debit)
To Realisation A/c
e r
i v
Note: Entry must be made to discharge all liabilities,

U n
whether recorded, unrecorded, or contingent, that the
Transferee Company did not assume and is required
to be incurred.
L ,
Realisation A/c

S O (Debit) [Actual payment]

L /
To Bank A/c
3. Recording entry for Purchase consideration due in

O
connection with the sale of a business

C
E /
Transferee (purchasing) company A/c (Debit) (With amount of Pur-

C
To Realisation A/c chase Consideration)

D
4. Different Approaches for Treating Realisation Ex-

©D
penses
(i) If borne and paid by the transferee (purchasing)
company
No Entry
(ii) If borne and paid by the transferor (vendor)
company
Realisation A/c (Debit)
To Bank A/c

48 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MERGER AND AMALGAMATION

(iii) If the Transferee Company fully or partially Notes

reimburses the Transferor Company for any amounts
paid by the Transferor Company
Realisation A/c (Debit)
To Bank A/c
[Payment by Transferor Company]
Bank A/c (Debit)
To Realisation A/c
h i
[Reimbursement by Transferee Company]
e l
D
5. For closing Preference Share Capital A/c

of
(Amount payable to Preference Shareholders at Par)
Preference Share Capital A/c (Debit)
To Preference Shareholders A/c
i ty
(Amount payable to Preference Shareholders at Pre- [Face value]
r s
mium)

v e
Preference Share Capital A/c
i
(Debit) [Face value]
n
U
Realisation A/c (Debit)
[Premium payable]

L ,
O
To Preference Shareholders A/c

/ S
(Amount payable to Preference Shareholders at Dis-
count)
L
CO
Preference Share Capital A/c (Debit) [Face value]

/
To Preference Shareholders A/c

E
C
To Realisation A/c

D D
[Discount]
6. For settling the claim of the Preference shareholders

©
Preference Shareholders A/c (Debit)
To Equity Shares in Transferee (purchasing)
company A/c
To Preference Shares in Transferee (purchasing)
company A/c
To Cash/Bank A/c

PAGE 49
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 7. Receiving purchase consideration from the Transferee

(purchasing) company
Equity shares in Transferee (purchasing) company A/c
(Debit)
Preference shares in Transferee (purchasing) company
A/c (Debit)
Cash/Bank A/c (Debit)

i
To Transferee (purchasing) company A/c
8. Closing the Realisation Account and transfer the
l h
profit/loss on Realisation to the Equity Shareholders
Account
D e
of
Realisation A/c (Debit)
To Equity Shareholders A/c

i
(Profit on Realisation Account transferred to Equity
ty
shareholder Account)
s
Equity Shareholders A/c

v er (Debit)
To Realisation A/c

n i
U
(Loss on Realisation Account transferred to Equity

,
shareholder Account)

O L
9. Transferring of Equity Share Capital as well as other
Reserves to Equity Shareholders Account

/ S
Equity Share Capital A/c (Debit)

OL
Securities Premium A/c (Debit)

C
General Reserve A/c (Debit)

E /
Profit & Loss A/c (Debit)

C
Capital Reserve A/c (Debit)

D D To Equity Shareholders A/c

10. Transferring of accumulated losses & fictitious

© assets to Equity Shareholders Account

Equity Shareholders A/c (Debit)
To Profit and Loss A/c
To Discount on issue of shares/debentures A/c
To Underwriting commission A/c
To Expenses on issue of shares/debentures A/c
To Preliminary Expenses A/c

50 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MERGER AND AMALGAMATION

11. Closing of the Equity Shareholders Account Notes

Equity Shareholders A/c (Debit)
To Equity Shares in Transferee (purchasing)
company A/c
To Cash/Bank A/c

IN-TEXT QUESTIONS
11. Which of the following is an example of vertical amalgamation?

h i
(a) Two competing airlines merging to form a larger airline
e l
D
(b) A manufacturer acquiring one of its suppliers

of
(c) Two companies in different industries merging to diversify
their operations
(d) A company acquiring a smaller company in the same
i ty
industry
r s
e
12. Which of the following is an example of a conglomerate merger?

v
i
(a) An automobile manufacturer merging with a steel producer
n
U
(b) A healthcare provider acquiring a pharmaceutical company
(c) None of these
L ,
O
(d) A food and beverage company merging with a steel

S
producer

L /
13. Which of the following is an example of a vertical merger?

O
(a) None of these
C
/
(b) A software company merging with an advertising agency
E
C
(c) A clothing retailer merging with a footwear manufacturer

D
(d) A gas exploration company merging with a gas distribution

©D
company
14. Which method of calculating purchase consideration considers
the sum of all payments made by the transferee business in
cash, shares, and debentures?
(a) Net Payment Method
(b) Exchange of Shares Method
(c) None of these
(d) Lump-Sum Method

PAGE 51
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 15. Which method of calculating purchase consideration determines

the intrinsic value of shares by dividing the realizable value of
Total Net Assets by the number of Shares Outstanding?
(a) Net Payment Method
(b) Exchange of Shares Method
(c) Net Assets Method

i
(d) Lump-Sum Method

l h
2.16 Summary
D e
of
Mergers and Amalgamations involve the combination of two or more
companies into a single entity. These transactions happen for various reasons,

ty
such as achieving cost savings, expanding market reach, accessing new
i
s
technologies or resources, diversifying business operations, or increasing
r
e
profits. From an accounting perspective, Mergers and Amalgamations

i v
has significant implications. It requires careful consideration of financial

U n
reporting, valuation, and disclosure requirements. Accountants play a
crucial role in assessing the financial impact of the transaction, ensuring

L ,
compliance with accounting standards and regulations, and accurately

O
representing the financial position and performance of the merged or

S
acquired entity. Accounting for Mergers and Amalgamations involves
/
L
important aspects. Firstly, it involves identifying and valuing the assets,

O
liabilities, and equity of the acquired or merged company. This includes

C
/
determining the fair value of physical and intangible assets, considering

C Ethe assumptions used in valuations, and recognizing any goodwill or

intangible assets resulting from the transaction. Accountants also need to

D address liabilities, such as debt and potential obligations, ensuring proper

©D
recognition and measurement. Allocating the purchase price to individual
assets and liabilities, and accounting for any changes in fair value, is
another crucial aspect. Financial reporting requirements come into play as
well. Consolidating financial statements may be necessary to reflect the
combined operations and financial position of the merged entities. This
involves integrating the financial statements of the acquiring and acquired
companies to provide a comprehensive view of the new entity. Disclosure
requirements involve transparent communication of information related
to the Mergers and Amalgamations transaction. This includes providing

52 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MERGER AND AMALGAMATION

detailed disclosures about the transaction’s nature and financial impact, Notes
any potential obligations or commitments, and significant assumptions
or estimates used in valuations. Overall, accounting for mergers and
acquisitions requires careful analysis, valuation, and financial reporting to
accurately represent the transaction’s impact on the financial statements.

2.17 Answers to In-Text Questions

1. (b) The process of combining two or more entities into a single entity
h i
2. (c) To reduce costs and improve efficiency
e l
3. (b) It involves the physical combination of two or more substances
D
4. (a) Increased market share and economies of scale
of
ty
5. (b) Increased risk and complexity in managing the combined entity

s i
6. (b) The purchase of one company by another, resulting in the acquiring
company controlling the acquired company
e r
i v
7. (b) It occurs when both companies mutually agree to merge or acquire

n
8. (b) A merger between companies in the same industry and at the
U
,
same stage of the supply chain

O L
9. (b) Synergy refers to the combined value created by the merger
or acquisition that is greater than the sum of the individual
companies
/ S
O L
10. (b) A merger between a car manufacturer and a steel mill

/ C
11. (b) A manufacturer acquiring one of its suppliers

E
12. (d) A food and beverage company merging with a steel producer
C
D
13. (d) A gas exploration company merging with a gas distribution

©D
company
14. (a) Net Payment Method
15. (b) Exchange of Shares Method

2.18 Self-Assessment Questions

1. Distinguish between amalgamation in the nature of a purchase and
amalgamation in the nature of a merger.

PAGE 53
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 2. Explain the meaning of purchase consideration in accordance with

AS-14.
3. AB Ltd. is considering the potential merger with XY Ltd. and has
gathered the following information:
Firm After Tax earn- No. of equity Market Price
ings shares per share
AB Ltd. Rs. 20,00,000 4,00,000 Rs. 150

i
XY Ltd. Rs. 6,00,000 1,00,000 Rs. 120

l
(i) If the merger proceeds through the exchange of equity shares,
h
earnings per share for AB Ltd.?
D e
based on the current market prices, what will be the new

of
(ii) XY Ltd. aims to ensure that its earnings per share remains

ty
unaffected by the merger. What exchange ratio should be
employed to achieve this objective?
s i
r
4. The following are the summarised Balance Sheets of AB Ltd. and
e
XY Ltd. as on 31st October, 2023:
i v
U n AB Ltd. XY Ltd.
Rs. (In crores) Rs. (In crores)

L
Sources of funds:
,
O
Share capital:

/
Authorised
S 50 10

L
Issued and Subscribed:

CO
Equity Shares of Rs. 10 each fully paid 24 10

/
Reserves and surplus 176 20

C E Shareholders’ funds
Unsecured loan from Yes Ltd.
200
--
30
20

D D 200 50

©
Funds employed in:
Property, Plant and Equipment: Cost 140 60
Less: Depreciation (100) (46)
Written down value 40 12

54 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MERGER AND AMALGAMATION

AB Ltd. XY Ltd. Notes

Rs. (In crores) Rs. (In crores)
Investments at cost:
60 lakhs equity shares of Rs. 10 each 6
Long-term loan to No. Ltd. 20
Current assets 200 68
Less: Current liabilities (66) (30)

i
200 50
On that day AB Ltd. merged with XY Ltd. The members of XY Ltd.
l h
are to get one equity share of AB Ltd. issued at a premium of Rs. 2 per
share for every five equity shares held by them in XY Ltd. The necessary
D e
of
approvals are obtained.

ty
You are required to pass journal entries in the books of the two companies
to give effect to the above.
s i
e r
v
2.19 Suggested Readings

n i
U
 ‹ ICSI
Study Material - Corporate Restructuring, Insolvency, Liquidation

,
& Winding-up
 ‹ De
L
Pamphilis, D.M. (2008). Mergers, Acquisitions, and Other
O
Restructuring Activities. (4th edn.).: Academic Press, Elsevier Inc.

/ S
L
 ‹ Rosenbaum, J. & Pearl, J. (2009) Investment Banking: Valuation,

O
Leverages Buyouts, and Mergers & Acquisitions. John Wiley and
Sons, Inc.
/ C
 ‹ ICWAI
E
Study Material - Financial Analysis & Business Valuation.

C
D
©D

PAGE 55
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
L E S S O N

3
Takeovers
Gurdeep Singh
Assistant Professor
Department of Finance and Business Economics
University of Delhi
Email-Id: g.swork@yahoo.com

h i
STRUCTURE
e l
D
of
3.1 Learning Objectives
3.2 Introduction
3.3 Takeovers - Meaning
i ty
3.4 Types of Takeovers
r s
3.5 Financial Accounting and Tax Aspects
v e
3.6 Stamp Duty on Takeover Documents
n i
3.7 Bailout Takeover
, U
3.8 Payment of Consideration
3.9 Legal Aspects
O L
/ S
L
3.10 SEBI Regulations
3.11 Summary
C O
/ Questions
3.12 Answers to In-Text Questions
E
C Readings
3.13 Self-Assessment

D
3.14 Suggested
D
3.1©Learning Objectives
‹ Describe the concept of takeovers.
‹ Explain the different types of takeovers.
‹ Understand the Legal Aspects of Takeovers.
‹ Understand the need to study SEBI Regulations for Takeovers.

56 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 TAKEOVERS

3.2 Introduction Notes

The corporate sector is like a magnet for businesses because it brings lots
of good things. One good thing is that businesses can ask the public for
money, and this helps them start big projects. When business promoters
want to grow, they look at the overall industrial and business landscape.
If they discover opportunities, they naturally want to invest in those
opportunities. When compared to the effort, cost, and time needed to start
a new business from scratch, it seems logical for them to consider the
h i
potential of acquiring an existing company. Think about a person who
e l
D
owns a small grocery store and has big ambitions to expand it further.

of
They’d carefully observe other grocery stores nearby. If they find attractive
possibilities, they’d be eager to make the most out of them. Rather than

ty
creating a new store from the ground up, it’s usually a more practical

s i
choice to buy an existing grocery store that’s already functioning. In 2011,

r
SEBI (Substantial Acquisition of Shares and Takeovers) introduced rules
e
v
about sharing information, thresholds for making public offers, and other

n i
steps involved in taking over a company. This lesson helps you grasp

, U
the meaning, idea, goals of takeovers, the step-by-step requirements for
taking over companies that are listed or unlisted.

O L
S
3.3 Takeovers - Meaning

L /
Intense competitive pressures and a growing desire for expansion have

C O
prompted companies worldwide, spanning various industries, to opt
/
for non-organic growth strategies. Among these strategies, Mergers &
E
C
Acquisitions (M&A) and Takeovers have emerged as robust avenues for

D
companies seeking to enter new markets, geographic regions, product

©D
categories, or broaden their customer base. A Takeover is a form of inorganic
corporate growth where one company attains control over another entity,
typically by purchasing a substantial portion, if not all, of its shares. This
entails acquiring control of an already established company by means
of purchasing or exchanging shares. Takeovers are commonly executed
by obtaining shares from existing shareholders at a predetermined price,
with the aim of securing a controlling interest in the target company. The
underlying rationale of the takeover strategy lies in enhancing corporate
value, optimizing productivity, and bolstering profitability by making

PAGE 57
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes efficient use of available resources, encompassing manpower, materials,

and machinery. The process of acquiring and taking over the management
and control of a business entity can be carried out using diverse methods.
Gaining authority over a company’s management could entail securing a
substantial portion of its share capital. In the case of unlisted companies,
shares can be procured using the method known as “acquisition under
Section 395 of the Companies Act, 1956.” If a company’s shares are
held by a limited group of individuals, a takeover might be accomplished
through negotiated agreements with those shareholders. Conversely, if
h i
e
a company’s shares are widely distributed among the general public,
l
D
the process outlined in the SEBI (Substantial Acquisition of Shares and

of
Takeovers) Regulations, 2011 comes into play. Typically, larger corporations
tend to acquire smaller ones in a takeover. Conversely, a reverse takeover

ty
scenario involves a smaller company assuming control over a larger one.

i
The acquiring company aims to achieve a controlling stake, which grants
s
r
it the authority to influence the target company’s decisions and direction.
e
v
Takeovers can be either amicable or hostile, depending on whether the

n i
target company’s management supports or opposes the acquisition.

, U
3.4 Types of Takeovers

O L
Takeovers can be classified into different types based on their characteristics

/ S
and the nature of the acquisition. Here are some common types of takeovers
L
along with examples:
O
C
Friendly Takeover: In a friendly takeover, the target company’s management

E /
and board of directors support the acquisition, and both parties collaborate

D C to complete the transaction. For example Company A Ltd., a leading

pharmaceutical company, decides to acquire Company B Ltd., a smaller

© D biotech start-up. Both companies have a mutual agreement, and the

management of B Ltd. supports the acquisition. The deal is seen as a positive
step toward strengthening their combined R&D capabilities and expanding
product offerings.
Hostile Takeover: In a hostile takeover, the acquiring company pursues the
target company’s shares without the approval of the target’s management.
This can involve direct purchase from shareholders or proxy battles to
gain control. For example Company Z Ltd, a well-established technology

58 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
School of Open Learning, University of Delhi
 TAKEOVERS

firm, launches a hostile takeover bid for Company A Ltd., a rapidly Notes
growing software development company. Despite opposition from A Ltd.’s
management, Z Ltd. acquires a substantial number of shares directly
from A Ltd.’s shareholders, eventually gaining control over the company.
Reverse Takeover: In a reverse takeover, a smaller company acquires
control over a larger company. This can be used as a strategy for a
private company to go public without undergoing the traditional Initial
Public Offering (IPO) process. For example Company B Ltd., a start-up
in the renewable energy sector, successfully acquires Company A Ltd.,
h i
an established utility company. This reverse takeover allows B Ltd. to
e l
benefit from A Ltd.’s resources and infrastructure while leveraging its
D
of
innovative energy solutions to transform A Ltd.’s operations.
Conglomerate Takeover: In a conglomerate takeover, the acquiring

i ty
company operates in a different industry or sector than the target company.

s
This type of takeover is aimed at diversifying the acquiring company’s
r
e
portfolio. For example Company Z Ltd., a conglomerate with interests in

v
n i
various industries, acquires Company B Ltd., a leading chain of fitness
centres. This acquisition diversifies Z Ltd.’s portfolio by entering the
fitness and wellness sector.
, U
O L
Asset Takeover: In an asset takeover, the acquiring company purchases
specific assets or divisions of the target company, rather than acquiring

/ S
the entire company. For example Company A Ltd., a global automotive

O L
manufacturer, acquires certain manufacturing facilities and distribution
channels of Company B Ltd., a struggling car parts supplier. This asset

/ C
takeover enables A Ltd. to enhance its production capabilities and

E
streamline its supply chain.
C
D
Management Takeover: In a management takeover, a group of investors

©D
or managers acquire control of a company to bring about operational
and strategic changes. For example Company Z Ltd., along with a group
of investors, undertakes a management takeover of Company A Ltd., a
struggling retail chain. The new management team restructures operations,
introduces efficient processes, and rejuvenates A Ltd.’s brand to restore
its profitability.
Bailout Takeover: A bailout takeover refers to a situation where one
company acquires another that is facing financial distress or insolvency

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes in order to rescue it from its dire financial condition. The acquiring
company steps in to provide the necessary capital and support to stabilize
the troubled company and prevent it from going bankrupt. For example
Company B Ltd., a well-capitalized conglomerate, steps in to acquire
Company A Ltd., a distressed airline facing financial difficulties. The
bailout takeover by B Ltd. provides A Ltd. with the necessary funds and
resources to stabilize its operations and continue offering air services.

i
IN-TEXT QUESTIONS
1. What is the primary motivation behind takeovers?
l h
(a) Regulatory compliance (b) Diversification
D e
of
(c) None of these (d) Legal enforcement
2. Which entity is responsible for ensuring that the payment of

ty
consideration is made to shareholders who accepted the open
offer?
s i
(a) Acquirer
e r
(b) None of these

v
ni
(c) Regulatory authority (d) Stock exchange
3. What does the term “takeover” in business refer to?

, U
(a) Sharing market information with competitors

L
(b) Gaining control of another company’s operations
O
/ S
(c) Outsourcing certain business functions

O L(d) None of the above

4. What term is used for a takeover initiated by the target company’s

/ C management with the support of its shareholders?

C E (a) Hostile takeover (b) None of these

DD
(c) Friendly takeover (d) Bailout takeover

© 3.5 Financial Accounting and Tax Aspects

The financial and accounting factors play a crucial role in strategizing a
takeover. In the case of a takeover, if the individual making the acquisition
is the acquirer, they need to record in their financial records the money
they’ve invested in the shares of the company they’re taking control of.
This investment in the shares of the company being acquired must also
be reported in their Income Tax Return at the end of the fiscal year.

60 PAGE
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 TAKEOVERS

When the acquirer is a company, once the acquired shares are officially Notes
registered in the target company’s list of members, the acquiring company
becomes the parent company, and the target company becomes its
subsidiary. This is because the acquiring company holds more than half
of the equity share capital’s nominal value, as outlined in Section 2(26)
and 2(87) of the Companies Act, 2013.
Financial accounting and tax aspects of takeovers in India involve various
considerations and implications for both the acquiring company and the
target company. Let’s explore some key points related to these aspects:
h i
Financial Accounting Aspects:
e l
Purchase Price Allocation: When an acquiring company takes over D
of
‹
another company, it needs to allocate the purchase price to various

ty
assets and liabilities acquired. This is essential for determining the

i
value of acquired assets and liabilities, including goodwill, which

s
r
represents the excess of the purchase price over the fair value of
net identifiable assets.
v e
‹

n i
Consolidation: After the takeover, if the acquiring company holds

U
a significant controlling interest, it may need to consolidate the

L ,
financial statements of the target company into its own financial
statements. This involves combining the financial information of

O
both companies as if they were a single entity.
S
‹

L /
Fair Value Measurement: Assets and liabilities of the target company

O
are typically recorded at their fair values as of the acquisition date.

C
This might involve revaluation of certain assets and liabilities to
/
E
reflect their current market values.
‹

D C
Contingent Liabilities: The acquiring company needs to assess
and recognize any contingent liabilities that might arise from the

©D
takeover. These are potential obligations that might or might not
occur in the future, like pending lawsuits or warranties.
Tax Aspects:
‹ Capital Gains Tax: The transfer of assets in a takeover may trigger
capital gains tax for both the acquiring company and the selling
shareholders of the target company. However, there are specific

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School of Open Learning, University of Delhi
 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes provisions that allow for certain exemptions or concessional rates

in certain cases.
‹ Minimum Alternate Tax (MAT): In India, companies are subject to
MAT, which is a form of alternate tax. In the context of takeovers,
MAT implications need to be evaluated, especially in cases where
the company being acquired has been enjoying tax benefits.
‹ Depreciation Benefits: The acquiring company may need to

i
re-evaluate the depreciation rates of the acquired assets based on
the new company’s policies and the income tax regulations.
l h
‹

D e
Withholding Tax: Payments made to non-resident shareholders might

of
be subject to withholding tax, which is the tax deducted at source.
The tax rates and exemptions depend on the double tax avoidance

ty
agreements and the Income-tax Act of India.
‹

s i
Indirect Tax Considerations: Takeovers may also have indirect tax

r
implications, like Goods and Services Tax (GST) on the transfer
e
v
of goods and services. Proper analysis of these implications is
necessary.
n i
, U Documents
3.6 Stamp Duty on Takeover

O L
In a takeover scenario, the document subject to stamp duty is the

/ S
Instruments of Transfer, which are established and exchanged between
L
those transferring shares and the recipient of the shares. These Instruments
O
C
of Transfer must conform to the specified form outlined in the Companies

/
(Central Government’s) General Rules and Forms of 1956. The levy of
E
C
stamp duty on these Instruments of Transfer is satisfied using Share

D
Transfer Stamps.

© D These specialized stamps are affixed to and cancelled on each transfer

document/instrument at the rate equates to 0.50 Paise for every one hundred
rupees or any fraction thereof, relating to the value of the shares being
transacted. Notably, in the event of shares being transferred through a
Depository, the obligation to pay stamp duty does not arise.
Essentially, within a takeover context, the alteration of share ownership
necessitates the utilization of Instruments of Transfer, with stamp duty
obligations met through the application of Share Transfer Stamps affixed

62 PAGE
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School of Open Learning, University of Delhi
 TAKEOVERS

to these documents. The stamp duty quantum hinges on the value of the Notes
shares transferred, with no stamp duty obligation existing when shares
are transferred through a Depository.

3.7 Bailout Takeover

A “bailout takeover” is when a company that’s doing well helps out another
company that’s in financial trouble. Imagine ABC Ltd., a strong and rich
company, seeing that XYZ Ltd. is struggling with money problems and
h i
might even go out of business. ABC Ltd. decides to step in and take,
e l
D
over XYZ Ltd. to save it.

of
Here’s how it works: XYZ Ltd. is having a hard time with debts, not
making much money, and maybe even losing customers. ABC Ltd. is

ty
doing great, has a lot of money, and is doing well in the market. ABC

s i
Ltd. thinks it’s a good idea to help XYZ Ltd. by taking over their

r
operations. They talk and agree on things like how much money ABC
e
v
Ltd. will pay to buy XYZ Ltd., how to manage the company, and how
i
n
to make things better.

U
ABC Ltd. then gives XYZ Ltd. money to pay off debts, improve their
,
L
products or services, and become stronger. They might even change the

O
way XYZ Ltd. works to make it more efficient. By doing this, XYZ Ltd.

/ S
gets another chance to succeed and grow. At the same time, ABC Ltd.

O L
might benefit from the deal too, like getting access to new markets or
getting stronger in their industry.

/ C
An example of this could be: B Ltd. is a big technology company

C E
with lots of money and resources. Z Ltd. is a small tech start-up that’s
struggling with money issues and hasn’t been able to make its product
D
©D
successful. B Ltd. decides to buy Z Ltd., gives them money to improve
their product, and uses their expertise to turn Z Ltd.’s situation around.
So, a bailout takeover is like a helping hand from a successful company
to a struggling one. It’s a win-win because the struggling company gets
a lifeline, and the successful company gets a chance to grow even more.
A “bailout takeover” is a type of corporate acquisition that occurs when
a financially stable company acquires or takes over another company that
is facing significant financial distress or the threat of insolvency. The
primary objective of a bailout takeover is to rescue the troubled company

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes by providing it with the necessary financial resources, management

expertise, and operational support to prevent it from collapsing or going
bankrupt. This type of takeover can also be referred to as a “distressed
acquisition” or a “financially troubled company acquisition.”
Here are the key details and components of a bailout takeover:
1. Financial Distress of the Target Company: The target company, which
is typically smaller and struggling financially, faces challenges such

i
as mounting debt, declining revenues, liquidity issues, operational

l h
inefficiencies, or adverse market conditions. These challenges may

D e
put the company’s survival at risk. Example: XYZ Electronics, a
small consumer electronics company, is struggling due to declining

of
sales, high debts, and increased competition from larger players in
the market. They’re finding it hard to pay their bills and keep their
operations running smoothly.
i ty
r s
2. Acquirer’s Financial Stability: The acquiring company, on the

e
other hand, is financially stable, well-capitalized, and capable of
v
n i
providing the necessary financial resources to support the distressed
target company. Example: ABC Corp, a well-established technology

, U
company, has a strong financial position with ample cash reserves

O L
and a steady revenue stream. They have the financial capacity to
support struggling companies.

/ S
3. Motivation and Benefits: The acquirer’s motivation for a bailout
L
takeover could include strategic expansion, access to new markets or
O
C
technologies, or synergies with its existing operations. Additionally,

E / the acquirer may see an opportunity to acquire assets or intellectual

C
property at a favourable price due to the target company’s financial

D
difficulties. Example: ABC Corp sees an opportunity to expand its

©D
product line and enter new markets by acquiring XYZ Electronics.
Additionally, they recognize that XYZ’s patents and technology
could enhance their own product offerings.
4. Due Diligence: Before proceeding with the takeover, the acquiring
company typically conducts thorough due diligence to assess the
target company’s financial health, liabilities, assets, operations, and
potential for recovery. This evaluation helps the acquirer determine
the feasibility of the bailout and the potential benefits. Example:
Before finalizing the takeover, ABC Corp thoroughly examines

64 PAGE
© Department of Distance & Continuing Education, Campus of Open Learning,
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TAKEOVERS

XYZ Electronics’ financial records, market position, and potential Notes

for improvement. They assess the extent of the financial difficulties
and the feasibility of turning the company around.
5. Negotiations and Terms: Negotiations take place between the acquiring
company and the target company’s management, stakeholders, and
creditors. The terms of the takeover are worked out, including the
purchase price, the allocation of liabilities, the infusion of capital,
and the post-acquisition integration plan. Example: ABC Corp
negotiates with XYZ Electronics’ management and creditors. They
h i
agree on a purchase price that takes into account XYZ’s financial
e l
challenges. The terms also outline how ABC Corp will provide the
D
of
necessary funds for stabilizing the company.
6. Capital Infusion and Restructuring: Once the takeover is completed,
the acquiring company provides the target company with the
i ty
s
necessary funds to stabilize its operations, pay off debts, and address
r
e
immediate financial concerns. This may involve restructuring the

v
n i
target’s operations, streamlining processes, and implementing cost-
saving measures. Example: After the takeover, ABC Corp injects

U
funds into XYZ Electronics to help pay off debts and invest in
,
L
new product development. They streamline operations, reducing

O
unnecessary costs and improving efficiency.

/ S
7. Management and Operations: Depending on the severity of the

O L
distress, the acquiring company may opt to replace the target
company’s management or provide support to improve its operational

/ C
efficiency. The target company’s operations may be integrated into

C E
the acquirer’s operations or maintained as a separate entity. Example:
ABC Corp appoints a new CEO with experience in turning around
D
©D
struggling companies to lead XYZ Electronics. They also provide
managerial expertise to reorganize the company’s operations for
better results.
8. Long-Term Recovery and Growth: The acquiring company’s goal
is to help the target company recover from its financial distress and
position it for long-term growth. This may involve implementing
turnaround strategies, introducing new management practices,
expanding market reach, and leveraging synergies between the two
companies. Example: Under ABC Corp’s leadership, XYZ Electronics

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes implements a new business strategy focused on innovation and

customer experience. They introduce new product lines and improve
their distribution channels, leading to increased sales and market
share.
In essence, a bailout takeover is a strategic move by a financially strong
company to rescue and rehabilitate a distressed company, leveraging its
own resources, expertise, and stability to support the target’s recovery and
future growth. This type of takeover can lead to a win-win situation, where
the target company avoids insolvency, and the acquiring company gains
h i
e l
strategic advantages and potential financial returns from its investment.

D
A real-world scenario might involve ABC Corp, a financially strong

of
technology company, acquiring XYZ Electronics, a struggling consumer
electronics company. XYZ Electronics is facing financial challenges, but

ty
ABC Corp’s stability, expertise, and resources allow them to help XYZ

s i
recover. Through strategic management, capital infusion, and operational

e r
improvements, XYZ Electronics is able to regain its position in the market

i v
and contribute to ABC Corp’s overall growth strategy.

IN-TEXT QUESTIONS
U n
,
5. What does the term “bailout takeover” emphasize?

L
O
(a) The rescue and support provided by a financially stable

/ S
company to a struggling company

L
(b) The importance of eliminating competition in the market

CO
(c) The role of government intervention in business takeovers

E/
(d) None of the above

DC
6. What is the significance of conducting due diligence in a takeover?

©D
(a) To delay the takeover process
(b) To assess the financial health of the target company
(c) To evaluate the regulatory authority’s involvement
(d) To assess the operational and financial aspects of the
target company

66 PAGE
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 TAKEOVERS

Notes
3.8 Payment of Consideration
According to Regulation 21(1), if the acquirer needs to pay the consideration
in cash, they must create a special escrow account with a registered banker
under the supervision of the Board. In this account, they should deposit
an amount that, combined with the cash transferred under clause (b) of
sub-regulation (10) of regulation 17, covers the total payment owed to
shareholders as consideration during the open offer. The acquirer should
authorize the offer manager to operate this special escrow account on
h i
their behalf, following the regulations’ requirements.
e l
Furthermore, as specified in Regulation 21, the Company that’s acquiring
D
of
another company needs to finish paying the agreed amount, whether
it’s in money (cash) or through exchange/transfer of Securities, within

i
10 working days after the time when shareholders have agreed to the
ty
s
takeover offer. This payment is done by moving the agreed payment into
r
e
a special bank account called the Special Escrow Account.

i v
In accordance with sub-regulation (3), if there are any unclaimed balances
n
remaining in the special escrow account mentioned in sub-regulation (1)
U
,
after seven years from the deposit date, these balances will be moved to

O L
the Investor Protection and Education Fund established under the Securities
and Exchange Board of India (Investor Protection and Education Fund)
Regulations, 2009.
/ S
L
In simpler terms, when a company is taking over another company
O
C
and needs to pay money to the shareholders of that company, it has to

/
make a separate bank account for this purpose. This account is watched
E
C
over by the takeover manager and holds all the money needed to pay

D
the shareholders. The company has to pay the shareholders within ten

©D
working days after the takeover offer ends. If, after seven years, there’s
still money left in the account that nobody has claimed, that money
goes into a special fund set up by the SEBI to safeguard and educate
investors.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes IN-TEXT QUESTIONS

7. What type of takeover involves acquiring another company to
prevent its financial collapse?
(a) Hostile takeover (b) None of these
(c) Bailout takeover (d) Strategic takeover
8. What is the main difference between a bailout takeover and a

i
regular acquisition?

l
(a) In a bailout takeover, both companies are financially
h
struggling
D e
of
(b) In a bailout takeover, the target company is financially
troubled, while the acquiring company is financially stable

ty
(c) In a bailout takeover, both companies are aiming for
international expansion
s i
e r
(d) In a bailout takeover, the acquiring company is looking to

i v
increase its competition

U n
9. Which stage of the takeover process involves negotiations about
terms, purchase price, and integration plans?

L ,
(a) Due diligence (b) Capital infusion

S O
(c) Operational restructuring (d) Negotiations and terms

L /
10. How does the acquiring company benefit from a bailout takeover?

CO
(a) By potentially accessing new markets, technologies, and

E / synergies
(b) By gaining control over the stock market
C
DD
(c) By inheriting the struggling company’s debts
(d) None of the above
© 3.9 Legal Aspects
The primary legal frameworks governing takeovers encompass the
following statutes:

68 PAGE
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 TAKEOVERS

‹ SEBI (SAST) Regulations, 2011 Notes

‹ Companies Act, 1956
‹ Listing Agreement
The SEBI (SAST) Regulations, 2011 serve as the guiding principles that
outline the steps an acquiring party must follow when seeking to attain
a substantial shareholding or controlling stake in another company.
Within the realm of the Companies Act, the acquisition of shares through a
company is subject to the stipulations laid out in Section 372A. Furthermore,
h i
Section 395 of the Companies Act delineates the legal prerequisites for
e l
D
facilitating the takeover of an unlisted company via the transfer of its

of
operations to another enterprise.
For listed companies, the mechanisms for takeover are governed by

ty
clauses 40A and 40B within the Listing Agreement. These specific clauses

s i
within the Listing Agreement function autonomously to supervise takeover

e r
endeavours, thereby establishing requirements that revolve around the

i v
disclosure of information and the fostering of transparency.

U n
In essence, these legislative frameworks converge to outline the comprehensive
guidelines that shape the landscape of takeover activities, ensuring that

L ,
the acquisition process is conducted with due diligence, compliance, and

O
a commitment to transparency.

/ S
3.10 SEBI Regulations
O L
/ C
The takeover process is governed by regulations set by SEBI, which is a

C E
regulatory body in India. The specific regulation that deals with takeover
details is known as the SEBI (Substantial Acquisition of Shares and

D
Takeovers) Regulations. These regulations are outlined in the SEBI (SAST)

©D
Regulations, which provide a comprehensive framework for the acquisition
of shares and control over companies. The SEBI (SAST) Regulations
specify various thresholds for open offers, disclosure requirements, and
procedural aspects that companies need to follow during the takeover
process. These rules help prevent unfair practices, provide information to
shareholders, and establish a clear process for companies to follow when
acquiring control over another company. In essence, the SEBI (SAST)

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Regulations play a crucial role in maintaining the integrity of the takeover
process and promoting a level playing field for all stakeholders.
SEBI (Securities and Exchange Board of India) regulations regarding
takeovers are governed by the SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 2011. These regulations provide guidelines and
procedures for acquiring substantial shares in a company and conducting
takeovers.

i
Here are some key provisions and regulations from the SEBI (Substantial
Acquisition of Shares and Takeovers) Regulations, 2011:
l h
e
Regulation 6 - Voluntary Offer: This regulation outlines the conditions
D
of
and procedures for making a voluntary open offer. It provides flexibility
to acquirers who wish to extend an offer to shareholders beyond the

ty
mandatory thresholds, thus promoting fairness in the process.

i
Regulation 11 - Exemptions by the SEBI: (Explained above) SEBI has
s
r
the authority to grant exemptions from strict compliance with certain
e
v
regulations if such exemptions are deemed to be in the interest of the
securities market.
n i
, U
Regulation 19 - Conditional Offer: This regulation sets out guidelines
for making a conditional open offer, where the acquirer places certain
L
conditions on the success of the offer. The offer is only effective if the
O
S
specified conditions are met.

L /
Regulation 20 - Competing Offer: This regulation allows for competing

O
offers, where multiple acquirers may simultaneously make open offers

C
/
for the same target company. The regulation outlines the process for

C Ehandling such scenarios.

Regulation 21 - Payment of Consideration: This regulation governs the
D
©D
payment of consideration to shareholders who accept the open offer. It
specifies the timeline within which the acquirer must make payments to
shareholders who have tendered their shares.
Regulation 23 - Withdrawal of Open Offer: This regulation provides
guidelines for the withdrawal of an open offer by the acquirer before its
completion. The regulation outlines the circumstances under which such
withdrawal is permissible and the procedures for doing so.
Regulation 25 - Obligations of the Acquirer: Regulation 25 outlines
the obligations of the acquirer throughout the open offer process. These

70 PAGE
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School of Open Learning, University of Delhi
 TAKEOVERS

obligations include timely communication, adherence to regulations, and Notes

fulfilment of payment obligations.
Regulation 26 - Obligations of the Target Company: This regulation
defines the obligations of the target company in facilitating the open offer
process. The target company is required to provide necessary information
and assistance to ensure a smooth open offer.
These regulations collectively ensure fairness, transparency, and proper

i
procedures in the context of takeovers and substantial acquisitions. They
aim to strike a balance between the interests of acquirers and public
l h
shareholders while safeguarding the overall integrity of the financial
markets.
D e
IN-TEXT QUESTIONS
of
ty
11. What is the main reason a struggling company might agree to
a bailout takeover?
s i
(a) To shut down the business
e r
i v
(b) To gain control over the acquiring company

U n
(c) To maintain its independence and avoid interference

L
from financial difficulties,
(d) To access financial resources and expertise to recover

S O
12. What is the purpose of a “withdrawal of open offer” in a takeover?

L /
(a) To terminate the takeover process after regulatory approval

O
(b) To delay the payment of consideration to shareholders
C
E /
(c) To cancel the open offer before its completion

C
(d) To challenge the legality of the takeover process

D
©D
13. What is the primary purpose of SEBI regulations in takeovers?
(a) Maximize acquirer’s financial gains
(b) Facilitate tax benefits for acquirers
(c) Protect minority shareholders and ensure transparency
(d) None of the above

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Notes 14. What is the main role of SEBI in the context of takeovers?
(a) Maximizing acquirer’s profits
(b) Ensuring transparency and shareholder protection
(c) Enforcing monopoly regulations
(d) Encouraging hostile takeovers
15. What is a “competing offer” in the context of takeovers?
(a) An offer made by the target company to acquire the
h i
acquirer
e l
D
(b) Multiple acquirers making offers for the same target company

of
(c) An offer made by the government to intervene in a takeover
(d) An offer made to acquire a competitor of the target
company
i ty
r s
3.11 Summary
v e
n i
Takeovers, a strategic business maneuver, involve one company acquiring

, U
control over another. The primary motivations include gaining market share,

O L
diversification, synergy creation, and enhanced profitability. Takeovers
can be friendly, where the target agrees, or hostile, when it resists.

/ S
Legal aspects are crucial, with SEBI regulations in India overseeing

O L
takeover processes to ensure transparency, equal treatment, and shareholder
protection. Compliance with these regulations is mandatory for acquirers

/ C
and target companies.

C EFinancial accounting and tax aspects influence takeover decisions. Valuation

D methods, such as discounted cash flows and comparable analysis, determine

©D
the offer price, impacting both parties’ financials. Tax implications, like
capital gains tax, influence structuring the deal.
Stamp duty is levied on transfer documents during takeovers, impacting
transaction costs. Payment of consideration involves ensuring that the
offered amount is paid to shareholders who accepted the open offer within
specified timelines, maintaining fairness.

72 PAGE
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 TAKEOVERS

Bailout takeovers involve acquiring financially distressed companies to Notes

stabilize them. This can lead to restructuring, financial injections, and
operational improvements to revive the target’s performance.
Takeovers of sick units aim to rejuvenate ailing businesses. Acquirers
undertake these takeovers with the goal of reviving operations, enhancing
efficiency, and turning around the target’s financial health.
Understanding these facets of takeovers is vital for businesses, investors, and

i
regulatory bodies alike. It ensures informed decision-making, compliance
with legal frameworks, and effective management of financial, tax, and
l h
operational aspects. In a dynamic business landscape, comprehending the
nuances of takeovers empowers stakeholders to navigate through these
D e
of
transformative transactions successfully.

3.12 Answers to In-Text Questions

i ty
r s
1. (b) Diversification

v e
2. (a) Acquirer
n i
U
3. (b) Gaining control of another company’s operations
4. (c) Friendly takeover

L ,
5. (a) The rescue and support provided by a financially stable company
to a struggling company
S O
L /
6. (d) To assess the operational and financial aspects of the target
company

C O
E /
7. (c) Bailout takeover
8. (b) In a bailout takeover, the target company is financially troubled,

D C
while the acquiring company is financially stable

©D
9. (d) Negotiations and terms
10. (a) By potentially accessing new markets, technologies, and synergies
11. (d) To access financial resources and expertise to recover from
financial difficulties
12. (c) To cancel the open offer before its completion
13. (c) Protect minority shareholders and ensure transparency
14. (b) Ensuring transparency and shareholder protection
15. (b) Multiple acquirers making offers for the same target company

PAGE 73
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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 3.13 Self-Assessment Questions

1. Explain the concept of a takeover in the context of corporate
finance. What are the key motivations behind companies engaging
in takeovers?
2. What is a friendly takeover, and how does it differ from a hostile
takeover? Provide examples of each.

i
3. What role does SEBI play in regulating takeovers in India? Why
is this important?
l h
D e
4. Imagine a situation where a company wants to increase its shareholding
in another company. What are some factors they need to consider

of
before proceeding with the takeover?

3.14 Suggested Readings

i ty
r s
‹

v e
ICSI Study Material - Corporate Restructuring, Insolvency, Liquidation
& Winding-up.

n i
U
‹ De Pamphilis, D.M. (2008). Mergers, Acquisitions, and Other

,
Restructuring Activities. (4th edn.): Academic Press, Elsevier Inc.
‹

O L
Rosenbaum, J. & Pearl, J. (2009) Investment Banking: Valuation,
Leverages Buyouts, and Mergers & Acquisitions. John Wiley and

/
Sons, Inc.S
‹

O L
ICSI Handbook on Mergers Amalgamations and takeovers.
‹
/ CICWAI Study Material - Financial Analysis & Business Valuation.

C E
D
©D

74 PAGE
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L E S S O N

4
Financial Restructuring
Dr. Rooplata
Assistant Professor
Department of Commerce (C.A.)
Jindal School of Banking and Finance
PSG College of Arts & Science

h
Coimbatore-641014, Tamil Nadu
i
e l
Email-Id.: rooplata91@gmail.com

D
Dr. Rupesh Sharma

of
Assistant Professor
O.P. Jindal University, Sonipat

ty
Email-Id: sharma2rupesh@gmail.com

s i
STRUCTURE
e r
4.1 Learning Objectives
i v
4.2 Introduction
U n
4.3 Financial Restructuring
L ,
O
4.4 Internal Reconstruction
4.5 Summary
/ S
L
4.6 Answers to In-Text Questions
O
C
4.7 Self-Assessment Questions
/
4.8 References

C E
4.9 Suggested Readings
D
‹
©D
4.1 Learning Objectives
Understand the concept and objectives of financial restructuring in Indian companies.
‹ Identify the different measures and strategies involved in financial restructuring to
maintain profitability and financial equilibrium.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes ‹ Explore the role of internal reconstruction in improving the financial

health and performance of Indian companies.
‹ Evaluate the effectiveness of financial restructuring and internal
reconstruction as recovery strategies for Indian companies in financial
distress.

4.2 Introduction
Corporate restructuring is the process of making significant changes
h i
e l
to the organizational, financial, or operational structure of a company.

D
Businesses restructure either to achieve their strategic objectives or

of
respond to changes in the business environment. The ambit of corporate
restructuring includes a variety of strategic actions, such as mergers and

ty
acquisitions, divestitures, spin-offs, joint ventures, reorganizations, and

s i
bankruptcy. Restructuring is a complex and challenging process as it often

r
involves making difficult decisions regarding the allocation of resources,
e
v
identification of core business functions, and management of stakeholder
i
n
expectations. However, when done successfully, corporate restructuring is

, U
helpful in maintaining competitiveness and achieving long-term success
in a rapidly evolving business landscape. In this chapter, we focus on
L
the financial, accounting, and regulatory aspects relating to corporate
O
S
restructuring.

L /
One of the key objectives of corporate restructuring is financial restructuring,

O
which involves making changes to a company’s financial structure to

C
/
improve its profitability and maintain financial equilibrium. Financial

C Erestructuring is crucial to ensure the effective management of resources,

including capital, and maintain a competitive edge in a rapidly changing

D business environment. Financial restructuring involves a range of measures

©D
and strategies aimed at optimizing costs, improving cash flows, enhancing
financial flexibility, and increasing shareholder value. It involves the
reorganization of a company’s capital structure, debt obligations, and
operations to improve its financial standing.
In India, financial restructuring has gained considerable attention in
recent years as companies strive to increase their competitiveness and
profitability. The final objective of financial restructuring is to maintain
an adequate ratio between a company’s own and borrowed capital in order

76 PAGE
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 FINANCIAL RESTRUCTURING

to be solvent and implement recovery strategies. Empirical studies have Notes

shown that financial restructuring can be an effective recovery strategy
for companies facing financial distress (Gutiérrez et al., 2015).
Internal reconstruction is one of the key strategies for financial restructuring.
It involves the analysis and redesign of a company’s organizational
structure, including hierarchical levels, responsibility centres, productive
centres, and support centres. This restructuring of the organization
ensures that it is aligned with the new objectives and strategies set
forth by the company. Internal reconstruction also involves the review
h i
of personal policies and wage structures to optimize costs, as well as
e l
the development of controlling departments for monitoring the financial
D
of
and commercial performance of the business. Such monitoring allows
for the identification and elimination of areas that generate cash losses,

ty
ensuring the implementation of strategies aimed at reducing costs and
optimizing their structure.
s i
e r
The chapter is organised in two major sections. In sections 4.3 and

i v
4.4, we discuss the concepts of financial restructuring and internal

U n
reconstruction. Specifically, we discuss types of financial restructuring in
section 4.3.1, key concepts of financial restructuring in section 4.3.2, legal

L ,
and regulatory aspects of financial restructuring in 4.3.3 and conclude

O
our discussion on financial restructuring with a case study in section

/ S
4.3.4. Further, we discuss the motivations for internal reconstruction in

O L
section 4.4.1, types of internal reconstruction in 4.4.2, accounting aspects
of internal reconstruction in 4.4.3, financial and other aspects of internal

/ C
reconstruction in 4.4.4 and apply the learnt concepts using a case study
in section 4.4.5.

C E
D
4.3 Financial Restructuring

©D
Often times, to improve a firm’s financial position there is a need to
modify the structure of the financial obligations. This process of analysis
and decision making to optimise the financial structure of the firm is
known as ‘Financial Restructuring’. The process results in the adoption
of a suitable strategy, such as refinancing debt, renegotiating payment
terms with creditors, restructuring business operations, or raising additional
capital.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Financial restructuring deals with restructuring of capital base and raising
finance for new business plan. Financial restructuring helps a firm to revive
from the situation of financial sickness without going into liquidation.
Financial restructuring is the process of reorganizing the company by
affecting major changes in ownership patterns, asset mix, and operations
which are outside the ordinary course of business. Therefore financial
restructuring implies many things such as mergers and takeovers,
recapitalization, leveraging divestitures, spin-offs, curve-outs, reorganization
of capital and financial reconstruction.
h i
Financial restructuring is done for various business reasons:
e l
Very bad financial performance D
of
u

u External competition

ty
u Erosion or loss of market share
Emerging market opportunities
s i
r
u

e
Financial restructuring involves Equity Restructuring like Alteration/
v
n i
Reduction of capital, buy-back and Debt Restructuring like restructuring
of the secured long-term borrowing, long-term unsecured borrowings,
short term borrowing.
, U
O L
4.3.1 Types of Financial Restructuring
/ S
u

O L
Internal vs. external financial restructuring
Internal restructuring is a method of corporate restructuring where

/ C
changes in the assets and liabilities are made to improve the financial

C E
position without liquidating the company or transferring the ownership to

D
an external party. In contrast, external restructuring is where an existing

© D company is liquidated and taken over by another newly formed company.

The transfer of assets and liabilities occurs, which is considered similar
to amalgamation.
Internal restructuring requires much time and statutory requirements
because, in internal restructuring, the company has to take the permission
from stakeholders and the court. On the other hand, external restructuring
can be done immediately without consent from the court. Both of these
restructurings make sure changes in financial structure. But since internal
restructuring doesn’t liquidate, things become difficult.

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 FINANCIAL RESTRUCTURING

In the case of internal restructuring, the company’s losses can be set Notes
off against the company’s future profit whereas in the case of external
restructuring, the losses of an old company can’t be set off against the
profit of the new company. Internal restructuring is done when there is
a possibility for the existing company to revive. External restructuring
is done to start the thing completely afresh.
Examples: Wipro had gone for a mid-level structural and management
makeover that had seen its IT services business being split vertically
into six strategic business units based on industry domains. Future Group
h i
recently restructured to create a pure play retail business in Pantaloon
e l
Retail and bring other non-retail businesses together.
D
of
‹ Debt-based vs. Equity-based financial restructuring

ty
Debt Restructuring

i
It involves a reduction of debt and an extension of payment terms or
s
r
changes in terms and conditions, which is less expensive. It is infact
e
v
negotiating with bankers, creditors, vendors. It is the process of reorganizing

n i
the entire debt capital of the company. It involves the reshuffling of the

U
balance sheet items as it contains the debt obligation of the company.

L ,
Debt capital of the company are secured long term borrowing, unsecured
long-term borrowing, and short term borrowings:

S O
/
‹ Restructuring of the secured long-term borrowing for improving

O L
liquidity and increasing the cash flows for a sick company and
reducing the cost of capital for healthy companies.

/ C
Restructuring of the long-term unsecured borrowings can be in form

E
‹
of public deposits and/or private loans (unsecured) and privately
C
placed, unsecured bonds or debentures.
D
©D
‹ Restructuring of other short-term borrowings are the borrowings that
are very short in nature are generally not restructured these can
indeed be renegotiated with new terms. These types of short-term
borrowings include inter-corporate deposits clean bills & clean
overdraft.
Best method for corporate debt restructuring is Debt-equity swap. In
the case of a debt-equity swap, specified shareholders have right to
exchange stock for a predetermined amount of debt (i.e. bonds) in the

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes same company. In debt-equity swap debt/bonds are exchanged with shares/
stock of the company.

CASE STUDY
Gammon India Ltd. invoked the Strategic Debt Restructuring (SDR)
mechanism in the 2015-2016. A total of 16 banks, led by ICICI Bank,
decided to convert a part of their loan into 63.07 per cent equity. The

i
SDR Scheme, an improved version of the erstwhile Corporate Debt
Restructuring, or CDR, mechanism, wherein lenders have sweeping
l h
D e
powers to throw out managements of companies whose assets have
turned bad. However, the bankers could not find a buyer for the

of
entire Gammon India and instead decided to restructure it into three
parts - Power Transmission & Distribution (T&D), Engineering,

ty
Procurement & Construction (EPC), and the residual business. The
i
s
Thailand-based GP Group has acquired the EPC assets while Ajanma
r
e
Holdings bought stake in the T&D business.

i v
Gammon India is one of other companies where bankers have invoked

U n
the SDR Scheme, to make the process of debt recovery faster and
smoother. The list includes Alok Industries, Usher Agro, Diamond

L ,
Power, Monnet Ispat, Jaiprakash Power and IVRCL.

S O
/
Equity Restructuring

O L
It is a process of reorganizing the equity capital. It includes a reshuffling of
the shareholders capital and the reserves that are appearing on the balance

/ C
sheet. Restructuring equity means changing how the firm’s residual cash

C Eflows are divided and distributed among the firms shareholders, with the
goal of increasing the overall market value of the firms common stock.
D
©D
Restructuring of equity and preference capital becomes complex process
involving a process of law and is a highly regulated area.
Equity restructuring can be done by the following ways:-
‹ Alteration of share capital
‹ Reduction of share capital
‹ Buy-back of shares
Let’s discuss them in detail.

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 FINANCIAL RESTRUCTURING

(a) Alteration of Share Capital Notes

The capital of a company is separated into units of a fixed
denomination and such unit is a share. A share means a share in
the share capital of a company and includes stock as defined under
Section 2(84) of the Companies Act, 2013. Alteration of share capital
means, an increase or decrease in or rearrangement of share capital
as permitted in Articles of Association. An increase or decrease in
the share capital of a company may be carried out as and when the
company requires thus leading to an alteration in the company’s
h i
share capital.
e l
(b) Reduction of Share Capital
D
of
Capital Reduction is the process of decreasing a company’s shareholder’s

ty
equity through share cancellations and share repurchases. The

i
reduction of share capital means reduction of issued, subscribed and

s
r
paid up share capital of the company. In simple words it can be

e
regarded as ‘Cancellation of Uncalled Capital’ i.e. part of subscribed
v
n i
share capital. The act of capital reduction is enacted by reducing
the amount of issued share capital in a response to a permanent

, U
reduction in a company’s operations or a revenue loss that cannot

O L
be recovered from a company’s future earnings.
Example: The shares of face value of INR 500 each of which INR 350

/ S
paid, the company may reduce them to INR 350 fully paid-up shares
L
and thus relieve the shareholders from liability on the uncalled capital
O
C
of INR 150 per share.
(c) Buy-Back
E /
D C
Buy-back of shares can be understand by two ways. First, when a
person sells shares or any specified securities and then buys again

©D
according to a fixed agreement, the buying back by a company of
its shares/securities from an investor who put venture capital up
for the formation of the company.
Second, buying of its own stock from open market in order to reduce the
number of outstanding shares. It is an eminent way of capital restructuring.
It is a corporate action in which a company buys back its shares from the
existing shareholders usually at a price higher than market price. When
it buys back, the number of shares outstanding in the market reduces.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes By reducing the number of shares outstanding in the market, buy-backs

increase the proportion of shares a company owns.
Buy-back of shares from open market can be done by way of: Book
Building Process and Stock exchange.
Examples: In the year 2017, Infosys decided to utilize cash reserves
of USD 6 billion either through share buy-back or generous dividend.
Cognizant and TCS announced mega buy-back offers worth USD 3.4 billion

i
and Rs. 16,000 crore, respectively, to return surplus cash to shareholders.

l
HCL Technologies also approved a buy- back of up to 3.50 crore shares
h
worth Rs. 3,500 crore.

D e
Mergers and acquisitions as a form of financial restructuring

of
‹

A company intending to acquire another company may buy the assets or

ty
stock or may combine with that. Thus, acquisition of an organization is
achieve either by merger or by takeover.
s i
e r
Merger is combination of two or more companies into a single company

i v
where one survives and the others lose their identity or a new company

U n
is formed. The survivor acquires the assets as well as liabilities of the
merged company. As a result of a merger, if one company survives and

L ,
others lose their independent entity, that case is ‘Absorption’. But if a
new company comes into existence because of merger, this process is

S O
called ‘Amalgamation’.

L /
Takeover is the purchase by one company of a controlling interest in the

O
share capital of another existing company. In takeover, both the companies

C
/
retain their separate legal entity. A takeover is turn to gain control over

C Ea company whereas companies are amalgamated to procure advantage

of scale of operations, attaining rapid growth and expansion and build

D strong managerial and technological competence to ensure higher value

©D
to shareholders. In Indian context, leading takeover are R P Goenka,
Khaitan, Kumar Mangalam Birla and London based Swaraj Paul.
Forms
‹ Horizontal Merger: A horizontal merger is a kind of merger that
takes place between two firms in the same line of business. Merger
of Hindustan Lever with TOMCO and Global Telecom Services Ltd.
with Atlas Telecom, GEC with EEC are examples of Horizontal
Merger.

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 FINANCIAL RESTRUCTURING

‹ Vertical Merger: Vertical Merger is when firms in successive Notes

stages of the same industry are integrated. Vertical Merger may be
backward, forward or both ways. Backward merger refers going
closer to the source of raw materials in their beginning form. Merger
of Renusagar Power Supply and Hindalco is a case of this type
of merger. Forward merger refers to going closer to the customer
ultimately. Example like DU Pont acquired a chain of stores that
sold chemical products at the retail level for increased control and
influence of its distribution.

h i
‹ Conglomerate Merger: Conglomerate Merger is a combination in
e l
D
unrelated lines of business. The main reason for this type of merger

of
is to look for diversification for the surviving company. One of the
such merger is of Brooke Bond Lipton with Hindustan Lever. While

ty
the former was mostly into foods, the latter was into detergents and
personal care.

s i
‹

e r
Reverse Merger: It occurs when firms want to take advantage of tax

v
savings under the Income Tax Act (Section 72A) so that a healthy

i
and profitable company is allowed the benefit of carry forward
n
U
losses when merged with a sick company.

L ,
Examples: Godrej soaps, which merged with the loss-making Godrej
Innovative Chemicals is an example of reverse merger. Reverse merger

O
can also occur when regulatory requirements need one to become one
S
into ICICI Bank.
L /
kind of company or another. For example, the reverse merger of ICICI

C O
/
4.3.2 Key Concepts in Financial Restructuring
E
D C
(a) Capital structure optimization

©D
The need of capital structure optimization arise in following situations:
‹ Eliminating losses, which may be preventing the payment of dividends.
‹ As part of scheme of compromise or arrangements it is an alternative
mode of reduction in capital without requiring approval of the
National Company Law Tribunal.
‹ To improve the earnings per share.
‹ To improve return on capital, return on net worth and to enhance
the long-term shareholders value.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes ‹ To provide an additional exit route to shareholders when shares are

undervalued or thinly traded.
‹ To enhance consolidation of stake in the company.
‹ To prevent unwelcome takeover bids.
‹ To return surplus cash to shareholders.
‹ To support share price during periods of sluggish market condition.

i
‹ To serve the equity more efficiently.
(b) Liquidation and dissolution
l h
Financial restructuring drive the path:
D e
of
‹ To improve liquidity and have direct access to cash resource.
‹ To dispose of surplus and outdated assets for cash out of combined

ty
enterprise.

s i
r
‹ To enhance gearing capacity, borrow on better strength and the
greater assets backing.

v e
‹ To avail tax benefits.
n i
U
‹ To improve EPS (Earning Per Share).

,
(c) Bankruptcy and insolvency laws
L
O
In a recession, revenues frequently dip but expenditures may take longer

S
/
to decrease. Additionally, businesses might have accumulated more debt

O L
during the expansion, which could make them more vulnerable during a
recession. Consider the USA, where business and household indebtedness

/ C
reached record levels between 2003 and 2007. When the economy began

C Eto decline in 2008 and the Great Recession began, many businesses were
unable to service their greater levels of debt. Increased bankruptcies are
D the logical outcome of poor economic growth and excessive levels of debt.

©D The Bankruptcy Code’s reorganisation clause was created to enable the

creation of a reorganisation plan that will allow the business to continue to
run. This business strategy will outline the adjustments that the company
will through in order to become profitable, according to its creators. If
a strategy for the firm’s profitable operation cannot be developed, the
company may have to be liquidated, with its assets being sold and the
money being used to pay down the company’s debts.

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 FINANCIAL RESTRUCTURING

(d) Debt restructuring and value creation Notes

Leveraged buyout (LBO) is an important form of financial restructuring
which represents transfer of an ownership consummated heavily with debt.
LBO involves an acquisition of a division of a company or sometime
other sub-unit. At times, it entails the acquisition of an entire company.
Another kind of financial restructuring is Leveraged Recapitalization
(LR). LR is a process of raising funds through increased leverage and

i
using the raised cash to distribute to equity owners, generally in form
of dividend. In this transaction, management and other insiders do not
l h
participate in the payout but take additional shares instead. As a result,
their proportional ownership of the company increases sharply.
D e
of
Spin-offs as a form of restructuring, involves creation of a new, independent

ty
company by detaching part of a parent company’s assets and operations.
Shares in the new company are distributed to the parent company’s

s i
r
stockholders.

v e
Carve-outs are similar to spin-off with only exception that shares in

n i
the new company are sold to public instead of distributing them among

U
existing equity owners. Carve outs result in new cash flows.

L ,
4.3.3 Legal and Regulatory Framework for Financial
Restructuring
S O
L /
O
In Indian context, the NCLT consolidates the corporate jurisdiction of the

C
Company Law Board, Board of Industrial and Financial Reconstruction,

E /
the Appellate Authority for Industrial and Financial Reconstruction and

C
Jurisdiction and powers related to the winding up, restructuring, and other

D
provisions as vested with the High Courts.

©D
Equity-based restructuring
Legal Provisions - Alteration of share capital
‹ Sections 61 to 64 read with Sections 13 and 14 of the Companies
Act, 2013.
‹ Companies (Share Capital and Debentures) Rules, 2014.
‹ National Company Law Tribunal Rules, 2016.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Legal Provisions - Reduction in share capital

‹ Section 66 of the Companies Act, 2013; Reduction by way of
cancellation of shares.
‹ Rules 2 to 6 of the National Company Law Tribunal (Procedure for
Reduction of Share Capital of Company) Rules, 2016.
‹ SEBI (LODR) Regulations, 2015.
Section 66 of the Companies Act, 2013; Reduction by way of
i
‹

h
cancellation of shares.
‹
e l
Rules 2 to 6 of the National Company Law Tribunal (Procedure for
Reduction of Share Capital of Company) Rules, 2016.
D
of
‹ SEBI (LODR) Regulations, 2015.

ty
Legal Framework - Buy-back
‹ Companies Act, 2013.
s i
‹

e r
Companies (Share Capital and Debentures) Rules, 2014.
‹
i v
Securities and Exchange Board of India (Buy-back of Securities)
Regulations, 2018.
U n
,
‹ Income Tax Aspects

O L
Section 46A of the Income-tax Act, 1961 provides that any
consideration received by a security holder from any company on

/ S
buy back shall be chargeable to tax on the difference between the
L
cost of acquisition and the value of consideration received by the
O
C
security holder as capital gains. The computation of capital gains

E / shall be in accordance with the provisions of Section 48 of the

C
Income-tax Act, 1961.

D In respect of Foreign Institutional Investors (FIIs), as per the provisions

©D
of section 196D(2) of the Income-tax Act,1961 no deduction of tax at
source shall be made before remitting the consideration for equity shares
tendered under the offer by FIIs as defined under section 115AD of the
Income-tax Act, 1961.
NRIs, OCBs and other non-resident shareholders (excluding FIIs) will
be required to submit a No Objection Certificate (NOC) or tax clearance
certificate obtained from the Income Tax authorities under the Income
Tax Act. In case the aforesaid NOC or tax clearance certificate is not

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 FINANCIAL RESTRUCTURING

submitted, the company should deduct tax at the maximum marginal Notes
rate as may be applicable to the category of shareholders on the entire
consideration amount payable to such shareholders.

CASE STUDY
Bajaj Auto Ltd.: Financial Restructuring
On May 17, 2007, the Bajaj Auto Ltd. Board of Directors approved
a demerger. The plan called for the main company, BAL, to change

h i
its name to Bajaj Holdings and Investment Ltd. (“BHIL”) and for
the company to be divided into Bajaj Auto Ltd. (“BAL”) and Bajaj
e l
Finserv Ltd. (“BFL”). While BFL would handle the wind power
D
of
project, interests in insurance firms, and consumer finance, BHIL
would hold the company’s manufacturing and vehicle industries. The

i
original company’s stockholders all received shares of the two new
ty
r s
firms in a 1:1 ratio, making them all owners of the new corporations.

v e
4.4 Internal Reconstruction
n i
, U
Internal reconstruction is one of the key strategies for financial restructuring.
L
It can be defined as the process of analyzing and redesigning a company’s
O
S
organizational structure, personal policies, wage structures, and controlling

L /
departments to align with new objectives and strategies. It involves

O
revaluing assets, negotiating liabilities, and writing off losses by reducing

C
the paid-up value of shares or varying the rights attached to different

E /
classes of shares. Internal reconstruction aims to reduce costs, optimize the

C
company’s structure, and improve financial and commercial performance

D
by identifying and eliminating areas that generate cash losses.

©D
4.4.1 Motivations for Internal Reconstruction
The primary motivation for internal reconstruction is linked to the need
to maintain profitability and business financial equilibrium. Some of the
main motivations for internal reconstruction are as follows:
‹ To reduce financial distress: Companies facing financial distress
may opt for internal reconstruction as a means of reducing the
current financial burden.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes ‹ To optimize the capital structure of the company: Internal

reconstruction can help to optimize the capital structure of the
company, which can improve its financial performance, reduce risk,
and increase value for shareholders.
‹ To improve the quality of management: Changes in management
or ownership can result in internal reconstruction, as new leaders
seek to implement their vision and strategies for the company.

i
‹ To respond to changes in the market: Companies that operate in

l h
dynamic and rapidly changing markets may need to restructure their

D e
operations, products, or services in order to remain competitive.
To merge with or acquire other companies: Internal reconstruction

of
‹
may be a part of merger or acquisition activities, aimed at creating

y
better synergies and optimizing the combined financial structure.

i t
r s
4.4.2 Types of Internal Reconstruction

i ve
(a) Reduction of Share Capital

U n
This involves a reduction in the amount of share capital that a

L ,
company has. It can be done by either cancelling shares or reducing
the nominal value of each share. This strategy is commonly used to

O
deal with accumulated losses and create a more sustainable capital
S
L /
structure. Reduction of share capital results in a concentration of
ownership and helps in limiting the loss of shareholder value.

C O
(b) Writing off of Capital

E / Writing off of capital is a process in which the company recognizes

D C that an asset has become permanently impaired and eliminates it

from its balance sheet by reducing the value of the asset. This

© D can be done through a charge against the company’s profits or a

reduction in share capital. This can help to improve the company’s
financial position and provide clarity to investors and stakeholders
on the value of the remaining assets.
(c) Reorganization of Share Capital
Reorganization of share capital refers to a change in a company’s
equity capital structure by altering the ownership structure of its
shares. This can involve a range of actions, such as issuing new

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 FINANCIAL RESTRUCTURING

shares, buying back existing shares, or consolidating or splitting Notes

existing shares in order to change the total number, value, or pattern
of ownership of the company’s shares. It can assist in optimising
the capital structure, managing financial risks, increasing liquidity,
reducing risk or dilution, facilitating acquisitions or mergers,
enhancing shareholder value and responding to dynamic market
conditions.
(d) Reconstruction with Outsiders

h i
l
Reconstruction with outsiders involves bringing in new investors
or partners to the company. This can be done through a capital
infusion, private equity investment or strategic collaboration. In this
D e
of
process, the existing management partners with external investors or
other companies to create a new entity that will acquire or invest

i ty
in the existing company’s assets or operations. This strategy is

s
used when a company is facing financial difficulties and requires
r
e
external financing or support but still has the potential to become

v
viable with some changes.
(e) Debt Restructuring
n i
, U
Debt restructuring is a process where the company renegotiates

O L
the terms of its existing debts with its lenders to reduce financial
distress, improve liquidity and avoid bankruptcy. This may involve

/ S
the modification or refinancing of existing loans, extending loan
L
repayment schedules, reducing interest rates, or converting debt to
O
C
equity. Reducing or waiving debt can help to ease the financial

/
burden on a company and improve its cash flow position, giving
E
C
it more resources to invest in growth opportunities. This strategy

D
is often used when a company is experiencing liquidity issues, has

©D
difficulty servicing its existing debt obligations, or has a high level
of debt relative to its income or assets.
(f) Alteration of Rights and Privileges of Shares
Alteration of rights and privileges of shares is a process that involves
changing the terms and conditions related to certain classes or types
of shares. This can be done either to address imbalances in the
rights and privileges of different classes of shares or as part of a
broader restructuring effort. It involves the modification of the terms

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes and conditions associated with a particular class or type of shares,

such as voting rights, dividend payments, conversion options or
liquidation preferences. However, it is essential to carefully evaluate
the potential impact of this strategy on existing shareholders and to
comply with all legal and regulatory requirements in implementing
these changes.

4.4.3 Accounting Aspects for Internal Reconstruction

h i
l
Accounting for corporate restructuring is dealt with following accounting
e
D
standards:

of
‹ Accounting for Amalgamation (AS-14) - Applicable to those who
have to comply with Companies (Accounting Standards) Rules,

ty
2016.

s i
Business Combinations (IND AS-103) - Applicable to those who have
r
‹

e
to comply with Companies (Indian Accounting Standards) Rules,
2015.
i v
U
4.4.4 Financial and OthernAspects of Internal Reconstruction

L ,
O
While the process of internal reconstruction of a company can be

S
challenging, but the benefits of such a strategy can be substantial.
/
‹

O L
Increased Financial Stability: Internal restructuring can help
businesses increase their financial stability. It entails altering their

/ C business practises or capitalization. This can help them come out

C E of heavy debt, increase their cash flow, and manage their money
more easily. Additionally, this may help them manage their liquidity

D D and cash flow better.

© ‹ Increased Profitability: Businesses can boost their profitability by

adopting internal rebuilding. This entails a decrease in expenses and
an increase in revenue. For instance, a business can merge to cut
costs. Their market share grows as a result of increased economies
of scale.
‹ Greater Flexibility: Internal reorganisation can help organisations
become more adaptable and flexible. As a result, they can react to

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FINANCIAL RESTRUCTURING

changes in their sector fast. This is done by altering their business Notes
practices or capitalization scheme.
For instance, a business may sell off a portion of its operations to
form a more manageable and focused business that is able to shift
with the market swiftly.
‹ Greater Customer Satisfaction: Internal reconstruction can increase
customer satisfaction by streamlining business operations. This

i
includes improving their productivity, efficiency, and flexibility. A
business can more successfully serve its consumers’ requirements
l h
when it accomplishes these things better. Customers that are satisfied
are more likely to use the business again and refer others to it.
D e
‹ Increased Employee Engagement: Internal reconstruction of a
of
ty
company’s operations and structure can increase employee engagement

i
by providing staff with guidance and training throughout the

s
r
procedure. The business may foster a more devoted and driven

e
workforce. Higher work satisfaction and decreased turnover rates
v
i
may result from this and higher revenues and productivity.
n
U
Ford began internal reorganization in 2006 to change its business

L ,
practises. They sought ways to reduce costs by selling off non-
essential business components, closing some of their plants, and

O
other means. By doing this, the company’s debt was decreased and
S
L /
its profitability increased. Ford was able to lower its debt by $9.9
billion as a result, returning to financial stability by 2009.

C O
CASE STUDY
E /
C
Tata Steel : Internal Restructuring

D
©D
India’s largest steel producer, Tata Steel, adopted an internal
reconstruction plan. Tata Steel decreased its financial obligations
in 2015 by reorganising the business internally. The plan called for
assigning their responsibilities to a separate business. Selling off
unrelated assets to raise more fund.
Volkswagen
Volkswagen, a German automaker, was caught in a scandal in 2015.
This is for cheating on its diesel car emissions tests. To fix the

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes problem, Volkswagen created a plan to restructure the company. They

reduced costs by cutting jobs and shifted their focus to electric cars.
Reliance Communications
Reliance Communications is a telecom company in India. Faced
financial difficulties in 2017 due to heavy competition. To overcome
this, the company came up with an internal reconstruction plan. The
plan involved selling off some of its assets and reducing its debts.

h i
IN-TEXT QUESTIONS
e l
1. Corporate restructuring is the process by which:
D
of
(a) A company changes its debt structure

ty
(b) A company changes its equity structure

s i
(c) A company changes its operational structure
(d) All of the above
e r
i v
2. Strategic actions in corporate restructuring include:

U n
(a) Merger and acquisition

,
(b) Only internal reconstruction

L
O
(c) Bankruptcy

/ S
(d) All of the above

O L
3. The key objectives of corporate restructuring is _____ ___________,
which include alteration in a company’s financial structure.

/ C
E
4. Mode of Equity restructuring include _________, ____________,

C
and _______.

D 5. ________ is a combination of two or more companies into single

©D
entity.
6. Vertical merger may be ____________, where company merge
with other company in order to reach its consumers; and
___________, where company merge with other company to
reach out its raw materials providers source.

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 FINANCIAL RESTRUCTURING

7. Changes in management or ownership is a form of: Notes

(a) Financial restructuring

(b) Internal reconstruction
(c) Both (a) and (b)
(d) Takeover
8. Which is not a type of internal reconstruction:
(a) Writing off capital
h i
(b) Reconstruction with external parties
e l
(c) Alteration of Rights and Privileges of Shares
D
of
(d) Appreciation of debt structure

ty
9. ______________ is a process where the company renegotiates the

i
terms of its existing debts with its lenders to reduce financial
s
distress, improve liquidity and avoid bankruptcy.

e r
i v
n
4.5 Summary

, U
Corporate restructuring is an episodic operation that entails a considerable

O L
change in at least one of the firm’s asset mix, liability composition, and
ownership and control patterns. It is a thorough procedure that enables

/ S
a business to streamline operations and improve its standing in order to

O L
achieve the intended goals of Surviving, Synergetic, Competitive, and
Successful. Plans for internal reconstruction may involve reducing share

/ C
capital and other obligations, reorganising or changing share capital,
E
changing shareholders’ rights, or compromising or agreeing to an agreement
C
D
in which shares are surrendered. Restructuring is the act of partially

©D
deconstructing and reorganising a business with the goal of increasing its
profitability. In most cases, it entails selling off a section of the business
and drastically cutting workers. Restructuring occurs frequently.
Restructuring is often done as part of a bankruptcy or of a takeover by
another firm, particularly a leveraged buyout by a private equity firm. The
rationale behind corporate restructuring is to conduct business operations
in more efficient, effective and competitive manner in order to increase
the organisation’s market value of share, brand power and synergies.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes
4.6 Answers to In-Text Questions

1. (d) All of the above

2. (d) All of the above
3. Financial restructuring
4. Reduction, alteration and buy-back of share

i
5. Merger
6. Forward merger, backward merger
l h
7. (b) Internal reconstruction
D e
of
8. (d) Appreciation of debt structure
9. Debt restructuring

i ty
4.7 Self-Assessment Questions
r s
v e
i
1. Explain financial restructuring and its types.

n
2. Discuss the equity- based restructuring legal and tax aspect.
U
,
3. What is internal reconstruction? Why is it necessary to go for

O L
internal reconstruction? Explain with examples.
4. Describe in detail the types of internal reconstruction.

/ S
O L
4.8 References

/ CCarlos López-Gutiérrez, Sergio Sanfilippo-Azofra, Begona, Torre-Olmo.

E
‹

C
(2015). Investment decisions of companies in financial distress. BRQ

D
Business Research Quarterly, 18(3), 174-187, ISSN 2340-9436.

©D
https://doi.org/10.1016/j.brq.2014.09.001.
‹ Damodaran, A. (2012). Damodaran on Valuation: Security Analysis
for Investment and Corporate Finance. (2nd ed.). John Wiley and
Sons, Inc. . ICWAI. Financial Analysis & Business Valuation (Final
study material). (Latest Editions)

94 PAGE
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FINANCIAL RESTRUCTURING

‹ ICSI. Corporate restructuring, insolvency, liquidation & winding-up Notes

(Final study material). (Latest Editions)
‹ Gaughan, P.A. (2017) Mergers, Acquisitions and Corporate Restructurings
(7th ed.). : John Wileys & Sons.

4.9 Suggested Readings

Arzac, E.R. (2008). Valuation for Mergers, Buyouts and Restructuring
i
‹

h
(2nd ed.). John Wiley and Sons, Inc.
‹ Brealey, Myers & Allen. (2023) Principles of Corporate Finance.
e l
(14th ed.). McGraw Hill.
D
of
‹ Hayward, R. (2015). Valuation: Principles into Practice (6th ed.).

ty
Routledge
‹

s i
Reed, S.F. Alexander, L. & Nesvold, H.P. (2007). The Art of M&A:
A Merger Acquisition Buyout. (4th ed.). McGraw-Hill.
e r
‹

i v
Rosenbaum, J. & Pearl, J. (2020) Investment Banking: Valuation,

Wiley and Sons, Inc.

U n
Leverages Buyouts, and Mergers & Acquisitions. (3rd edition). John

L ,
Shapiro, E. Mackmin, D & Sams, G. (2018) Modern Methods of

O
Valuation, 12th Editions: Routledge

/ S
O L
/ C
C E
D
©D

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L E S S O N

5
Approaches to Valuation
Mr. Ranjeet Kumar Ambast
Assistant Professor
Gargi College
University of Delhi
Email-Id: Ranjeetka20@gmail.com

h i
STRUCTURE
e l
D
of
5.1 Learning Objectives
5.2 Introduction
5.3 Needs and Purpose of Valuation
i ty
5.4 Valuation of Worth of an Enterprise or a Property
r s
5.5 Summary
v e
5.6 Answers to In-Text Questions
n i
5.7 References
, U
5.8 Suggested Readings

O L
5.1 Learning Objectives
/ S
O L
Describe the concepts of Valuation of Shares of Business entities.
C
‹

E /
Understanding the various Valuation of Business on different parameter.
‹

D C
Know the concepts of Valuation of Shares, Valuation of Business, Valuation of
Intangibles, Valuing Private Companies, Valuing firms with Negative Earnings,

© D
Valuing start-up firms, and Value enhancement.

5.2 Introduction
Approaches to valuation in business are methods used to determine the financial worth or
value of a company or its assets. These approaches are crucial in various business contexts,
such as mergers and acquisitions, financial planning, investment analysis, and determining

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 APPROACHES TO VALUATION

Notes
the sale price of a business. By using these valuation approaches, investors,
analysts, and business owners can make informed decisions based on a
company’s estimated value.
The market approach is one common method used in valuation. It
involves comparing the company being valued to similar businesses in the
marketplace. This approach relies on market data, such as recent transactions
of comparable companies or the prices of publicly traded companies in
the same industry. By examining these comparable transactions or market

h i
multiples, such as price-to-earnings (P/E) ratios or price-to-sales (P/S)
ratios, analysts can estimate the value of the company under consideration.
e l
D
of
Another option known as the income approach focuses on a company’s
capacity to generate future income or cash flow. This tactic is based on the

ty
notion that a company’s worth is determined by its projected earnings in the

i
future. The strategy under the income approach that is most frequently used
s
r
is Discounted Cash Flow (DCF) analysis. The present value of predicted

e
v
future cash flows is calculated using DCF by discounting them back to

i
their current value using an appropriate discount rate. Capitalization of
n
U
profits is another income approach strategy that entails multiplying the

,
company’s current or projected earnings to determine its worth.

L
The asset approach, on the other hand, values a company based on its
O
S
net asset value. This approach considers both tangible and intangible

/
assets owned by the company, such as property, equipment, inventory,
L
O
intellectual property, and goodwill. The asset approach assumes that the

C
value of a company is derived from the value of its underlying assets.

E /
Adjusted Net Asset Value (NAV) is a common method within the asset

C
approach, which deducts liabilities and adjusts the values of assets to

D
reflect their fair market value.

©D
In actuality, these valuation techniques are frequently combined to offer
a more thorough study of a company’s value. The industry dynamics,
data accessibility, and the precise objective of the appraisal all play a
role in the approach choice. It is necessary to remember that valuation is
both an art and a science, and that expert judgment and knowledge are
essential for correctly applying these methods and properly understanding
the outcomes.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 5.3 Needs and Purpose of Valuation

The valuation of the worth of an enterprise serves several important
needs and purposes. Here are some key reasons why valuation is crucial:
1. Investment Decisions: Valuation aids investors in deciding whether to
invest in a business. Investors can analyse the prospective returns and
dangers of their investment by determining the business’s financial
worth. A framework for analysing various investment opportunities

h i
and choosing the ones that offer the best value for their capital is
provided by valuation.
e l
D
2. Mergers and Acquisitions: In the context of mergers and acquisitions,

of
valuation plays a vital role. It helps determine the fair value of the
target company being acquired or merged with. Valuation guides

ty
negotiations, helps establish the exchange ratio or share price, and
i
s
enables the parties involved to make informed decisions about the

e r
transaction. It ensures that the terms of the deal are equitable and

i v
reflect the relative value of the enterprises involved.

U n
3. Fund raising and Financing: When a business looks for outside
financing or has to borrow money through equity or debt, valuation is

L ,
crucial. The valuation is used by lenders and investors to determine

O
a company’s value, creditworthiness, and potential for future growth.

S
/
The likelihood of obtaining favourable financing arrangements is

O L
increased by a thorough and well-supported valuation investigation.
4. Financial Planning and Reporting: For the sake of financial

/ C
planning, valuation is required. It assists companies in establishing

C E sensible objectives, assessing their financial standing, and making

D
plans for potential expansion or capital requirements. Financial

©D
reporting may require organisations to estimate the fair value of
specific assets, such as investments or intangible assets, for their
financial statements. This is where valuation comes into play.
5. Exit Strategies and Business Sales: When owners or investors plan
to exit an enterprise, valuation becomes critical. It helps determine
the fair market value of the business and assists in setting an
appropriate selling price. Valuation is essential for conducting

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 APPROACHES TO VALUATION

successful business sales, mergers, or succession planning, ensuring Notes

that the stakeholders receive a fair return on their investment.
6. Corporate Restructuring: Valuation plays a significant role in
corporate restructuring activities, such as spin-offs, divestitures, or
strategic alliances. It helps assess the financial impact of restructuring
options, determines the value of assets being transferred, and guides
decision-making to maximize shareholder value.

i
7. Legal and Regulatory Compliance: Valuation is often required to
comply with legal and regulatory requirements. For instance, during
l h
shareholder disputes, valuation can help determine the fair value
of shares in contentious situations. Valuation is also necessary for
D e
of
tax purposes, such as calculating capital gains or establishing the
value of assets for estate planning.

i
The valuation of the worth of an enterprise serves various needs and
ty
r s
purposes, including investment decision-making, mergers and acquisitions,

e
fund raising, financial planning, exit strategies, legal compliance, and
v
n i
reporting. It provides a quantitative assessment of the enterprise’s value
and helps stakeholders make informed decisions regarding the management

,
and financial aspects of the business. U
O L
5.4 Valuation of Worth of an Enterprise or a Property
/ S
O L
Calculating an enterprise’s financial worth or value is the process of
valuation. The intrinsic worth of the company is evaluated based on a

/ C
number of variables, including its financial performance, assets, growth

C E
potential, market circumstances, and industry trends. The goal of valuation
is to give a ballpark figure for the company’s monetary value.
D
©D
Analysing pertinent financial statements, such as the company’s balance
sheet, income statement, and cash flow statement, is a typical step in
the valuation process. Additionally, it might include qualitative elements
like competitive advantages, brand reputation, and managerial quality.
In order to obtain a complete picture of the enterprise’s value, valuation
takes into account both quantitative and qualitative factors.
Valuation is important in many contexts, including mergers and acquisitions,
fundraising, financial planning, investment analysis, and determining the

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes fair market value of a business. It enables stakeholders, including investors,

owners, and potential buyers, to make informed decisions about buying,
selling, or investing in the enterprise.
A variety of valuation techniques are used, including the market approach,
the income approach, and the asset-based approach. These approaches rely
on diverse methods of valuation, such as comparative analysis, discounted
cash flow analysis, and adjusted Net Asset Value (NAV) computations.
The type of the enterprise, the data that are available, and the goal of
the valuation all influence the approach and method that is chosen.
h i
e l
Valuation is both an art and a science, as it requires professional judgment,

D
expertise, and consideration of multiple factors. It is important to note

of
that valuation is an estimate and subject to uncertainties, as it relies on
assumptions and projections about the future performance of the enterprise

i ty
and the prevailing market conditions. However, a well-conducted valuation

s
analysis provides valuable insights and helps stakeholders make informed
r
e
decisions regarding the worth of the enterprise.

v
n i
Valuation plays a critical role in mergers and corporate restructuring
activities within the realm of finance. These processes involve combining

, U
or reorganizing companies, and the valuation of the entities involved is

O
financial feasibility. L
essential in determining the terms of the transaction and assessing its

/ S
In mergers, valuation helps determine the exchange ratio or share price
L
at which the acquiring company will offer its own shares in exchange
O
C
for the target company’s shares. The valuation of both companies is

E /
necessary to ensure a fair exchange ratio that reflects the relative value

C
of the entities being merged. This typically involves applying valuation

D
methods such as the market approach, income approach, or asset-based

©D
approach to arrive at a valuation for each company. The valuation results
guide negotiations and help establish the terms and ownership structure
of the merged entity.
Similarly, in corporate restructuring, valuation plays a vital role in assessing
the financial impact of various restructuring options. Whether it’s a spin-
off, divestiture, or strategic alliance, valuation helps determine the value
of the assets being transferred or reorganized. This allows companies to
make informed decisions about the best course of action to maximize
shareholder value and achieve their strategic objectives.

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 APPROACHES TO VALUATION

Valuation in mergers and corporate restructuring also considers factors Notes

such as synergies and potential cost savings resulting from the transaction.
Synergies arise when the combined entity can achieve higher operational
efficiency, market expansion, or other strategic advantages. These synergies
are typically quantified and included in the valuation analysis to capture
their potential impact on the overall value of the transaction.
Moreover, valuation is essential for securing financing for mergers and
corporate restructuring activities. Lenders and investors rely on valuations
to assess the creditworthiness and investment potential of the restructured
h i
entity. A well-supported and comprehensive valuation analysis enhances
e l
the likelihood of securing favourable financing terms.
D
of
Valuation in mergers and corporate restructuring provides a financial
framework for assessing the worth of entities involved, determining fair

i ty
exchange ratios, evaluating synergies, and making informed decisions

s
to optimize shareholder value. It is a crucial component in the strategic
r
e
planning and execution of these complex financial transactions.

v
5.4.1 Valuation of Shares
n i
, U
L
The process of figuring out the fair value or worth of a company’s shares

O
or stock is known as share valuation. This valuation is crucial for a

/ S
number of situations, including mergers and acquisitions, Initial Public

O L
Offers (IPOs), shareholder disputes, and investment analysis. Investors and
stakeholders can decide whether to acquire, sell, or maintain investments

/ C
in a firm with confidence by knowing the value of the shares they own.

C E
Share valuation can be done in a number of ways. The comparative
method is one strategy, in which the shares are valued by comparison to
D
©D
comparable publicly traded companies in the same industry. This approach
takes into account several market multiples and financial ratios, such as
Price-to-Earnings (P/E), Price-to-Sales (P/S), and Price-to-Book (P/B)
ratios. Analysts can determine the value of the shares being considered
by examining the valuation multiples of comparable companies.
The Discounted Cash Flow (DCF) method, which is based on the company’s
anticipated future cash flows, is an alternative method. By discounting
expected future cash flows back to their current value using a suitable
discount rate, DCF analysis determines the present value of those projected

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes future cash flows. Based on the anticipated creation of cash flow by the
company, this method estimates the intrinsic value of the shares while
taking the time value of money into consideration.
Another approach to share valuation is the asset-based approach. This
strategy focuses on the company’s Net Asset Value (NAV), which is
equal to the sum of its assets less its liabilities. By dividing the net asset
value by the total number of outstanding shares, this method calculates
the worth of the company’s shares. This strategy is especially pertinent
for enterprises that have sizable tangible assets, such real estate or
h i
manufacturing operations.
e l
D
Other elements like the company’s growth potential, market conditions,

of
industry trends, and management calibre may also be taken into account
when valuing shares. Depending on the unique conditions and information

i ty
available, many valuation models and methodologies may be used. It’s

s
vital to remember that share valuation is both an art and a science, and
r
e
that correct and thorough value study requires professional judgment and

v
knowledge.

n i
Evaluating the fair market value of a company’s ownership interests and

, U
making investment decisions depend greatly on the share valuation. It

O L
gives investors a framework for evaluating the risks and potential returns
of buying shares of a specific company.

/ S
Valuation of shares can be approached using the following steps:

O L
1. Gather Financial Information: Collect the necessary financial

/ C
statements and information about the company, including its balance

E
sheet, income statement, and cash flow statement. This data will

D C serve as the basis for the valuation analysis.

2. Determine the Purpose of Valuation: Identify the reason for valuing

©D
the shares. Is it for investment analysis, a potential sale, or another
specific purpose? This will help determine the appropriate valuation
method and the key factors to consider.
3. Choose the Valuation Method: Select the most suitable valuation
method based on the company’s characteristics and the purpose of
the valuation. Common methods include the comparative method,
Discounted Cash Flow (DCF) analysis, and the asset-based approach.

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 APPROACHES TO VALUATION

4. Comparative Method: Information on comparable publicly traded Notes

companies in the same industry should be gathered if employing the
comparative method. Compare them to the target firm by examining
their market multiples and financial measures. To determine the
value of the shares, compute pertinent valuation ratios such price-
to-earnings (P/E), price-to-sales (P/S), or price-to-book (P/B) ratios.
5. Discounted Cash Flow (DCF) Analysis: Project the company’s
future cash flows over a given time period to use the DCF method.
Establish a suitable discount rate while taking the company’s risk
h i
profile and current market conditions into account. Using the discount
e l
rate, reduce the anticipated cash flows to their current value. To
D
of
determine the estimated value of the shares, add up the present
values.

i ty
6. Asset-Based Approach: Analyse the financial sheet of the company

s
and identify its tangible and intangible assets if you’re using the
r
e
asset-based approach. To get the value per share, ascertain the fair

v
n i
market value of these assets, subtract any liabilities, and divide the
net asset value by the total number of outstanding shares.

, U
7. Consider Other Factors: Include other elements that could affect

O L
the valuation, such as the company’s growth potential, competitive
positioning, management calibre, and market trends. Based on these

/ S
qualitative elements, adjust the valuation appropriately.

L
8. Perform Sensitivity Analysis: Assess the impact of changes in key
O
C
assumptions or variables on the valuation results. Conduct sensitivity

/
analysis to understand how the valuation may vary under different
E
C
scenarios.

D
9. Interpret and Communicate Results: Analyze the valuation results

©D
and interpret their implications. Clearly communicate the findings,
including the estimated value per share and any caveats or limitations,
to relevant stakeholders.
10. Review and Update: Periodically review and update the valuation as
the company’s financial performance and market conditions change.
This ensures that the valuation remains relevant and accurate over
time.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Approaches to valuing shares

There are several approaches to valuing shares, each with its own
methodology and considerations. Here are some common approaches to
valuation:
1. Market Approach: The market approach bases the value of shares on
market pricing for comparable publicly traded corporations. This strategy
makes use of valuation multiples such the price-to-earnings ratio (P/E),

i
price-to-sales ratio (P/S), or price-to-book value ratio (P/B). Comparing

l h
the company being appraised to other similar publicly traded businesses
with similar financial indicators is the aim.

D e
One of the frequently employed techniques for valuing shares or stocks

of
is the market approach. To ascertain the worth of a certain share, it

ty
includes examining the prices at which comparable shares are currently

i
trading on the market. The basic idea is that the market price reflects

s
r
how investors as a whole see the worth of the company.

v e
To illustrate the market approach, let’s consider an example:

n i
Suppose you want to value the shares of a company called XYZ Inc.

, U
You find three similar companies, ABC Corp., DEF Ltd., and GHI Co.,
which are publicly traded and operate in the same industry as XYZ Inc.

O L
Here are some relevant details:

/
1. ABC Corp:
S
L
- Current share price: $50
O
/ C
- Earnings per share (EPS): $4

C E 2. DEF Ltd.:

D
- Current share price: $60

©D
- EPS: $5
3. GHI Co.:
- Current share price: $70
- EPS: $6
Now, to determine the value of XYZ Inc.’s shares using the market
approach, you can calculate the price-to-earnings (P/E) ratio for each
comparable company. The P/E ratio is the ratio of the market price per
share to the earnings per share.

104 PAGE
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 APPROACHES TO VALUATION

Calculating the P/E ratios: Notes

1. ABC Corp.: P/E ratio = $50/$4 = 12.5
2. DEF Ltd.: P/E ratio = $60/$5 = 12
3. GHI Co.: P/E ratio = $70/$6 = 11.67
Next, you can calculate the average P/E ratio of the comparable companies:
Average P/E ratio = (12.5+12+11.67)/3 = 12.06
Finally, to value XYZ Inc.’s shares, you multiply the average P/E ratio

h i
l
by the EPS of XYZ Inc.:
Valuation of XYZ Inc.’s shares = Average P/E ratio × XYZ Inc.’s EPS
D e
of
Suppose XYZ Inc. has an EPS of $3.5. Using the average P/E ratio of
12.06, the valuation would be:

ty
Valuation of XYZ Inc.’s shares = 12.06 × $3.5 = $42.21

s i
Therefore, based on the market approach, the estimated value of XYZ
Inc.’s shares would be approximately $42.21 per share.
e r
i v
The price-to-sales (P/S) ratio is another valuation metric used in the market
n
approach to value shares. Instead of using Earnings Per Share (EPS), the
U
,
P/S ratio compares the market price per share to the company’s revenue

O
yet profitable or have volatile earnings.L
per share. This approach is particularly useful for companies that are not

/ S
Let’s continue with the example of valuing the shares of XYZ Inc. using
L
the market approach, but this time we’ll use the P/S ratio. Assume we
O
C
have the following information:
1. ABC Corp.:
E /
C
- Current share price: $50
D
©D
- Revenue per share: $10
2. DEF Ltd.:
- Current share price: $60
- Revenue per share: $12
3. GHI Co.:
- Current share price: $70
- Revenue per share: $15

PAGE 105
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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes To calculate the P/S ratio for each comparable company:

1. ABC Corp.: P/S ratio = $50/$10 = 5
2. DEF Ltd.: P/S ratio = $60/$12 = 5
3. GHI Co.: P/S ratio = $70/$15 = 4.67
Next, calculate the average P/S ratio:
Average P/S ratio = (5+5+4.67)/3 = 4.89
Finally, to value XYZ Inc.’s shares, multiply the average P/S ratio by

h i
l
XYZ Inc.’s revenue per share. Let’s assume XYZ Inc.’s revenue per
share is $8:

D e
of
Valuation of XYZ Inc.’s shares = Average P/S ratio × XYZ Inc.’s revenue
per share

ty
Valuation of XYZ Inc.’s shares = 4.89 × $8 = $39.12

s i
Therefore, based on the market approach using the P/S ratio, the estimated

e r
value of XYZ Inc.’s shares would be approximately $39.12 per share.

i v
The price-to-book value (P/B) ratio is another valuation metric used in

U n
the market approach to value shares. It compares the market price per
share to the company’s book value per share. The book value per share

L ,
represents the net asset value of the company, calculated by subtracting

O
its liabilities from its assets.

/ S
Let’s continue with the example of valuing the shares of XYZ Inc. using

O L
the market approach, but this time we’ll use the P/B ratio. Assume we
have the following information:

/ C
1. ABC Corp.:

CE - Current share price: $50

DD
- Book value per share: $20

© 2. DEF Ltd.:
- Current share price: $60
- Book value per share: $25
3. GHI Co.:
- Current share price: $70
- Book value per share: $30

106 PAGE
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 APPROACHES TO VALUATION

To calculate the P/B ratio for each comparable company: Notes

1. ABC Corp.: P/B ratio = $50/$20 = 2.5
2. DEF Ltd.: P/B ratio = $60/$25 = 2.4
3. GHI Co.: P/B ratio = $70/$30 = 2.33
Next, calculate the average P/B ratio:
Average P/B ratio = (2.5 + 2.4 + 2.33)/3 = 2.41
Finally, to value XYZ Inc.’s shares, multiply the average P/B ratio by

h i
l
XYZ Inc.’s book value per share. Let’s assume XYZ Inc.’s book value
per share is $18:

D e
of
Valuation of XYZ Inc.’s shares = Average P/B ratio × XYZ Inc.’s book
value per share

ty
Valuation of XYZ Inc.’s shares = 2.41 × $18 = $43.38

s i
Therefore, based on the market approach using the P/B ratio, the estimated

e r
value of XYZ Inc.’s shares would be approximately $43.38 per share.

i v
2. Income Approach: The income approach values shares based on the

U n
present value of expected future cash flows generated by the company.
This approach typically involves discounting projected cash flows, such

L ,
as earnings or free cash flow, to their present value using an appropriate

O
discount rate. The discount rate takes into account the time value of

/ S
money and the risk associated with the investment.

O L
(a) Dividend Discount Model (DDM): This specific method of the income
approach values shares based on the present value of expected future

/ C
dividends. It assumes that the value of a share is the sum of its

E
expected future dividends, discounted to their present value.
C
D
(b) Free Cash Flow to Equity (FCFE) Model: This model focuses on

©D
the cash flows available to the equity shareholders of the company.
It involves estimating the future free cash flows to equity and
discounting them to their present value.
The Dividend Discount Model (DDM) is a popular valuation method that
estimates the value of shares based on the present value of expected future
dividends. It assumes that the value of a share is equal to the sum of the
present value of all future dividends discounted at an appropriate rate.
Let’s consider an example to illustrate the DDM for valuing shares:

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Suppose you want to value the shares of XYZ Inc. The company is
expected to pay dividends over the next five years as follows:
Year 1: $2 per share
Year 2: $2.5 per share
Year 3: $3 per share
Year 4: $3.5 per share

i
Year 5: $4 per share

l
To calculate the present value of these future dividends, you need to
h
D e
determine an appropriate discount rate. The discount rate represents the
required rate of return by investors. Let’s assume a discount rate of 8%

of
for this example.

ty
Using the DDM formula, the present value of each dividend is calculated
as follows:

s i
PV1 = $2/(1 + 0.08)^1 = $1.85
e r
PV2 = $2.5/(1 + 0.08)^2 = $2.18
i v
PV3 = $3/(1 + 0.08)^3 = $2.47

U n
,
PV4 = $3.5/(1 + 0.08)^4 = $2.72

L
PV5 = $4/(1 + 0.08)^5 = $2.98
O
S
Next, sum up the present values of all the dividends:

L /
Total present value = PV1 + PV2 + PV3 + PV4 + PV5

C O = $1.85 + $2.18 + $2.47 + $2.72 + $2.98

E / = $12.20

C
Therefore, based on the Dividend Discount Model (DDM), the estimated

D
value of XYZ Inc.’s shares would be approximately $12.20 per share.

©D
The Free Cash Flow to Equity (FCFE) model is a valuation method that
estimates the value of shares based on the present value of expected future
free cash flows available to equity shareholders. It calculates the value
of equity by discounting the FCFE using an appropriate discount rate.
Let’s consider an example to illustrate the FCFE model for valuing shares:
Suppose you want to value the shares of XYZ Inc. The company is
expected to generate the following free cash flows to equity over the
next five years:

108 PAGE
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 APPROACHES TO VALUATION

Year 1: $10 million Notes

Year 2: $15 million
Year 3: $20 million
Year 4: $25 million
Year 5: $30 million
Choose a suitable discount rate in order to compute the present value of

i
these future free cash flows. The discount rate takes into account both
the risk involved in the investment and the time worth of money. For
l h
the sake of this illustration, let’s use a 12% discount rate.
Using the FCFE model, the present value of each cash flow is calculated
D e
of
as follows:

ty
PV1 = $10 million/(1 + 0.12)^1 = $8.93 million
PV2 = $15 million/(1 + 0.12)^2 = $11.33 million
s i
PV3 = $20 million/(1 + 0.12)^3 = $13.48 million
e r
i
PV4 = $25 million/(1 + 0.12)^4 = $15.01 million
v
n
PV5 = $30 million/(1 + 0.12)^5 = $15.89 million
U
,
Next, sum up the present values of all the cash flows:

L
O
Total present value = PV1 + PV2 + PV3 + PV4 + PV5

S
= $8.93 million + $11.33 million + $13.48 million
/
L
+ $15.01 million + $15.89 million

O
= $64.64 million

C
/
Therefore, based on the Free Cash Flow to Equity (FCFE) model, the

C E
estimated value of XYZ Inc.’s equity would be approximately $64.64
million. To determine the value per share, divide the equity value by the

D
total number of outstanding shares.

©D
3. Asset-Based Approach: The net assets or book value of the company
are used to value shares under the asset-based method. The net asset value
(NAV) or book value is obtained by deducting the company’s liabilities
from its assets. This strategy is frequently employed by businesses whose
primary holdings are tangible assets like real estate or machinery.
The asset-based approach is a method of valuation that bases its assessment
of the value of the company’s shares on its net asset value. By deducting

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes the company’s obligations from its total assets, it determines the share
value.
Let’s consider an example to illustrate the asset-based approach for
valuing shares:
Suppose you want to value the shares of XYZ Inc. The company’s balance
sheet shows the following information:
Total Assets: $100 million
Total Liabilities: $40 million
h i
Preferred Equity: $10 million
e l
Common Equity: $50 million
D
of
To calculate the net asset value, subtract the total liabilities and preferred

ty
equity from the total assets:
Net Asset Value =
s i
Total Assets - Total Liabilities - Preferred Equity
=
r
$100 million - $40 million - $10 million
e
= $50 million
i v
U n
The net asset value represents the total value of the company’s common
equity. To determine the value per share, divide the net asset value by

L ,
the total number of outstanding shares.

O
Assuming XYZ Inc. has 10 million outstanding shares:

S
L /
Value per Share =
=
Net Asset Value/Total Number of Shares
$50 million/10 million shares

C O = $5 per share

E /
Therefore, based on the asset-based approach, the estimated value of

D C XYZ Inc.’s shares would be approximately $5 per share.

4. Comparable Transactions Approach: This method examines the prices

©D
paid in recent transactions for comparable businesses or the acquisition
of comparable enterprises. To determine the worth of the shares being
appraised, it takes into account the purchase price multiples and transaction
specifics of comparable transactions.
The Comparable Transactions Approach is a method of valuing shares that
bases its estimate on the prices at which shares of comparable companies
have recently been bought or sold. To calculate the value of the shares
being valued, comparable companies must be found and their transaction
values must be examined.

110 PAGE
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 APPROACHES TO VALUATION

Let’s consider an example to illustrate the Comparable Transactions Notes

Approach for valuing shares:
Suppose you want to value the shares of XYZ Inc. You research and
identify three recent transactions involving similar companies in the same
industry. The transaction details are as follows:
Transaction 1:
Company: ABC Corp
Transaction Value: $50 million
h i
Number of Shares: 10 million
e l
Transaction 2:
D
Company: DEF Ltd.
of
ty
Transaction Value: $70 million
Number of Shares: 15 million
s i
Transaction 3:
e r
Company: GHI Co.
i v
Transaction Value: $90 million
U n
Number of Shares: 20 million
L ,
O
To calculate the average transaction value per share, divide the transaction

S
/
value by the number of shares for each transaction:

L
Transaction 1: $50 million/10 million shares = $5 per share
O
C
Transaction 2: $70 million/15 million shares = $4.67 per share

E /
Transaction 3: $90 million/20 million shares = $4.50 per share

C
Next, calculate the average transaction value per share:
D
©D
Average Transaction Value per Share = ($5 + $4.67 + $4.50)/3
= $4.72 per share
Therefore, based on the Comparable Transactions Approach, the estimated
value of XYZ Inc.’s shares would be approximately $4.72 per share,
considering the average transaction value per share of comparable companies.
5. Options Pricing Approach: This method is frequently employed to
value stock options or the shares of businesses with intricate capital
structures. To calculate the value of shares depending on variables

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes including the stock price of the firm, the exercise price, volatility, time
till expiration, and interest rates, option pricing models like the Black-
Scholes model are applied.
The Black-Scholes model, which uses the options pricing methodology, is
a method of valuation that determines the value of shares by taking into
account the pricing of options on those shares. This method calculates the
theoretical value of an option and extrapolates it to determine the value
of the underlying shares by taking into account a number of variables,

h i
including the current stock price, strike price, time till expiration, risk-
free rate, and volatility.
e l
D
While the options pricing approach is primarily used for valuing options,

of
it can also provide insights into the valuation of shares. However, it’s
important to note that this approach is more commonly used for derivative

i ty
securities rather than direct valuation of shares.

r s
As the options pricing approach requires specific inputs and assumptions,

e
such as the risk-free rate and volatility, it’s not practical to provide a
v
n i
comprehensive numerical example here. Additionally, the approach is
more complex and involves mathematical calculations.

, U
L
5.4.2 Valuation of intangibles
O
/ S
Valuation of intangibles refers to the process of determining the monetary

O L
value of assets that do not have a physical form. Intangible assets can
include intellectual property, brands, customer relationships, patents,

/ C
trademarks, copyrights, software, and goodwill. Here are some common

C Emethods used for valuing intangibles:

D
1. Cost Approach: This approach estimates the value of an intangible asset

©D
based on the cost incurred to create or replace it. It takes into account
the historical costs, development expenses, research and development
costs, and any other expenses associated with creating or acquiring the
intangible asset.
This approach considers the historical costs, development expenses, research
and development costs, and other expenses associated with the intangible
asset. Here’s a numerical example to illustrate the Cost Approach:

112 PAGE
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 APPROACHES TO VALUATION

Let’s say a company has developed a software program, and you want to Notes
determine the value of the software using the Cost Approach. The costs
incurred in developing the software are as follows:
1. Research and Development (R&D) expenses: $5,00,000
2. Employee salaries and benefits for software development: $3,00,000
3. Equipment and software licenses used in development: $2,00,000
To calculate the value of the software using the Cost Approach, you
would add up these costs:
h i
Total cost = R&D expenses + Employee salaries and benefits +
e l
Equipment and software licenses
D
of
= $5,00,000 + $3,00,000 + $2,00,000
= $10,00,000

ty
Based on the Cost Approach, the value of the software would be estimated
i
s
at $10,00,000. This approach assumes that the value of the intangible
r
e
asset is equivalent to the costs incurred to create or replace it.

i v
It’s important to note that the Cost Approach does not consider the market

n
demand or the future income generated by the intangible asset. Therefore,
U
,
it may not capture the full value of the asset, especially if there are

O L
market factors or other intangible attributes that contribute to its value.
2. Market Approach: The market approach values intangibles by

/ S
comparing them to similar assets that have been bought or sold in the

O L
market place. It involves analyzing market transactions or licensing
agreements of comparable intangible assets and applying those values

/ C
to the asset being valued.

C E
The Market Approach is a method used to value intangible assets by

D
comparing them to similar assets that have been bought or sold in the

©D
market place. This approach relies on market transactions or licensing
agreements involving comparable intangible assets. Let’s consider a
numerical example to illustrate the Market Approach for valuing an
intangible asset:
Example:
Suppose a company owns a trademark for a specific product brand. To
determine the value of the trademark using the Market Approach, we
can look at recent transactions or licensing agreements involving similar
trademarks.
PAGE 113
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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Based on market research, we find three recent transactions of trademarks

for similar product brands:
Transaction 1: Brand X trademark sold for $5,00,000
Transaction 2: Brand Y trademark sold for $4,00,000
Transaction 3: Brand Z trademark licensed for an annual royalty of
$1,00,000
To estimate the value of the company’s trademark using the Market
Approach, we can calculate an average value or range based on these
h i
transactions:
e l
D
Average Value = (Transaction 1 + Transaction 2 + Transaction 3)/

of
Number of Transactions
= ($5,00,000 + $400,000 + $1,00,000)/3
= $333,333.33
i ty
r s
In this example, the average value of the trademarks from recent transactions
is approximately $333,333.33.
v e
i
It’s important to note that the Market Approach relies on the availability
n
U
of comparable market data, and the valuation may vary depending on the

,
specific characteristics and market demand for the intangible asset being

O L
valued. Obtaining accurate market data and identifying truly comparable
assets is crucial for an effective valuation using the Market Approach.

/ S
L
Consulting with a professional appraiser or valuation expert with expertise

O
in intangible asset valuation can help ensure a thorough and accurate

C
valuation using the Market Approach.

E /
3. Income Approach: The income approach assesses an intangible asset’s

D C value based on its potential to provide future cash flows or income. The
value based on anticipated future earnings related to the intangible asset

©D
is estimated using methods like the Relief from Royalty method, Excess
Earnings method, or Multi-Period Excess Earnings method.
Based on their potential to produce future income or cash flows, intangible
assets are valued using the Income Approach. With this method, the
present value of anticipated future economic benefits associated with the
intangible asset is estimated. To demonstrate the Income Approach for
valuing an intangible asset, let’s take a numerical example:

114 PAGE
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 APPROACHES TO VALUATION

Example: Notes
Suppose a company holds a patent for a unique technology that is expected
to generate annual royalty income for the next five years. The estimated
royalty income for each year is as follows:
Year 1: $1,00,000
Year 2: $1,20,000
Year 3: $1,40,000
Year 4: $1,60,000
h i
Year 5: $1,80,000
e l
D
of
To determine the value of the patent using the Income Approach, we need
to calculate the present value of these future royalty income streams. Let’s

ty
assume a discount rate of 10% to calculate the present value:

i
Present Value = Year 1 Value + Year 2 Value + Year 3 Value +
s
Year 4 Value + Year 5 Value
e r
i v
Year 1 Value = $1,00,000/(1 + 0.10)^1 = $90,909.09

n
Year 2 Value = $1,20,000/(1 + 0.10)^2 = $99,173.55

U
,
Year 3 Value = $1,40,000/(1 + 0.10)^3 = $1,07,355.37

L
Year 4 Value = $1,60,000/(1 + 0.10)^4 = $1,15,240.33
O
S
Year 5 Value = $1,80,000/(1 + 0.10)^5 = $1,22,881.45
Present Value
L /
= $90,909.09 + $99,173.55 + $107,355.37

C O + $115,240.33 + $122,881.45

E / = $5,35,559.79
In this example, the present value of the expected future royalty income

D C
streams is approximately $5,35,559.79, which represents the estimated

©D
value of the patent using the Income Approach.
It’s important to note that the accuracy of the valuation depends on factors
such as the accuracy of the income projections, the chosen discount rate,
and the underlying assumptions made in the valuation process. Consulting
with a professional appraiser or valuation expert experienced in intangible
asset valuation is recommended for a comprehensive and accurate valuation
using the Income Approach.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 4. Royalty Relief Method: By computing the present value of anticipated

future royalties that might be received from licencing an asset to third
parties, this method determines the worth of an intangible asset.
By estimating the current value of anticipated future royalties that might
be received from licencing an asset to third parties, the Royalty Relief
Method is a method of valuation used to determine the worth of an
intangible asset. This approach makes the assumption that the value of
the intangible asset is derived from the financial gains it produces from

h i
royalties. Consider the following numerical example to better understand
the Royalty Relief Method:
e l
Example:
D
of
Suppose a company owns a patented technology and licenses it to third

ty
parties. The estimated royalty rate for the technology is 5% of the

i
licensee’s sales revenue. The projected annual sales revenue for the next

s
r
five years is as follows:
Year 1: $20,00,000
v e
Year 2: $25,00,000
n i
Year 3: $30,00,000
, U
O L
Year 4: $35,00,000
Year 5: $40,00,000

/ S
L
To determine the value of the technology using the Royalty Relief

O
Method, we need to calculate the present value of the expected future

/ C
royalty income streams. Let’s assume a discount rate of 8% to calculate

E
the present value:

D C Present Value = (Year 1 Royalty + Year 2 Royalty + Year 3 Royalty

+ Year 4 Royalty + Year 5 Royalty)/(1 + Discount Rate)^n

©D Year 1 Royalty = $20,00,000 × 0.05 = $1,00,000

Year 2 Royalty = $25,00,000 × 0.05 = $1,25,000
Year 3 Royalty = $30,00,000 × 0.05 = $1,50,000
Year 4 Royalty = $35,00,000 × 0.05 = $1,75,000
Year 5 Royalty = $40,00,000 × 0.05 = $2,00,000

116 PAGE
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 APPROACHES TO VALUATION

Present Value = ($1,00,000/(1 + 0.08)^1) + ($1,25,000/(1 + 0.08)^2) Notes

+ ($1,50,000/(1 + 0.08)^3) + ($1,75,000/(1 + 0.08)^4) + ($2,00,000/
(1 + 0.08)^5)
Calculating the present value using the discount rate and formula above
will give the estimated value of the technology using the Royalty Relief
Method.
It’s important to note that the accuracy of the valuation depends on

i
various factors, including the accuracy of the sales revenue projections,
the chosen discount rate, and the underlying assumptions made in the
l h
valuation process. Consulting with a professional appraiser or valuation
expert experienced in intangible asset valuation is recommended for a
D e
of
comprehensive and accurate valuation using the Royalty Relief Method.

ty
5. Multi-Period Excess Earnings Method: By taking into consideration

i
the returns attributed to tangible assets and normalising the profits over

s
r
a specific time period, this method determines the value of an intangible

e
asset based on the predicted future earnings generated by the asset.
v
n i
An intangible asset’s worth is estimated using the multi-period excess

U
earnings method, which works by computing the present value of the

L ,
asset’s anticipated future earnings. The earnings during a specific time
are normalised using this method, which also distinguishes between the

O
earnings attributable to tangible assets and those attributable to intangible
S
L /
assets. In order to better understand the Multi-Period Excess Earnings
Method, let’s look at a numerical example:
Example:
C O
E /
Suppose a company has developed a proprietary software program that

D C
is expected to generate excess earnings over a period of five years. The
estimated excess earnings from the software program for each year are

©D
as follows:
Year 1: $2,00,000
Year 2: $2,20,000
Year 3: $2,40,000
Year 4: $2,60,000
Year 5: $2,80,000

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes To determine the value of the software program using the Multi-Period
Excess Earnings Method, we need to calculate the present value of the
excess earnings over the defined period. Let’s assume a discount rate of
10% to calculate the present value:
Present Value = (Year 1 Excess Earnings/(1 + Discount Rate)^1) + (Year
2 Excess Earnings/(1 + Discount Rate)^2) + (Year 3 Excess Earnings/(1
+ Discount Rate)^3) + (Year 4 Excess Earnings/(1 + Discount Rate)^4)
+ (Year 5 Excess Earnings/(1 + Discount Rate)^5)

h i
l
Present Value = ($2,00,000/(1 + 0.10)^1) + ($2,20,000/(1 + 0.10)^2) +

0.10)^5)
D e
($2,40,000/(1 + 0.10)^3) + ($2,60,000/(1 + 0.10)^4) + ($2,80,000/(1 +

of
Calculating the present value using the discount rate and formula above

ty
will give the estimated value of the software program using the Multi-
Period Excess Earnings Method.

s i
r
It’s important to note that the accuracy of the valuation depends on
e
v
various factors, including the accuracy of the excess earnings projections,

n i
the chosen discount rate, and the underlying assumptions made in the

U
valuation process. Consulting with a professional appraiser or valuation

L ,
expert experienced in intangible asset valuation is recommended for a
comprehensive and accurate valuation using the Multi-Period Excess
Earnings Method.
S O
L /
6. Relief from Legal Restrictions Method: This method assesses the

O
value of an intangible asset by determining the potential financial benefits

C
gained from the removal of legal restrictions that limit the asset’s use
/
E
or ownership.

D C The relief from Legal Restrictions Method is a valuation approach used

to estimate the value of an intangible asset by determining the potential

©D
financial benefits gained from the removal of legal restrictions that limit
the asset’s use or ownership. This method assesses the value by considering
the increase in expected cash flows or the reduction in costs resulting
from the removal of legal restrictions. Let’s consider a numerical example
to illustrate the Relief from Legal Restrictions Method:
Example:
Suppose a company owns a valuable piece of real estate, but it is currently
subject to a legal restriction that prevents the company from developing

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 APPROACHES TO VALUATION

or utilizing the property to its full potential. The removal of this legal Notes
restriction would allow the company to develop and monetize the property
more effectively.
The estimated increase in cash flows resulting from the removal of the
legal restriction is projected to be as follows:
Year 1: $5,00,000
Year 2: $6,00,000
Year 3: $7,00,000
h i
Year 4: $8,00,000
e l
Year 5: $9,00,000
D
To determine the value of the intangible asset (the removal of the legal
of
ty
restriction) using the Relief from Legal Restrictions Method, we need to

i
calculate the present value of the expected incremental cash flows. Let’s

s
r
assume a discount rate of 8% to calculate the present value:

v e
Present Value = (Year 1 Incremental Cash Flow/(1 + Discount Rate)^1)

n i
+ (Year 2 Incremental Cash Flow/(1 + Discount Rate)^2) + (Year 3

U
Incremental Cash Flow/(1 + Discount Rate)^3) + (Year 4 Incremental

+ Discount Rate)^5)
L ,
Cash Flow/(1 + Discount Rate)^4) + (Year 5 Incremental Cash Flow/(1

S O
Present Value = ($5,00,000/(1 + 0.08)^1) + ($6,00,000/(1 + 0.08)^2) +

L /
($7,00,000/(1 + 0.08)^3) + ($8,00,000/(1 + 0.08)^4) + ($9,00,000/(1 +

O
0.08)^5)

/ C
Calculating the present value using the discount rate and formula above

C E
will give the estimated value of the removal of the legal restriction using
the Relief from Legal Restrictions Method.
D
©D
It’s important to note that the accuracy of the valuation depends on
various factors, including the accuracy of the projected incremental cash
flows, the chosen discount rate, and the underlying assumptions made
in the valuation process. Consulting with a professional appraiser or
valuation expert experienced in intangible asset valuation is recommended
for a comprehensive and accurate valuation using the Relief from Legal
Restrictions Method.
It’s important to note that valuing intangibles can be complex, as their
value is subjective and relies on various factors. Professional appraisers

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes or valuation experts with expertise in intangible asset valuation are often
consulted to perform comprehensive valuations of intangible assets.

5.4.3 Valuing Private Companies

Valuing private companies can be challenging due to the limited availability
of financial information and the absence of a publicly traded market for
their shares. However, there are several common approaches used to
value private companies:
h i
Approach of Valuing Private Companies
e l
D
1. Market Multiple Approach: This strategy employs financial multiples

of
based on recent transactions of comparable private companies, much like

ty
the comparable company analysis. To determine the value of a target

i
private company, multiples like enterprise value-to-revenue or enterprise

s
r
value-to-EBITDA are applied to the related financial measures.

v e
A private company’s financial indicators and valuation multiples are

n i
compared to those of comparable publicly traded companies as part of

U
the Market Multiple Approach, also known as Comparable Company

L ,
Analysis (CCA), a method of valuation. Based on the market valuation
multiples of similar companies, this method provides an estimate of the

O
private company’s value. Here is a numerical illustration of how to value
S
/
a private firm using the Market Multiple Approach:
L
O
(a) Identify Comparable Companies:

/ C
Decide on a set of publicly traded businesses that, in terms of size,

C E industry, business model, future development, and risk profile, are

comparable to the private company. Consider that we’re valuing a

D private technology company and that we’ve found three comparable

©D
publicly traded firms: Company A, Company B, and Company C.
(b) Gather Financial Information:
Gather the pertinent financial data for the private company and
the analogous businesses. In the Market Multiple Approach, key
financial indicators like sales, EBITDA (earnings before interest,
taxes, depreciation, and amortisation), net income, and market
capitalization are frequently employed.

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 APPROACHES TO VALUATION

(c) Calculate Valuation Multiples: Notes

Divide the market capitalization of the similar companies by the
appropriate financial statistic to determine the valuation multiples.
Price-to-earnings (P/E), price-to-EBITDA (P/EBITDA), and price-
to-sales (P/S) ratios are often employed valuation multiples in the
Market Multiple Approach.
(d) Apply Valuation Multiples to the Private Company:
Once the valuation multiples are determined, apply them to the
h i
financial metrics of the private company to estimate its value. For
example, if the average P/E ratio of the comparable companies is
e l
17.67x, the estimated value of the private company based on its D
of
net income of $1 million would be approximately $17.67 million

ty
(17.67x $1 million).
(e) Adjust for Specific Factors:
s i
e r
A private company’s valuation may be impacted by a number of

i v
factors, such as variations in growth potential, risk profile, market

U n
position, and financial performance, when compared to similar
companies. Based on these variables, change the predicted value
as necessary.
L ,
O
2. Asset-Based Approach: This method evaluates the company based

/ S
on the fair value of its net assets, taking into account both tangible and

O L
intangible assets. To arrive at the net asset value, the fair value of the
company’s assets is subtracted from that sum.

/ C
A private company’s value is estimated using the asset-based approach by

C E
calculating the value of its net assets. Using this method, the Net Asset
Value (NAV) is determined by deducting the company’s entire liabilities
D
©D
from its total assets. Here is a numerical illustration of how to value a
private firm using the asset-based approach:
(a) Determine Total Assets:
Start by calculating the overall asset worth of the business. This
encompasses both tangible assets (such as real estate, machinery,
and stock) and intangible assets (including goodwill, patents, and
trademarks).

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes (b) Determine Total Liabilities:

Identify and quantify all the company’s liabilities, including loans,
accounts payable, and other outstanding obligations. Let’s assume
the total value of the company’s liabilities is $3 million.
(c) Calculate Net Asset Value (NAV):
Calculate the net asset value by subtracting the total liabilities from
the total assets. In our example:
Net Asset Value = Total Assets - Total Liabilities
h i
e
Net Asset Value = $10 million - $3 million = $7 million l
(d) Adjust for Intangible Assets and Goodwill:
D
of
Consideration and adjustment should be made if the company has

ty
sizeable intangible assets or goodwill that are not shown on the

i
balance sheet. This adjustment can entail calculating the fair value

s
r
of goodwill or intangible assets and adding it to the net asset value.
(e) Consider Market Value:
v e
n i
The market value of a company’s assets may occasionally fluctuate

, U
significantly from its book value. Adjustments should be made to
reflect the market value of the assets if there are signs that their
L
market value differs from their carrying value.
O
/ S
(f) Assess Other Factors:

O L
The company’s growth prospects, market position, intellectual
property, brand value, and any particular assets or liabilities that

/ C
are not shown in the balance sheet should all be taken into account

C E as they may have an impact on the valuation.

D It’s crucial to remember that the Asset-Based Approach may not

©D
accurately reflect the value of intangible assets or future earning
potential and is best suited for businesses with significant tangible
assets. In order to arrive at an accurate valuation of a private
company, it is frequently employed as a secondary valuation method
or in conjunction with other techniques.
3. Venture Capital Method: This approach is frequently used to evaluate
early-stage businesses and start-ups. It entails making assumptions about
future growth, market potential, and expected returns on investment in

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 APPROACHES TO VALUATION

order to determine the company’s eventual exit valuation (for example, Notes
through an acquisition or initial public offering). Then, using a discount
rate, the present value of the anticipated exit valuation is determined.
Venture investors typically use the Venture Capital Method when
appraising start-up or early-stage private companies. Using this method,
the investment’s present value is computed while accounting for the
company’s potential exit value in the future. Here is an example using
numbers showing how to evaluate a private company using the venture
capital approach:
h i
(a) Estimate Future Exit Value:
e l
D
of
The first step is to calculate the company’s potential exit value
in the future. This can be done by considering variables like the

ty
company’s development predictions, market size, competitive climate,

i
and comparable industry transactions. Assume the anticipated exit

s
r
value will be $50 million.
(b) Determine Target Rate of Return:
v e
n i
The venture capitalist’s anticipated target rate of return should then

, U
be ascertained. Normally, this rate of return represents the degree
of risk involved in making investments in start-ups or early-stage
L
businesses. Let’s assume a goal rate of return of 30% for the
O
S
purposes of this example.

L /
(c) Calculate Post-Money Valuation:

O
Calculate the post-money valuation by dividing the future exit value
C
/
by the expected rate of return. The formula is:

E
C
Post-Money Valuation = Future Exit Value/(1 + Target Rate of Return)

D
In our example:

©D
Post-Money Valuation = $50 million/(1 + 30%) = $38.46 million
(d) Determine Pre-Money Valuation:
The company’s valuation prior to the investment is known as the
pre-money valuation. The calculation is performed by deducting the
investment amount from the post-money valuation. Let’s say the
venture capitalist wants to put $5 million into the business.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes In that case:

Pre-Money Valuation = Post-Money Valuation - Investment Amount
Pre-Money Valuation = $38.46 million - $5 million = $33.46 million
(e) Calculate Ownership Percentage:
Based on the investment amount and the pre-money valuation, determine
the ownership stake that the venture capitalist will acquire. Since
the venture capitalist in our example is putting $5 million into the
project:
h i
Ownership Percentage = Investment Amount/Pre-Money Valuation
e l
D
Ownership Percentage = $5 million/$33.46 million = 14.95%

of
(f) Determine Investment Value:
Finally, multiply the ownership percentage by the post-money valuation

i ty
to arrive at the investment value. The investment’s present value is
shown by this. In this instance:
r s
e
Investment Value = Ownership Percentage × Post-Money Valuation
v
n i
Investment Value = 14.95% × $38.46 million = $5.75 million

, U
It’s crucial to remember that the Venture Capital Method places a
major emphasis on forecasts and assumptions, and the projected

O L
valuation might be highly uncertain. Therefore, when making
investment decisions in private companies, this method should be

/ S
used as a tool for preliminary valuation assessment and should be
L
supplemented with other valuation approaches and due diligence.
O
/ C
It’s crucial to remember that valuing private enterprises necessitates

E
a careful evaluation of a number of variables, including industry

C
dynamics, market circumstances, financial performance, potential

D for growth, and the unique qualities of the company being valued.

©D
To achieve a thorough and accurate assessment, it is advised to
consult with a qualified appraiser, company valuation specialist, or
investment banker with experience in valuing private enterprises.

5.4.4 Valuing firms with Negative Earnings

Since conventional valuation techniques mainly rely on positive cash flows
or earnings, it can be difficult to value companies with negative earnings.
Alternative methods for valuing businesses with negative earnings do exist.

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 APPROACHES TO VALUATION

1. Asset-based Approach: This method bases an assessment of the firm’s Notes

value on its net assets. The fair worth of the company’s assets, such as
its tangible and intangible assets as well as its intellectual property, is
subtracted from the total liabilities to arrive at the net asset value. This
approach is better suited for businesses with substantial tangible assets
or priceless intangible assets.
The Asset-Based Approach is a method of valuation that determines a
company’s value by taking into account its net assets. However, given
that negative earnings could be a sign of troubled finances or subpar
h i
performance, assessing businesses with negative earnings using the asset-
e l
based approach can be difficult. To show how the Asset-Based Approach
D
of
can be used in this situation, let’s use a simplified numerical example.
(a) Determine Total Assets:

i ty
Start by calculating the asset total of the company. This encompasses

r s
both tangible assets (such real estate, machinery, and stock) and

e
intangible assets (including goodwill, patents, and trademarks).

v
Assume the firm has $10 million in total assets.
(b) Determine Total Liabilities:
n i
, U
Identify and quantify all the firm’s liabilities, including loans, accounts

total liabilities are $8 million.

O L
payable, and other outstanding obligations. Let’s assume the firm’s

/ S
(c) Calculate Net Asset Value (NAV):

O L
Calculate the net asset value by subtracting the total liabilities from

/ C
the total assets. In our example:

C E
Net Asset Value = Total Assets - Total Liabilities
Net Asset Value = $10 million - $8 million = $2 million
D
©D
(d) Adjust for Intangible Assets and Goodwill:
If the firm has significant intangible assets or goodwill that are not
reflected in the balance sheet, they should be considered and adjusted
accordingly. This adjustment may involve assessing the fair value
of intangible assets or goodwill and incorporating it into the net
asset value.
(e) Consider Market Value:
In some circumstances, the market value of the company’s assets
may differ markedly from their book value. Adjustments should
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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes be made to reflect the market value of the assets if there are signs
that their market value differs from their carrying value.
(f) Assess Other Factors:
The firm’s potential for a turnaround, potential for future growth,
the value of intellectual property, the value of the company’s brand,
and any special assets or liabilities that are not shown on the balance
sheet should all be taken into account.

i
It’s vital to remember that utilising the Asset-Based Approach to

l h
value companies with negative earnings may not accurately reflect

D e
their underlying value or potential for future earnings. The strategy
works better for businesses that have substantial tangible assets or

of
for struggling businesses that are being liquidated. To arrive at a
thorough and accurate valuation when assessing companies with

ty
negative earnings, it is essential to take other valuation techniques,
i
s
industry analysis, and qualitative aspects into account.
r
e
2. Liquidation Approach: This strategy is predicated on the idea that

v
n i
the company will be liquidated and its assets will be sold to satisfy
creditors. By figuring out the fair market worth of the company’s assets

U
and deducting liabilities, the value is estimated. This approach is more
,
L
appropriate if the company is in financial difficulty or is in the process

O
of shutting down operations.

/ S
The Liquidation Approach is a valuation technique used when assessing

O L
companies with negative earnings, particularly when the company is
in financial trouble or is about to shut down. It entails calculating the

/ C
asset value of the company while assuming that it will be sold off after

C Ea liquidation. Using a simplified numerical example, the Liquidation

Approach is demonstrated here:
D
©D
(a) Identify Liquidation Value:
Establish the projected liquidation value of the company’s assets.
This entails determining the fair market worth of the company’s
tangible assets, including its machinery, supplies, and real estate.
Assume that $5 million is the projected liquidation value of the
company’s assets.
(b) Assess Liquidation Costs:
Take into account any expenditures related to the liquidation
process, such as expert fees, legal charges, and any unpaid liabilities

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 APPROACHES TO VALUATION

or obligations that must be addressed. Assume that the expected Notes

liquidation expenses for this case are $1 million.
(c) Calculate Net Liquidation Value:
Subtract the liquidation costs from the estimated liquidation value
to determine the net liquidation value. In our example:
Net Liquidation Value = Liquidation Value - Liquidation Costs
Net Liquidation Value = $5 million - $1 million = $4 million
(d) Consider Priority of Claims:
h i
Consider the priority of claims in the liquidation process. Certain
e l
D
creditors may have priority over others, such as secured creditors or

of
preferred stockholders. Deduct any outstanding claims or obligations
that have priority in the liquidation process from the net liquidation

ty
value.
(e) Distribute Remaining Value:
s i
r
Distribute the remaining value to the stakeholders based on their
e
v
respective priority and rights. This may involve allocating funds

n i
to repay creditors, shareholders, and other parties according to the
liquidation plan.

, U
It’s important to note that the Liquidation Approach typically yields
L
a lower value compared to other valuation methods since it assumes
O
S
a distressed or forced sale scenario. The approach is most relevant

L /
when a firm is facing financial distress, is unable to generate positive

O
earnings, or is expected to cease operations. When valuing firms with

C
negative earnings, it’s advisable to consider other valuation methods,

E /
such as the Asset-Based Approach or the Market Approach, as well

C
as the specific circumstances and industry dynamics impacting the
firm.
D
©D
3. Option Pricing Model: This model values the firm’s equity as a call
option on its assets. The negative earnings and financial distress are
taken into account in estimating the volatility of the firm’s assets. The
value is derived based on the probability of the firm’s assets exceeding
its liabilities, considering the risk and time to expiration.
The Option Pricing Model is a valuation method that can be used to
value firms with negative earnings by treating the firm as an option on
its underlying assets. This approach is based on the idea that the firm’s
value is derived from the potential upside that can occur if the firm’s

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes financial performance improves. Here’s a simplified numerical example

to illustrate the Option Pricing Model:
(a) Estimate Future Upside Potential:
Assess the potential for the firm’s financial performance to improve
in the future. This can be based on factors such as market conditions,
industry trends, management initiatives, and other relevant factors.
Let’s assume that based on the analysis, there is a 50% chance that
the firm’s earnings will turn positive in the future.

h i
l
(b) Determine Strike Price:

D e
Define a strike price, which represents the threshold level of earnings
that the firm needs to achieve for the upside potential to be realized.

of
Let’s assume the strike price is $1 million in annual earnings.
(c) Calculate Option Value:

i ty
To determine the option’s value, use option pricing models like

r s
the Black-Scholes model or the binomial options pricing model.

e
These models take into consideration elements like the existing
v
n i
asset worth of the company, the earnings volatility, the remaining
time, and the risk-free rate. Assume that the estimated value of the

,
option is $5,00,000.
U
O L
(d) Adjust for Debt and Liabilities:
Consider the firm’s outstanding debt and liabilities that need to be

/ S
deducted from the option value. Subtract the present value of the
L
debt and liabilities from the calculated option value to arrive at the
O
C
adjusted option value.

/
CE
(e) Determine Firm Value:
Add the adjusted option value to the firm’s net assets, which include

D D tangible and intangible assets, to determine the overall firm value.

This takes into account both the potential upside value and the

© underlying asset value.

It’s important to note that valuing firms with negative earnings using the
Option Pricing Model requires making assumptions about the likelihood
and magnitude of the potential upside, as well as selecting appropriate
option pricing models and input parameters. This approach is more suitable
for firms with significant growth potential or those operating in volatile
industries. It’s recommended to consult with financial professionals or
valuation experts to ensure the accuracy and reliability of the valuation.

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4. Comparative Transactions: This approach involves analyzing transactions Notes

of similar firms in the industry that had negative earnings. By comparing
the transaction multiples (e.g., price-to-sales, price-to-book) of these
firms, a relative valuation can be derived for the firm in question. This
method requires finding comparable firms that have gone through similar
circumstances.
The Comparative Transactions approach, also known as the Market
Approach, can be used to value firms with negative earnings by analyzing
the financial metrics and transactional data of similar companies that
h i
have been sold or acquired in the market. This approach relies on the
e l
assumption that the market value of the firm can be estimated based on
D
of
the valuation multiples observed in comparable transactions. Here’s a
simplified numerical example to illustrate the Comparative Transactions

ty
approach:
(a) Identify Comparable Transactions:
s i
e r
Identify recent transactions involving companies in the same industry or

i v
sector that are similar to the firm being valued. Look for transactions
n
where the financial metrics and characteristics of the companies are
U
,
comparable, even if they have negative earnings. Let’s assume you

and Transaction C.
O L
find three comparable transactions: Transaction A, Transaction B,

(b) Collect Transaction Data:

/ S
O L
The prices of the comparable deals, as well as financial measures

C
(such as earnings, sales, or book value), and valuation multiples (such
/
E
as price-to-earnings, price-to-sales, or price-to-book ratios), should

D C
also be gathered. Assume that the comparable deals’ transaction
prices are as follows: $5,00,00,000 for Transaction A, $6,00,00,000

©D
for Transaction B, and $5,50,00,000 for Transaction C.
(c) Calculate Valuation Multiples:
Determine the valuation multiples based on the transaction data.
Calculate the average multiples observed in the comparable transactions.
Let’s assume the average price-to-earnings (P/E) ratio is 10x, the
average price-to-sales (P/S) ratio is 2x, and the average price-to-
book (P/B) ratio is 1.5x.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes (d) Apply Valuation Multiples to the Firm:

Apply the average valuation multiples to the corresponding financial
metrics of the firm being valued to estimate its market value. For
example, if the firm has negative earnings of -$2 million, sales of
$10 million, and a book value of $5 million, the estimated market
value using the valuation multiples would be:
- Market Value based on P/E ratio: -$2 million (earnings) × 10

i
(P/E ratio) = -$20 million

l h
- Market Value based on P/S ratio: $10 million (sales) × 2 (P/S
ratio) = $20 million
D e
of
- Market Value based on P/B ratio: $5 million (book value) ×
1.5 (P/B ratio) = $7.5 million

ty
(e) Weighted Average Market Value:

s i
Calculate a weighted average market value based on the importance

e r
or relevance of each valuation multiple. Assign appropriate weights

i v
to each multiple based on factors such as the reliability of the data

U n
or the significance of each multiple. Then, calculate the weighted
average market value using the formula:

L ,
Weighted Average Market Value = (Market Value based on P/E

O
ratio × Weight) + (Market Value based on P/S ratio × Weight) +

S
L /
(Market Value based on P/B ratio × Weight)
Assuming equal weights are assigned to each multiple, the weighted

C O
average market value would be:

E / Weighted Average Market Value = (-$20 million + $20 million

D C + $7.5 million)/3 = -$4.17 million

In this example, the Comparative Transactions approach estimates the

©D
market value of the firm to be approximately -$4.17 million based
on the observed multiples in comparable transactions. However,
it’s important to note that valuing firms with negative earnings
using this approach can be challenging, and additional adjustments
and considerations may be required to arrive at a more accurate
valuation. Consulting with valuation professionals or financial experts
is recommended for a comprehensive analysis.

130 PAGE
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 APPROACHES TO VALUATION

It’s important to note that valuing firms with negative earnings Notes
requires careful analysis, considering the reasons behind the negative
earnings, the firm’s financial position, future growth prospects,
industry trends, and risk factors. Consulting with a professional
appraiser, business valuation expert, or financial analyst experienced
in valuing firms with negative earnings is recommended to ensure
a comprehensive and accurate valuation.

5.4.5 Valuing Start-up Firms

h i
e l
D
Valuing start-up firms can be challenging due to the limited operating

of
history and uncertainty associated with their future cash flows. However,
there are several methods commonly used to value start-up firms:

ty
1. Discounted Cash Flow (DCF) Analysis: The future cash flows of

s i
the start-up are estimated using the DCF approach. A discount rate is

r
used to bring future cash flows to their present value after creating cash
e
v
flow estimates. Assumptions must be made for this strategy’s revenue
i
n
expansion, profitability, capital expenditure, working capital, and suitable
discount rate.

, U
L
When valuing start-up businesses using the Discounted Cash Flow (DCF)

O
approach, future cash flows are projected and discounted to their current

/ S
value. This method considers both the risk related to the start-up’s cash

O L
flows and the time value of money. The following simple numerical
example shows how to value a start-up company using the DCF analysis:

/ C
(a) Estimate Future Cash Flows:

C E
Predict the start-up’s anticipated cash flows over a given projection

D
period, usually three to five years. Revenues, operating costs,

©D
capital expenditures, and taxes are possible components of these
cash flows. Suppose the start-up’s anticipated cash flows over the
following five years are as follows:
Year 1: $1,00,000
Year 2: $1,50,000
Year 3: $2,00,000
Year 4: $2,50,000
Year 5: $3,00,000

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes (b) Determine the Terminal Value:

Calculate the startup’s terminal value, which is the estimated worth
of its future cash flows, after the projection period. The terminal
value can be determined using a variety of techniques, including
the perpetuity growth approach and the exit multiple method. Let’s
suppose that after Year 5, the start-up’s terminal value is predicted
to be $10,00,000.

i
(c) Determine the Discount Rate:

l h
Select an appropriate discount rate to reflect the risk associated
e
with the start-up’s cash flows. The discount rate is typically the
D
of
Weighted Average Cost of Capital (WACC) or the required rate of
return. Let’s assume a discount rate of 10% is used.

ty
(d) Calculate Present Value:

s i
Discount each projected cash flow and the terminal value to their

e r
present value using the discount rate. The present value is calculated

i v
by dividing the projected cash flow by (1 + discount rate) raised to

U n
the power of the corresponding period. In our example, the present
value of each projected cash flow would be:

L ,
PV Year 1 = $100,000/(1 + 0.10)^1 = $90,909

O
PV Year 2 = $150,000/(1 + 0.10)^2 = $1,23,967

S
/
PV Year 3 = $200,000/(1 + 0.10)^3 = $1,51,290
L
O
PV Year 4 = $250,000/(1 + 0.10)^4 = $1,81,405

/ CPV Year 5 = $300,000/(1 + 0.10)^5 = $2,07,256

CE
Similarly, calculate the present value of the terminal value:

D D PV Terminal Value = $10,00,000/(1 + 0.10)^5 = $6,20,921

(e) Calculate the Sum of Present Values:
© Sum up the present values of the projected cash flows and the terminal
value to determine the total present value. In our example:
Total Present Value = PV Year 1 + PV Year 2 + PV Year 3 + PV
Year 4 + PV Year 5 + PV Terminal Value
Total Present Value = $90,909 + $1,23,967 + $1,51,290 + $1,81,405
+ $2,07,256 + $6,20,921 = $13,75,748

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 APPROACHES TO VALUATION

(f) Determine the Equity Value: Notes

The equity value of the start-up is calculated by subtracting any
outstanding debt or liabilities from the total present value. If there
are no outstanding debt or liabilities, then the equity value would
be equal to the total present value.
In this example, assuming no outstanding debt or liabilities, the
equity value of the start-up would be $13,75,748.
It’s important to note that valuing start-up firms using the DCF
h i
analysis requires making assumptions about future cash flows,
terminal value.
e l
D
of
2. Market Multiple Approach: This approach involves comparing the
start-up to similar companies in the industry that have already been

ty
valued or have undergone acquisitions. Key financial multiples, such as

i
price-to-earnings ratio or price-to-sales ratio, of comparable companies are
s
r
used to estimate the start-up’s value. However, finding truly comparable
e
v
companies can be challenging for start-ups.

n i
The Market Multiple Approach is a valuation method that involves

, U
comparing the financial metrics of a start-up firm with similar publicly
traded companies in the market to determine its value. This approach
L
uses valuation multiples, such as price-to-earnings (P/E), price-to-sales
O
S
(P/S), or price-to-book (P/B) ratios, to estimate the value of the start-up.

L /
Here’s a simplified numerical example to illustrate the Market Multiple

O
Approach for valuing a start-up firm:

/ C
(a) Identify Comparable Publicly Traded Companies:

C E
Identify a group of publicly traded companies that are similar to the
start-up firm in terms of industry, size, growth prospects, and other
D
©D
relevant factors. Let’s assume the following three companies are
identified as comparable: Company A, Company B, and Company
C.
(b) Collect Financial Data:
Gather financial data for comparable companies, including their
market capitalization, earnings, sales, or book value. Let’s assume
the following financial metrics for the comparable companies:

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Company A: Market Capitalization - $50 million, Earnings - $5

million
Company B: Market Capitalization - $60 million, Earnings - $6
million
Company C: Market Capitalization - $55 million, Earnings - $5.5
million
(c) Calculate Valuation Multiples:

h i
Determine the valuation multiples based on the financial data of the

e l
comparable companies. Calculate the average multiples observed in

D
the market for each metric. Let’s assume the average P/E ratio is

of
10x, the average P/S ratio is 2x, and the average P/B ratio is 1.5x.
(d) Apply Valuation Multiples to the Start-up:

i ty
Apply the average valuation multiples to the corresponding financial

s
metrics of the start-up to estimate its value. For example, if the
r
e
start-up has earnings of $1 million, sales of $10 million, and a

v
multiples would be:
n i
book value of $2 million, the estimated values using the valuation

, U
- Estimated Value based on P/E ratio: $1 million (earnings) ×

O L
10 (P/E ratio) = $10 million
- Estimated Value based on P/S ratio: $10 million (sales) × 2

/ S
(P/S ratio) = $20 million

O L
- Estimated Value based on P/B ratio: $2 million (book value)

/ C × 1.5 (P/B ratio) = $3 million

CE
(e) Weighted Average Value:

D
Calculate a weighted average value based on the importance or

D
relevance of each valuation multiple. Assign appropriate weights

© to each multiple based on factors such as the reliability of the data

or the significance of each multiple. Then, calculate the weighted
average value using the formula:
Weighted Average Value = (Value based on P/E ratio × Weight)
+ (Value based on P/S ratio × Weight) + (Value based on P/B
ratio × Weight)
Assuming equal weights are assigned to each multiple, the weighted
average value would be:

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 APPROACHES TO VALUATION

Weighted Average Value = ($10 million + $20 million + $3 Notes

million)/3 = $11 million
In this example, the Market Multiple Approach estimates the value
of the start-up firm to be approximately $11 million based on
the observed multiples in comparable publicly traded companies.
However, it’s important to note that valuing start-up firms using this
approach requires selecting appropriate comparable companies and
making adjustments to account for differences in growth prospects,
risk, and other factors. Consulting with valuation professionals or
h i
financial experts is recommended for a comprehensive analysis.
e l
3. Venture Capital (VC) Method: This method is commonly used by
D
of
venture capitalists to value start-up firms. It involves estimating the future
exit valuation of the start-up, typically through an acquisition or initial

i ty
public offering (IPO). The expected exit valuation is based on assumptions

s
about growth, market potential, competition, and the expected return
r
e
on investment. The present value of the expected exit valuation is then

v
calculated using an appropriate discount rate.

n i
The Venture Capital (VC) Method is a widely used approach for valuing

, U
start-up firms, particularly in the context of venture capital investments.

O L
It involves estimating the post-money valuation of the start-up based
on the expected return on investment for the venture capitalist. Here’s

/ S
a simplified numerical example to illustrate the VC Method of valuing
a start-up firm:

O L
C
(a) Determine the Expected Return:

E /
The venture capitalist (VC) typically has a desired rate of return

D C
based on the risk and time horizon of the investment. Let’s assume
the VC expects a 40% annualized return on their investment.

©D
(b) Estimate the Exit Value:
Estimate the future exit value of the start-up, which represents the
value the VC expects to receive when they exit their investment.
This can be based on various factors such as expected revenue
growth, industry trends, and potential acquisitions. Let’s assume
the expected exit value after 5 years is $100 million.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes (c) Calculate the Pre-money Valuation:

The pre-money valuation is the estimated value of the start-up
before the investment by the VC. It is calculated by dividing the
expected exit value by the expected return plus 1. Let’s assume the
expected return is 40%:
Pre-money Valuation = Expected Exit Value/(1 + Expected Return)
Pre-money Valuation = $100 million/(1 + 0.40)
Pre-money Valuation = $71.43 million
h i
(d) Determine the Investment Amount:
e l
D
The investment amount is the amount of capital the VC is willing

of
to invest in the start-up. This can be determined based on various
factors such as the VC’s investment strategy, the start-up’s funding

i ty
needs, and negotiation between the parties involved. Let’s assume

s
the VC is willing to invest $10 million.
r
e
(e) Calculate the Post-money Valuation:
v
n i
The post-money valuation is the sum of the pre-money valuation

U
and the investment amount. It represents the estimated value of the

L ,
start-up after the investment by the VC. In this example:
Post-money Valuation = Pre-money Valuation + Investment Amount

S O
/
Post-money Valuation = $71.43 million + $10 million

L
Post-money Valuation = $81.43 million

O
C
Therefore, the post-money valuation of the start-up would be $81.43
/ million.

D CE The VC Method provides a framework for valuing start-up firms

based on the expected return on investment and the exit value.

© D However, it’s important to note that the actual valuation of a start-up

can be influenced by various factors, including market conditions,
competition, growth potential, and other qualitative aspects. The
VC Method serves as a starting point for negotiations between
the start-up and the venture capitalist and is subject to further due
diligence and evaluation.

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 APPROACHES TO VALUATION

4. The Risk-adjusted Rate of Return: Method is a valuation approach Notes

used to assess the value of start-up firms by adjusting the expected rate
of return for the level of risk associated with the investment. This method
takes into account the riskiness of investing in a start-up compared to a
risk-free investment. Here’s a simplified numerical example to illustrate
the Risk-adjusted Rate of Return Method for valuing a start-up firm:
(a) Determine the Risk-free Rate:

i
Identify the risk-free rate, which represents the expected return on
a risk-free investment such as government bonds. Let’s assume the
l h
risk-free rate is 5%.
(b) Assess the Risk Profile: D e
of
Evaluate the risk profile of the start-up, considering factors such as

ty
the industry, competitive landscape, technology risks, and market

i
conditions. Assign a risk premium based on the perceived level of
s
r
risk associated with the investment. Let’s assume a risk premium
e
v
of 10% is applied to account for the start-up’s risk profile.
(c) Determine the Risk-adjusted Rate of Return:
n i
U
Calculate the risk-adjusted rate of return by adding the risk premium
,
L
to the risk-free rate. In this example:

O
Risk-adjusted Rate of Return = Risk-free Rate + Risk Premium

S
/
Risk-adjusted Rate of Return = 5% + 10%
L
O
Risk-adjusted Rate of Return = 15%

/ C
(d) Estimate the Future Cash Flows:

E
Forecast the expected future cash flows of the start-up over a specific
C
D
time period. This may include revenue projections, operating expenses,

©D
taxes, and capital expenditures. Let’s assume the expected cash
flows for the start-up over the next five years are as follows:
Year 1: $1,00,000
Year 2: $1,50,000
Year 3: $2,00,000
Year 4: $2,50,000
Year 5: $3,00,000

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes (e) Discount the Cash Flows:

Discount each projected cash flow to its present value using the risk-
adjusted rate of return. The present value is calculated by dividing
the projected cash flow by (1 + risk-adjusted rate of return) raised
to the power of the corresponding period. In our example, the
present value of each projected cash flow would be:
PV Year 1 = $1,00,000/(1 + 0.15)^1 = $86,956
PV Year 2 = $1,50,000/(1 + 0.15)^2 = $1,02,324
h i
PV Year 3 = $2,00,000/(1 + 0.15)^3 = $1,08,512
e l
PV Year 4 = $2,50,000/(1 + 0.15)^4 = $1,07,932
D
of
PV Year 5 = $3,00,000/(1 + 0.15)^5 = $1,02,181

ty
(f) Calculate the Sum of Present Values:

i
Sum up the present values of the projected cash flows to determine
s
r
the total present value. In our example:
e
i v
Total Present Value = PV Year 1 + PV Year 2 + PV Year 3 + PV
Year 4 + PV Year 5

U n
Total Present Value = $86,956 + $1,02,324 + $1,08,512 + $1,07,932

L ,
+ $1,02,181 = $5,07,905

O
Therefore, the total present value of the projected cash flows for

S
L /
the start-up would be $5,07,905.
The Risk-adjusted Rate of Return Method incorporates the risk

C O
associated with investing in a start-up by adjusting the discount rate

E / used in the discounted cash flow analysis. This method provides

C
a risk-adjusted valuation based on the expected rate of return and

D
the forecasted cash flows. However, it’s important to note that the

©D
valuation is still subject to various assumptions and uncertainties
inherent in projecting the future cash flows of a start-up.
5. Scorecard Method: This method is particularly relevant for early-
stage start-ups and involves assigning weights to various factors such as
the management team’s experience, market size, product differentiation,
competitive landscape, and intellectual property. Each factor is scored,
and the overall score is used to estimate the start-up’s value.

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 APPROACHES TO VALUATION

The Scorecard Method is a valuation approach used to assess the value Notes
of start-up firms by assigning scores to various factors that contribute to
the success and growth of the business. These factors typically include the
experience and track record of the management team, market potential,
competitive advantage, product or technology, and other relevant aspects.
Here’s a simplified numerical example to illustrate the Scorecard Method
for valuing a start-up firm:
(a) Identify Key Factors:

h i
l
Identify the key factors that are important for the success and growth
of the start-up. For this example, let’s consider the following factors:

D e
of
- Management Team: Score of 8 out of 10
- Market Potential: Score of 7 out of 10

ty
- Competitive Advantage: Score of 9 out of 10
- Product or Technology: Score of 6 out of 10
s i
- Financial Projections: Score of 8 out of 10
e r
i v
n
(b) Assign Weightings:

, U
Assign weightings to each factor based on their relative importance.
The weightings are subjective and can be based on expert judgment
L
or industry norms. For this example, let’s assume the following
O
S
weightings:

L /
- Management Team: Weighting of 30%

O
- Market Potential: Weighting of 20%
C
/
- Competitive Advantage: Weighting of 25%
E
D C
- Product or Technology: Weighting of 15%
- Financial Projections: Weighting of 10%

©D
(c) Calculate Factor Scores:
Calculate the weighted scores for each factor by multiplying the score
of each factor by its corresponding weighting. In this example:
Management Team Score = 8 (Factor Score) × 30% (Weighting) =
2.4
Market Potential Score = 7 (Factor Score) × 20% (Weighting) = 1.4

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Competitive Advantage Score = 9 (Factor Score) × 25% (Weighting)

= 2.25
Product or Technology Score = 6 (Factor Score) × 15% (Weighting)
= 0.9
Financial Projections Score = 8 (Factor Score) × 10% (Weighting)
= 0.8
(d) Calculate the Total Score:

h
Sum up the weighted scores of all factors to determine the total
i
score. In this example:
e l
D
Total Score = Management Team Score + Market Potential Score

of
+ Competitive Advantage Score + Product or Technology Score +
Financial Projections Score

i ty
Total Score = 2.4 + 1.4 + 2.25 + 0.9 + 0.8 = 7.75
(e) Determine the Valuation Multiplier:
r s
v e
The valuation multiplier is a factor that is multiplied by the total

n i
score to determine the valuation of the start-up. The multiplier can

U
vary depending on industry norms, market conditions, and other

L
for this example. ,
relevant factors. Let’s assume a valuation multiplier of 0.5 is used

S O
(f) Calculate the Valuation:

L /
Multiply the total score by the valuation multiplier to determine the

O
valuation of the start-up. In this example:

C
/ Valuation = Total Score × Valuation Multiplier

CE
Valuation = 7.75 × 0.5 = $3.875 million

DD
Therefore, the valuation of the start-up based on the Scorecard
Method would be $3.875 million.
© The Scorecard Method provides a qualitative and subjective approach
to valuing start-up firms by considering multiple factors and assigning
weightings and scores to each. It provides a holistic assessment of
the start-up’s potential value based on various aspects that contribute
to its success. However, it’s important to note that the Scorecard
Method relies on subjective judgments and can be influenced by
individual biases and assumptions. It is recommended to use this

140 PAGE
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 APPROACHES TO VALUATION

method in conjunction with other valuation approaches for a more Notes

comprehensive analysis.
It’s important to note that valuing start-up firms is highly subjective and
relies heavily on assumptions and projections. The stage of the start-up,
industry dynamics, market conditions, competition, and the quality of
the management team should all be considered. Consulting with venture
capitalists, angel investors, business valuation experts, or industry
professionals experienced in valuing start-up firms can provide valuable
insights and guidance in the valuation process.
h i
e l
5.4.6 Value Enhancement: A Discounted Cash Flow, EVA,
D
of
CFROI and other Tools

ty
Value enhancement refers to the strategies and techniques used to increase
i
s
the value of a business or investment. Several tools and frameworks can
r
e
be utilized in the process of value enhancement, including the discounted

i v
cash flow (DCF) valuation framework, Economic Value Added (EVA),
and Cash Flow Return on Investment (CFROI).

U n
1. Discounted Cash Flow (DCF) Valuation Framework: DCF is a widely

L ,
used valuation method that estimates the present value of expected

O
future cash flows. It involves projecting the cash flows generated by a

S
/
business or investment over a specific period and discounting them back

O L
to their present value using an appropriate discount rate. By analyzing
and adjusting the key assumptions underlying the cash flow projections,

/ C
businesses can identify areas for value enhancement. This can include

E
improving revenue growth, optimizing costs, or increasing profitability.

C
D
The Discounted Cash Flow (DCF) Valuation Framework is a commonly

©D
used method to assess the value enhancement potential of a business. It
involves estimating the present value of the future cash flows generated
by the business and comparing it to the current value. Here’s an overview
of how the DCF valuation framework can be applied to assess value
enhancement:
(a) Estimate Future Cash Flows:
The first step is to forecast the expected future cash flows generated
by the business. This can be done by analyzing historical financial

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes data, market trends, industry forecasts, and other relevant factors.
It is important to make realistic assumptions about revenue growth,
operating expenses, capital expenditures, and working capital
requirements.
(b) Determine the Discount Rate:
The next step is to determine the appropriate discount rate, also
known as the required rate of return or cost of capital. The discount

i
rate reflects the time value of money and the risk associated with

l h
the business. It should reflect the expected return that an investor

D e
would demand to invest in the business. The discount rate can be
determined using methods such as the weighted average cost of

of
capital (WACC) or a risk-adjusted rate of return.

ty
(c) Calculate Present Value:

i
Using the estimated future cash flows and the discount rate, calculate
s
r
the present value of each cash flow. This involves discounting each
e
v
cash flow back to its present value using the discount rate. The

n i
formula for calculating the present value of cash flows is:

U
Present Value = Cash Flow/(1 + Discount Rate)^n

,
L
Where “Cash Flow” is the expected cash flow in a specific period,

O
“Discount Rate” is the discount rate, and “n” is the number of

/ S
periods into the future.

L
(d) Sum up the Present Values:

O
C
Sum up the present values of all the future cash flows to determine
/ the total present value of the business.

CE (e) Compare Present Value to Current Value:

DD
Compare the total present value of the business to its current value to

©
assess the potential value enhancement. If the present value is higher
than the current value, it suggests that there is value enhancement
potential. Conversely, if the present value is lower than the current
value, it indicates that the business may be overvalued.
(f) Identify Value Drivers and Enhancement Opportunities:
Analyze the factors that contribute to the present value and identify
specific value drivers and enhancement opportunities. This can

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 APPROACHES TO VALUATION

include strategies to increase revenue, improve profitability, reduce Notes

costs, optimize capital structure, expand market share, or enhance
operational efficiency. By focusing on these value drivers, the
business can enhance its future cash flows and increase its overall
value.
The DCF Valuation Framework provides a quantitative approach to
assess value enhancement by considering the present value of expected
future cash flows. However, it is important to note that the accuracy
of the valuation depends on the quality of the assumptions made,
h i
the reliability of the cash flow forecasts, and the appropriateness of
e l
the discount rate used. Therefore, it is crucial to conduct thorough
D
of
analysis and consider various scenarios and sensitivities to obtain
a comprehensive understanding of the potential value enhancement.

i ty
Numerical Example : Illustrate the Discounted Cash Flow (DCF) Valuation
Framework for value enhancement:
r s
(i) Estimate Future Cash Flows:
v e
n i
Let’s assume a start-up company is projected to generate the following

U
annual cash flows over the next five years:
Year 1: $1,00,000
L ,
O
Year 2: $1,50,000
Year 3: $2,00,000
/ S
Year 4: $2,50,000
O L
/ C
Year 5: $3,00,000

E
(ii) Determine the Discount Rate:

C
D
For this example, let’s assume a discount rate of 12% is appropriate for

©D
the start-up based on its risk profile and market conditions.
(iii) Calculate Present Value:
Using the discount rate of 12%, we can calculate the present value of each
cash flow. The present value of each cash flow is calculated as follows:
PV Year 1 = $1,00,000/(1 + 0.12)^1 = $89,285.71
PV Year 2 = $1,50,000/(1 + 0.12)^2 = $1,12,108.86
PV Year 3 = $2,00,000/(1 + 0.12)^3 = $1,41,267.79

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes PV Year 4 = $2,50,000/(1 + 0.12)^4 = $1,76,798.10

PV Year 5 = $3,00,000/(1 + 0.12)^5 = $2,10,587.47
(iv) Sum the Present Values:
Sum up the present values of all the cash flows to determine the total
present value of the business:
Total Present Value = PV Year 1 + PV Year 2 + PV Year 3 + PV
Year 4 + PV Year 5

h
Total Present Value = $89,285.71 + $1,12,108.86 + $1,41,267.79 + i
$1,76,798.10 + $2,10,587.47
e l
Total Present Value = $7,30,048.93
D
(v) Compare Present Value to Current Value:
of
ty
Compare the total present value of $7,30,048.93 to the current value of

i
the business. If the current value is higher than the present value, there
s
may be value enhancement potential.
e r
i v
(vi) Identify Value Drivers and Enhancement Opportunities:

U n
Analyze the factors that contribute to the present value and identify
specific value drivers and enhancement opportunities. For example,

L ,
the start-up can focus on strategies to increase revenue, improve profit

O
margins, reduce operating costs, expand into new markets, or develop

/ S
innovative products or services to enhance future cash flows and increase

O L
the overall value of the business.
By applying the DCF Valuation Framework, we can assess the potential

/ C
value enhancement of the start-up based on the present value of its

C Eprojected cash flows. It provides a quantitative approach to understanding

D
the value of the business and identifies areas for improvement and value

©D
creation. However, it’s important to note that the accuracy of the valuation
depends on the quality of assumptions and forecasts used, as well as the
appropriateness of the discount rate applied.
2. Economic Value Added (EVA): EVA is a financial performance measure
that calculates the difference between a company’s net operating profit
after tax (NOPAT) and its cost of capital. It measures how effectively
a company generates profits above its required return. By focusing on

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 APPROACHES TO VALUATION

increasing NOPAT and managing the cost of capital, companies can enhance Notes
their EVA. This can involve initiatives such as improving operational
efficiency, optimizing capital structure, and investing in high-return projects.
Economic Value Added (EVA) is a financial metric used to assess the
value enhancement of a business by measuring its ability to generate
returns above its cost of capital. It is calculated by deducting the cost of
capital from the net operating profit after tax (NOPAT). Here’s a numerical
example to illustrate the calculation of EVA for value enhancement:

h i
l
(a) Calculate Net Operating Profit After Tax (NOPAT):
Let’s assume a company generated a net operating profit of $5,00,000
D e
of
in a given year, and the tax rate is 30%. Therefore, the NOPAT can be
calculated as follows:

ty
NOPAT = Net Operating Profit × (1 - Tax Rate)
NOPAT = $5,00,000 × (1 - 0.30) = $3,50,000
s i
(b) Determine the Cost of Capital:
e r
i v
The cost of capital represents the expected rate of return that investors
n
require for providing capital to the business. Let’s assume the cost of
U
,
capital for the company is 10%.

L
(c) Calculate the Economic Value Added (EVA):

O
S
EVA is calculated by deducting the cost of capital from the NOPAT:

L /
EVA = NOPAT - (Capital × Cost of Capital)

O
Assuming the company’s capital invested is $20,00,000, the EVA can be
C
calculated as follows:

E /
C
EVA = $3,50,000 - ($20,00,000 × 0.10) = $1,50,000

D
In this example, the positive EVA of $1,50,000 indicates that the company

©D
generated returns above its cost of capital, which implies value enhancement.
It suggests that the business is creating value for its shareholders by
earning profits that exceed the required return on invested capital.
EVA is a valuable metric for assessing the efficiency and value creation
of a business. It provides insights into whether a company is generating
returns that are above or below its cost of capital, thus indicating its
ability to enhance value. By continuously monitoring and improving the

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes EVA, a company can focus on strategies to increase profitability, optimize

capital allocation, and improve overall financial performance.
3. Cash Flow Return on Investment (CFROI): CFROI is a financial
metric that measures the return generated on invested capital. It compares
the net cash flows generated by an investment with the capital invested
in that investment. By analyzing the drivers of CFROI, businesses can
identify opportunities to enhance value. This can involve initiatives such
as optimizing capital allocation, improving asset utilization, and enhancing
cash flow generation.
h i
e l
4. Other Tools and Techniques: Various other tools and techniques can
be employed in the value enhancement process, including:
D
of
- Balanced Scorecard: This tool focuses on a balanced set of financial

ty
and non-financial performance metrics to align strategic goals with

i
operational activities and monitor progress towards value creation.

s
r
- Lean Six Sigma: This methodology aims to improve operational
e
v
efficiency and eliminate waste by reducing defects, cycle times,
and variability.
n i
, U
- Customer Relationship Management (CRM): By effectively managing
customer relationships, businesses can enhance customer satisfaction,
L
increase customer retention, and drive revenue growth.
O
/ S
- Pricing Optimization: Analyzing pricing strategies and optimizing

O L
pricing models can contribute to revenue enhancement and profitability
improvement.

/ C
- Supply Chain Optimization: Streamlining the supply chain, reducing

C E costs, improving delivery times, and enhancing inventory management

can generate value through increased operational efficiency.
D
©D
- Talent Management and Human Capital Development: Focusing
on attracting, developing, and retaining top talent can enhance
organizational capabilities and drive long-term value creation.

146 PAGE
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APPROACHES TO VALUATION

IN-TEXT QUESTIONS Notes

1. What is the valuation method that compares a company’s share

price to its earnings per share?
(a) Market capitalization
(b) Price/Earnings ratio
(c) Discounted Cash Flow (DCF)
(d) Enterprise Value (EV)

h i
2. Which of the following factors can affect the valuation of
e l
D
shares?

of
(a) Company’s financial performance
(b) Market conditions
(c) Industry comparables
i ty
(d) All of the above
r s
v e
3. What does EPS stand for in the context of share valuation?
(a) Earnings per share
n i
(b) Enterprise value per share
, U
(c) Equity price per share

O L
S
(d) Estimated profit per share

L /
4. Which valuation approach considers the estimated price at which

O
an asset or business would change hands between a willing

C
/
buyer and a willing seller?

E
(a) Market approach

C
D
(b) Income approach

©D
(c) Asset approach
(d) Cost approach
5. Which of the following is an example of an intangible asset?
(a) Inventory
(b) Machinery
(c) Trademark
(d) Land

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 6. How can the value of intangible assets be determined?

(a) Based on their book value
(b) Through market capitalization
(c) By estimating future cash flows
(d) Using industry comparables
7. Which valuation method is commonly used for valuing intangible
assets such as patents or trademarks?

h i
(a) Income approach
e l
(b) Cost approach
D
of
(c) Market approach
(d) Discounted Cash Flow (DCF)

i ty
8. What does the term “brand value” refer to in the context of
intangible asset valuation?
r s
v e
(a) The monetary value of a company’s physical assets

n i
(b) The estimated value of a company’s brand name and
reputation

, U
L
(c) The market value of a company’s outstanding shares

O
(d) The discounted value of a company’s projected cash flows
S
/
9. What is a common challenge in valuing private companies?
L
CO
(a) Lack of publicly available financial information

E / (b) Inconsistent financial reporting standards

C
(c) Limited access to industry comparables

DD
(d) All of the above
10. Which valuation method is often used for valuing private
© companies based on the prices paid for comparable transactions?
(a) Market approach
(b) Income approach
(c) Asset approach
(d) Cost approach

148 PAGE
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APPROACHES TO VALUATION

Notes
11. What is meant by the term “control premium” in the valuation
of private companies?
(a) Additional value paid to acquire a controlling stake in a
company
(b) Reduction in value due to lack of liquidity
(c) Adjustment for negative earnings
(d) Increase in value due to favourable market conditions

h i
12. Which of the following factors may be considered when valuing
e l
D
a private company?

of
(a) Revenue growth potential
(b) Market share
(c) Management team
i ty
(d) All of the above
r s
v e
13. When valuing a firm with negative earnings, what is an important
consideration?
n i
(a) Future growth prospects

, U
L
(b) Historical financial performance

O
(c) Comparable company analysis
S
/
(d) Market capitalization
L
O
14. Which valuation approach is often used for firms with negative

C
/
earnings based on their potential future cash flows?

E
(a) Discounted Cash Flow (DCF)
C
D
(b) Price/Earnings ratio

©D
(c) Book value
(d) Comparable company analysis
15. What is a possible challenge in valuing firms with negative
earnings?
(a) Difficulty in projecting future cash flows
(b) Lack of industry comparables

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes (c) Inconsistent financial reporting

(d) All of the above
16. What is a common valuation method used for start-up firms
with limited operating history?
(a) Market capitalization
(b) Discounted Cash Flow (DCF)

i
(c) Price/Earnings ratio
(d) Comparable company analysis
l h
e
17. Which of the following factors are often considered when
D
of
valuing start-up firms?
(a) Industry growth potential

ty
(b) Management team and expertise
(c) Unique value proposition
s i
(d) All of the above
e r
i v
18. What is meant by the term “venture capital valuation”?

U n
(a) Valuing publicly traded companies

(IPOs)
L ,
(b) Valuing Private Companies for Initial Public Offerings

S O
/
(c) Valuing start-up companies for investment purposes

O L
(d) Valuing firms with negative earnings
19. Which of the following may be used as a valuation metric for

/ C start-up firms?

CE
(a) Revenue multiples

DD
(b) Earnings per share

©
(c) Book value per share
(d) Market capitalization
20. What does value enhancement aim to achieve?
(a) Increasing a company’s market share
(b) Maximizing profitability
(c) Improving operational efficiency
(d) All of the above

150 PAGE
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 APPROACHES TO VALUATION

5.5 Summary Notes

Valuation is the process of determining the financial value of an asset or

a business. Several approaches are used to conduct valuations.
The market approach involves comparing the asset or business to similar
ones that have recently been sold in the market. This approach relies on
market-based indicators such as price-to-earnings ratios or sales multiples.
By examining comparable transactions, the market approach seeks to
derive a value based on prevailing market conditions.
h i
The income approach focuses on the expected future income or cash flows
e l
generated by the asset or business. It utilizes methods such as Discounted
D
of
Cash Flow (DCF) analysis, which calculates the present value of projected
future cash flows, and capitalization of earnings, which determines value
based on the anticipated income generated. By evaluating the income-
i ty
s
generating potential, the income approach provides insights into the value
of the asset or business.
e r
i v
The asset approach centers on the underlying assets of the entity being

U n
valued. It considers the net value of the assets after deducting liabilities.
The cost approach is a method within this approach, which calculates

L ,
value based on the cost to replace or reproduce the assets. Alternatively,

O
the liquidation approach assumes the assets would be sold individually,

S
/
determining their value based on this assumption. The asset approach is

O L
particularly relevant when the value of the assets is significant or when
the entity is not expected to generate substantial future income.

/ C
Valuation approaches may be used individually or in combination,
E
depending on the specific circumstances and purpose of the valuation.
C
D
The choice of approach depends on the nature of the asset or business

©D
being valued and the availability and reliability of data. By employing
appropriate valuation approaches, stakeholders can make informed decisions
regarding investments, acquisitions, financial reporting, or other financial
transactions.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes 5.6 Answers to In-Text Questions

1. (b) Price/Earnings ratio

2. (d) All of the above
3. (a) Earnings per share
4. (a) Market approach
5. (c) Trademark
6. (c) By estimating future cash flows
7. (a) Income approach
h i
8. (b)
e l
The estimated value of a company’s brand name and
reputation
D
of
9. (d) All of the above
10. (a) Market approach
11. (a)
ty
Additional value paid to acquire a controlling stake in a
i
company
r s
e
12. (d) All of the above
13. (a)
i v
Future growth prospects
14.
15.
(a)
(d)
U n
Discounted Cash Flow (DCF)
All of the above
16. (b)
L ,
Discounted Cash Flow (DCF)
17. (d)

S O
All of the above

/
18. (c) Valuing start-up companies for investment purposes

O
19.
20. L
(a)
(d)
Revenue multiples
All of the above
C
/ References
C E5.7

DD
‹ International Valuation Standards Council (IVSC): https://www.ivsc.

©
org/
‹ Financial Accounting Standards Board (FASB): https://www.fasb.org/
‹ American Society of Appraisers (ASA): https://www.appraisers.org/
‹ National Association of Certified Valuators and Analysts (NACVA):
https://www.nacva.com/
‹ CFA Institute: https://www.cfainstitute.org/
‹ Financial Times (FT): https://www.ft.com/

152 PAGE
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APPROACHES TO VALUATION

‹ Angel Capital Association (ACA): https://www.angelcapitalassociation. Notes

org/
‹ Venture Capital Association (NVCA): https://nvca.org/
‹ Harvard Business Review (HBR): https://hbr.org/
‹ McKinsey & Company: https://www.mckinsey.com/

5.8 Suggested Readings

h i
‹ Lev, B., Petrovits, C., & Radhakrishnan, S. (2010). Is doing good,
good for you? How corporate charitable contributions enhance
e l
revenue growth. Strategic Management Journal, 31(2), 182-200.
D
‹ Damodaran, A. (2015). The Dark Side of Valuation: Valuing Young,
of
ty
Distressed, and Complex Businesses (3rd ed.). Pearson.
‹

s i
Pratt, S. P., Reilly, R. F., & Schweihs, R. P. (2017). Valuing a

e r
Business: The Analysis and Appraisal of Closely Held Companies
(6th ed.). McGraw-Hill Education.
i v
‹
of Approaches.
U n
Mercer Capital. (2021). Valuing Private Companies: A Comparison

‹
L ,
Damodaran, A. (2017). Narrative and Numbers: The Value of Stories

O
in Business. Columbia University Press.

S
‹

L /
Aswath Damodaran’s blog: http://aswathdamodaran.blogspot.com/

O
‹ Ries, E. (2011). The Lean Startup: How Today’s Entrepreneurs Use

C
Continuous Innovation to Create Radically Successful Businesses.
/
E
Crown Business.
‹

D C
Blank, S. G., & Dorf, B. (2012). The Startup Owner’s Manual: The
Step-by-Step Guide for Building a Great Company. K&S Ranch.

©D
‹ McKinsey & Company. (2014). Valuation: Measuring and Managing
the Value of Companies (6th ed.). Wiley.
‹ Bennett Stewart, G. (1990). The Quest for Value: A Guide for Senior
Managers. Harper Business.

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© Department of Distance & Continuing Education, Campus of Open Learning,
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 Glossary
Amalgamation: It refers to a situation where a new company comes into existence because
of merger.
Book Value: The value of a company’s assets minus its liabilities, as reported on the
balance sheet. It represents the net worth of a company and can be used as a baseline
for valuing shares.

h i
Comparable Company Analysis (CCA): A valuation method that compares the financial
e l
ratios, multiples, and operating metrics of a company to those of similar publicly traded
D
of
companies. It helps determine the relative value of a company’s shares.
Control Premium: An additional amount paid to acquire a controlling stake in a company,

ty
reflecting the increased value and influence associated with control over the decision-
making processes.
s i
e r
Discounted Cash Flow (DCF): A valuation method that estimates the intrinsic value of a

i v
company by projecting its future cash flows and discounting them back to present value.
It considers the time value of money.

U n
Earnings Per Share (EPS): The portion of a company’s profit allocated to each outstanding

L ,
share of common stock. It is calculated by dividing the company’s net income by the
number of outstanding shares.

S O
L /
Enterprise Value (EV): The total value of a company, including its equity value and debt,
minus its cash and cash equivalents. It represents the cost of acquiring the entire business,
O
including its shareholders’ equity and debt obligations.
C
/
Fair Market Value: The estimated price at which an asset or business would change
E
C
hands between a willing buyer and a willing seller, both having reasonable knowledge of

D
the relevant facts and neither being under compulsion to buy or sell.

©D
Financial Restructuring: It is the process of reorganizing the company by affecting major
changes in ownership pattern, asset mix, operations which are outside the ordinary course
of business.
Internal Reconstruction: Internal Reconstruction is an arrangement made by the companies
whereby the claims of shareholders, debenture holders, creditors and other liabilities are
altered/reduced, so that the accumulated loss are written off, asset are valued at its fair
price.

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 MBAFT 7414 MERGERS AND CORPORATE RESTRUCTURING

Notes Leveraged Buyout: Leveraged buyout represents transfer of an ownership

consummated heavily with debt.
Leveraged Recapitalization: It is a process of raising funds through
increased leverage and using the cash so raised to distribute to equity
owners.
Liquidity Discount: A reduction in the valuation of illiquid shares or
businesses due to the lack of ready buyers or sellers in the market. It

i
accounts for the difficulty of converting the investment into cash quickly.
Market Capitalization: The total value of a company’s outstanding
l h
e
shares, calculated by multiplying the current market price per share by
D
of
the total number of shares outstanding.
Minority Discount: A reduction in the valuation of a minority stake in

ty
a company, reflecting the lack of control and influence compared to a

i
controlling interest. It accounts for the limited ability to affect major
s
decisions.
e r
i v
Post-money Valuation: The value of a company or business after a new

U
the additional funds invested. n
investment or financing round. It includes the pre-money valuation plus

L ,
Pre-money Valuation: The value of a company or business before a new

O
investment or financing round. It represents the company’s total worth

/ S
before accounting for the new funds injected.

O L
Price/Earnings (P/E) Ratio: A valuation ratio that compares a company’s
share price to its earnings per share. It is calculated by dividing the

/ C
market price per share by the earnings per share.

C EShare Valuation: The assessment of the value of a company’s shares

D
based on various factors such as financial performance, market conditions,

©D
growth potential, and industry comparables.
Spin-offs: Spin-offs involve creation of a new, independent company by
detaching part of a parent company’s assets and operations.
Takeover: Takeover is the purchase by one company of a controlling
interest in the share capital of another existing company.
Valuation: The process of determining the worth or fair value of a
company, business, or its shares.

156 PAGE
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