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Strategic Management

Notes The parent company may sell a 100% interest in subsidiary company or it may choose to
remain in the subsidiary's line of business by selling only a partial interest (shares) and
keeping the remaining percentage of ownership. After the sale of shares to the public, the
subsidiary company's shares will be listed and traded separately in the capital market.
The parent company receives cash from the sale of shares of the subsidiary company. The
parent company may still control the company by holding controlling interest in the
subsidiary.
Many firms look to equity carveouts as a means of reducing their exposure to a riskier line
of business. They also help to raise funds for the parent company.

Notes Spin-offs vs. Equity Carveouts

The following are the differences between the spin-offs and equity carveouts:
1. In case of spin-off, there is no new set of shareholders. The same shareholders in the
parent company become shareholders in the spun-off company.

In case of equity carveouts, there will be new shareholders as shares are sold to the
public.
2. In case of spin-off, there is no cash inflow to the parent company. The shareholders
of the parent company are allotted free shares in the new company.
In case of equity carveouts, as the shares of the subsidiary company are sold to the
public, this results in cash inflow to the parent company.
3. In case of spin-off, there is a formation of a new company.
In case of equity carveouts, there is no new company that comes into existence. Here the
shares of a subsidiary company are now offered to the public for sale.
5. Leveraged buyouts (LBO's): A leveraged buyout is an acquisition of a company in which
the acquisition is substantially financed through debt. Debt typically forms 70-90% of the
purchase price. Much of the debt may be secured by the assets of the company (asset based
lending). Firms with assets that have a high collateral value can more easily obtain such
loans. So LBOs are generally found in capital intensive industries. Debt is obtained on the
basis of company's future earnings potential.

In LBOs, a buyer generally looks for a company with high growth rate and good market
share. The company should be profitable and the demand for the product should be
known and stable, so that the earnings can be forecasted. The company should have low
debt and its liquidity position should be very good. Low operating risk of such companies
allows the acquisition with high degree of financial leverage and risk.
The lender is prepared to lend even if the company is highly leveraged because he has full
confidence in the abilities of buyer to fully utilise the potential of the business and convert
it into an enormous value. He also charges high rate of interest for the loan as it involves
high risk.

7.2.3 Bankruptcy

This is a form of defensive strategy. It allows organisations to file a petition in the court for legal
protection to the firm, in case the firm is not in a position to pay its debts. The court decides the
claims on the company and settles the corporation's obligations.

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