Legal Analysis of Demerger in Corporate

Narendra Kumar

01 Jul, 2021

Companies may often reorganize and restructure their operations to perform various business activities in more focused way. The operational reorganization or restructuring of their operations can be done for different reasons and may have various objectives as well. In this article, we shall analyse Demerger in Corporate.

What is Demerger?

A demerger^[1] is a strategy in which a single business is broken into different subunits, either to operate on their own, to be sold or to be dissolved. A de-merger allows a large company to split off its various units to invite or prevent an acquisition, to raise funds by selling off its units that are no longer part of the business’s core line, or to create separate units to handle different operations.

E.g. In early 2001, British Telecom led a de-merger of its mobile phone unit, BT Wireless, in an attempt to increase the performance of its stock. British Telecom took this action because it was struggling under high debt levels from the wireless venture.

Reasons for Demergers

A company may demerge due to the following reasons:

• To adjust to the changing political as well as economic environment of the country.
• Corporate restructuring allows exploiting the opportunities effectively to optimize the use of the resources when the parent company is unable to do so.
• If the company has got engaged in a business without any expertise or any experience and has not been able to earn any profits.
• When a company is planning for acquisition but lacks finances, then they go for demerger to generate resources.
• To realize capitals gains out of assets that are underperforming.
• To develop more profitable opportunities by restructuring financial as well as managerial resources available.
• Demerger of a company assists in selling unwanted, surplus or unconnected parts of the business. In this way, one can get rid of the sick part of the company.

Advantages of Demerger

Some of the advantages of demerger have been listed below:

• Focus on Core Competency:Conglomerate companies are known for not having focused business operations. These companies manage various diverse operations which need different competencies. In many cases, these companies lose to competitors who have a single-minded focus on any one line of business. The modern business environment is more about specialization. It is because of that it is necessary that companies should focus on their core competencies. This reasoning has caused many conglomerates to streamline their functioning, and demerger has been an essential tool used in the process.
• Management Accountability:When companies are split, the management of every company has its own balance sheet. Therefore, it is not possible for certain entities in the group to live off the earnings of other entities. The management of every company becomes accountable for their own financial results. Also, the management tends to have more control over their operations. They have the right to make their own investments and raise funds from the market on their own account.
• Increase in Market Capitalization:In some instances, demergers are used to create stock market value. Investors have increased visibility over the operations and over the cash flow of a firm that has been spun off. This allows them to make better investment decisions. Investors are ready to pay a premium for this better information. Therefore, spinning off units to form separate legal entities result in increased market capitalization for the group as a whole.

Conclusion

It is now a just and precise statement to give that, nowadays demergers are a common term involved with corporate restructuring. A demerged company refers to the one whose undertakings are transferred to the other company, and the company to which such undertakings are transferred is called as resulting company. The demerger can take place in any of the forms like spin off and split up.