Unit 2: Demergers, LBOs and valuation

• Demerger: transfer of one or more undertakings of a company to a resulting company, with the resulting company's shares issued to the demerged company's shareholders (defined in the Income-tax Act for tax neutrality).
• Reasons: unlock value, sharpen focus, separate businesses with different risk profiles, enable separate fund raising, resolve family succession.
• Process: scheme under Sections 230–232 of the Companies Act — board approval, shareholder and creditor meetings, NCLT sanction, listing of the resulting company.

• Reverse merger: a smaller or loss-making company acquires (or a parent merges into) a larger or profitable one, or an unlisted company merges into a listed shell to obtain listing.
• Motives: use accumulated losses for tax benefit (subject to conditions), quicker listing, simplify structure.

• Companies Act, Section 68: buy-back up to 25% of paid-up capital and free reserves (equity buy-back limited to 25% of paid-up equity in a year); debt–equity ratio not more than 2:1 after buy-back; funded from free reserves, securities premium or proceeds of a different issue.
• Methods: tender offer (proportionate), open market (stock exchange), odd-lot buy-back (SEBI Buy-back Regulations, 2018); open-market route being phased out.
• Reasons: return surplus cash, raise EPS and ROE, signal undervaluation, increase promoter holding, defend against takeover.
• Tax: since 1 October 2024, buy-back proceeds are taxed as dividend in shareholders' hands.

• Structuring issues: contributions and ownership, governance and control, profit sharing, IP rights, dispute resolution, exit clauses.
• Success factors: complementary strengths, trust, clear goals, compatible cultures, active alliance management.

• LBO: acquisition financed largely with debt, secured on the target's assets and cash flows; often by private equity; MBO when the management team buys the business.
• Characteristics of good LBO targets: stable and predictable cash flows, low existing debt, strong market position, saleable assets, scope for efficiency gains, capable management.

• Value creation: debt repayment from cash flows, operational improvement, multiple expansion; exit by IPO or sale after 4–7 years.
• Risks: high leverage in downturns, financial distress.

• Insolvency and Bankruptcy Code: default of ₹1 crore triggers CIRP; Committee of Creditors approves a resolution plan (66% vote); 330-day outer limit; IBBI regulates insolvency professionals.
• Outcomes: large recoveries in cases like Essar Steel and Bhushan Steel; challenges — delays, low recovery in many cases, haircuts.

Financial reconstruction reorganises the capital structure of a company in financial difficulty so that it can survive — involving shareholders and creditors.

• Capital reconstruction (non-distress): changes in capital such as consolidation, conversion, reduction of surplus capital.
• Insolvency and Bankruptcy Code, 2016: Corporate Insolvency Resolution Process — resolution plan approved by the Committee of Creditors (66%) and NCLT; else liquidation.

• Factors: strategic importance, control premium, synergies, competition among bidders, market conditions, target's growth and risk, form of payment, liabilities found in due diligence.

• Intangibles: brands, patents, technology, customer relationships, licences, goodwill.

• Accounting: identifiable intangibles are recognised separately at fair value in a business combination (Ind AS 103); the residual is goodwill, tested annually for impairment (Ind AS 36).