Analysis of Corporate Growth and Restructuring

TOPIC NINE
ANALYSIS OF CORPORATE GROWTH AND

RESTRUCTURING
Sustainable Growth
In simple terms and with reference to a business, sustainable growth is the realistically attainable
growth that a company could maintain without running into problems. A business that grows too
quickly may find it difficult to fund the growth. A business that grows too slowly or not at all
may stagnate. Finding the optimum growth rate is the goal. A sustainable growth rate (SGR) is
the maximum growth rate that a company can sustain without having to increase financial
leverage. In essence, finding a company's sustainable growth rate answers the question: how
much can this company grow before it must borrow money?
The models used to calculate sustainable growth assume that the business wants to: 1) maintain a
target capital structure without issuing new equity; 2) maintain a target dividend payment ratio;
and 3) increase sales as rapidly as market conditions allow. Since the asset to beginning of period
equity ratio is constant and the firm's only source of new equity is retained earnings, sales and
assets cannot grow any faster than the retained earnings plus the additional debt that the retained
earnings can support. The sustainable growth rate is consistent with the observed evidence that
most corporations are reluctant to issue new equity. If, however, the firm is willing to issue
additional equity, there is in principle no financial constraint on its growth rate. Indeed, the
sustainable growth rate formula is directly predicated on return on equity.
To calculate the sustainable growth rate for a company, one must know how profitable the
company is based on a measure of its return on equity (ROE). One must also know what
percentage of a company's earnings per share it pays out in dividends, which is called the
dividend-payout ratio. With these figures one can multiply the company's ROE by its plowback
ratio, which is equal to 1 minus the dividend-payout ratio. [Sustainable growth rate = ROE Ã—
(1—dividend-payout ratio). Just as the break-even point for a business is the 'floor' for minimum
sales required to cover operating expenses, the SGR is an estimate of the 'ceiling' for maximum
sales growth that can be achieved without exhausting operating cash flows. The SGR can be
thought of as a growth break-even point.
THE CHALLENGE OF ATTAINING SUSTAINABLE GROWTH
Creation of sustainable growth is a prime concern of small business owners and big corporate
executives alike. Obviously, however, achieving this goal is no easy task, given rapidly changing
political, economic, competitive, and consumer trends. Each of these trends presents unique
challenges to business leaders searching for the elusive grail of sustainable growth. Customer
expectations, for example, have changed considerably over the last few generations. Modern
consumers have less disposable wealth than their parents, which makes them more
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discriminating buyers. This fact, coupled with the legacy of a decade of quality and cost
reduction programs, means that companies must try to attract customers by redefining value and
keep those customers by beating their competitors in enhancing value. Similarly, competition is
keen in nearly all industries, which have seen unprecedented breakdowns in the barriers that
formerly separated them.
The growth challenge is articulated differently by different companies and within different
industries. For some, developing and launching new products and services to meet the evolving
needs of their customers is the issue. For others, capitalizing on global opportunities is key.
Some companies look to new business areas that will represent the next major thrust for their
business. And for a few companies, all of these strategic efforts are simultaneously used, along
with ongoing efforts to rebuild organizational capabilities.
Economists and business researchers contend that achieving sustainable growth is not possible
without paying heed to twin cornerstones: growth strategy and growth capability. Companies
that pay inadequate attention to one aspect or the other are doomed to failure in their efforts to
establish practices of sustainable growth (though short-term gains may be realized). After all, if a
company has an excellent growth strategy in place, but has not put the necessary infrastructure in
place to execute that strategy, long-term growth is impossible. The reverse is true as well.
USING THE SUSTAINABLE GROWTH RATE
The concept of sustainable growth can be helpful for planning healthy corporate growth. This
concept forces managers to consider the financial consequences of sales increases and to set sales
growth goals that are consistent with the operating and financial policies of the firm. Often, a
conflict can arise if growth objectives are not consistent with the value of the organization's
sustainable growth.
According to economists, if a company's sales expand at any rate other than the sustainable rate,
one or more of the basic business ratios must change. If a company's actual growth rate
temporarily exceeds its sustainable rate, the required cash can likely be borrowed. When actual
growth exceeds sustainable growth for longer periods, management must formulate a financial
strategy from among the following options: 1) sell new equity; 2) permanently increase financial
leverage (i.e, take on more debt); 3) reduce dividends; 4) increase the profit margin; or 5)
decrease the percentage of total assets to sales.
In practice, companies are often reluctant to undertake these measures. Firms dislike issuing
equity because of high issue costs, possible dilution of earnings per share, and the unreliable
nature of equity funding on terms favorable to the issuer. A firm can only increase financial
leverage if there are assets that can be pledged and if its debt-to-equity ratio is reasonable in
relation to its industry. The reduction of dividends typically has a negative impact on the
company's stock price. Companies can attempt to liquidate marginal operations, increase prices,
or enhance manufacturing and distribution efficiencies to improve the profit margin. In addition,
firms can source more activities from outside vendors or rent production facilities and
equipment, which has the effect of improving the asset turnover ratio. Increasing the profit
margin is difficult, however, and large sustainable increases may not be possible. Therefore, it is

possible for a firm to grow too rapidly, which in turn can result in reduced liquidity and the
unwanted depletion of financial resources.
The sustainable growth model is particularly helpful in situations in which a borrower requests
additional financing. The need for additional loans creates a potentially
potentially risky situation of too
much debt and too little equity. Either additional equity must be raised or the borrower will have
to reduce the rate of expansion to a level that can be sustained without an increase in financial
leverage.
Mature firms often have

ave actual growth rates that are less than the sustainable growth rate. In
these cases, management's principal objective is finding productive uses for the cash flows that
exist in excess of their needs. Options available to business owners and executives in such cases
include returning the money to shareholders through increased dividends or common stock
repurchases, reducing the firm's debt load, or increasing possession of lower earning liquid
assets. Note that these actions serve to decrease the sustainable
sustainable growth rate. Alternatively, these
firms can attempt to enhance their actual growth rates through the acquisition of rapidly growing
companies.
Measures of Profitability
Although the income statement allows us to estimate how profitable a firm is in absolute terms, it
is just as important that we gauge the profitability of the firm in comparison terms or percentage
returns. The simplest and most useful gauge of profitability is relative to the capital employed to
get a rate of return on investment. This
This can be done either from the viewpoint of just the equity
investors or by looking at the entire firm.
I. Return on Assets (ROA) and Return on Capital (ROC)
The return on assets (ROA) of a firm measures its operating efficiency in generating
profits from its assets, prior to the effects of financing.
Earnings before interest and taxes (EBIT) is the accounting measure of operating income from
the income statement, and total assets refers to the assets as measured using accounting rules,
that is, using book value for most assets. Alternatively, ROA can be written as

By separating the financing effects from the operating effects, the ROA provides a cleaner
measure of the true return on these assets.
ROA can also be computed on a pretax basis with no loss of generality, by using the
EBIT and not adjusting for taxes:
This measure is useful if the firm or division is being evaluated for purchase by an acquirer with
a different tax rate or structure.
A more useful measure of return relates the operating

operating income to the capital invested in
the firm, where capital is defined as the sum of the book value of debt and equity, net of cash and
marketable securities. This is the return on capital (ROC). When a substantial portion of the
liabilities is either current (such as accounts payable) or non–interest-bearing,
non bearing, this approach
provides a better measure of the true return earned on capital employed in the business.
The ROC of a firm can be written as a function of its operating profit margin and its
capital turnover ratio:

Thus, a firm can arrive at a high ROC by either increasing its profit margin or more efficiently
using its capital to increase sales. There are likely to be competitive and technological constraints
on increasing sales, but firms
ms still have some freedom within these constraints to choose the mix
of profit margin and capital turnover that maximizes their ROC. The return on capital varies
widely across firms in different businesses, largely as a consequence of differences in profi
profit
margins and capital turnover ratios.
II. Return on Equity
Although ROC measures the profitability of the overall firm, the return on equity (ROE)
examines profitability from the perspective of the equity investor by relating profits to the equity
investor
tor (net profit after taxes and interest expenses) to the book value of the equity investment.
Because preferred stockholders have a different type of claim on the firm than common
stockholders, the net income should be estimated after preferred dividends, and the book value of
common equity should not include the book value of preferred stock.
Common
ommon reasons for restructuring
There are several reasons you may have to reorganize the operations and other structures of the
organization. Restructuring a company can improve efficiency, keep technology up to date, or
implement strategic or governance changes
changes made by, or mandated to, company owners.
1. Changed Nature of Business

In today’s business environment, the only constant is change. Companies that refuse to change
with the times face the risk of their product line becoming obsolete. Because of th
this, businesses
experiment with new products, explore new markets, and reach out to new groups of customers
on a continuous basis. Businesses seek to diversify into new areas to increase sales, optimize
their capacity, and conversely shed off divisions that do not add much value, to concentrate on
core competencies instead.

All such initiatives require restructuring. For instance, expansion to an overseas market may
require changes in the staff profile to better connect with the international market, and changes in
work policies and routines to ensure compliance with export regulations. Starting a new product
line may require changes in the system of work, hiring new experts familiar in the business line
and placing them in positions of authority, and other interventions. Hiving off unprofitable or
unneeded business lines may require changes to retain specific components of such divisions that
the main business may wish to retain.
2. Downsizing
One common reason for restructuring a company is to downsize the workforce. The changing
nature of economy may force the business to adopt new strategies or alter their product mix,
making staff redundant. Similarly, cutthroat competition and pressure on margins from
competitors who adopt a low price strategy may force the company to adopt lean techniques, just
in time inventory, and other measures to cut input costs and achieve process efficiency.
In such situations, the organization will need to redo job descriptions, rework its team, group,
and communication structures and reporting relationships to ensure that the remaining workforce
does the job well. Very often, downsizing-induced restructuring leads to a flatter organizational
structure, and broader job descriptions and duties.
3. New Work Methods

Traditional organizational systems and controls cater to standard 9 AM to 5 PM office or factory
based work. Newer methods of work, especially outsourcing, telecommuting, and flex time
require new systems, policies, and structures in place, besides a change in culture, and such
requirements may trigger organizational restructuring
The presence of telecommuting employees, temporary employees, and outsourcing work may
require a drastic overhaul of performance management parameters, compensation and benefits
administration, and other vital systems. The newer work methods may, for instance, require
placing emphasis on the results rather than the methods, flexible reporting relationships, and a
strong communication policy.
4. New Management Methods

Traditional management science recommends highly centralized operations, and the top
management adopting a command and control style. The new behavioral approach to
management considers human resources a key driver of strategic advantage, and focuses on
empowering the workforce and providing considerate leeway to line managers in conducting
day-to-day operations. The top management intervenes only to set strategy and ensure
compliance; strategic business units receive autonomy in functioning.
Traditional management structures were bureaucratic and hierarchical. Of late, management
experts see wisdom in flatter organizations with wider roles and responsibilities for each member
of the team. Job flexibility, enlargement and enrichment are key features of such new structures,
but successful implementation requires changes in the communication and reporting structures of

the organization. While new organizations can start with such new paradigms, old organizations
have to restructure themselves to keep up with these best practices to remain competitive.
5. Quality Management
Competitive pressures force most companies to have a serious look at the quality of their
products and services, and adopt quality interventions such as Six Sigma and Total Quality
Management. Implementing new quality standards may require changes in the organization.
Most of the new quality applications strive to imbibe quality in the actual work process rather
than maintain a separate quality control department to accept or reject output based on quality
specifications.
In many cases, an organizational level audit precedes quality interventions, and such audits
highlight inefficiencies in the organizational structure that may impede quality in the first place.
For instance, reducing waste may require eliminating certain processes, and thereby reallocation
of personnel undertaking such activities.
6. Technology
Innovations in technology, work processes, materials and other factors that influence the
business, may require restructuring to keep up with the times. For instance, enterprise resource
planning that links all systems and procedures of an organizational by leveraging the power of
information technology may initially require a complete overhaul of the systems and procedures
first.
Such technology-centric change may be part of a business process engineering exercise that
involves redesigning the business processes to maximize potential and value added, while
minimizing everything else. Failure to do so may result in the company systems and procedures
turning obsolete and discordant with the times.
7. Mergers and Acquisitions

In today’s corporate world, where survival of the fittest is the maxim, mergers and acquisitions
are commonplace and any merger or acquisition invariably heralds a restructuring exercise. The
reasons for such restructuring accompanying mergers and acquisitions are many. Some of the
common reasons are:
 Reconciling the systems and procedures of the merged organizations to ensure that the new
entity has consistency of approach.
 Eliminating duplication of work or systems, such as two human resource or finance
departments.
 Incorporating the preferences of the new owners, and more.
Joint ventures may also require formation of matrix teams, special task forces, or a new
subsidiary.
8. Finance Related Issues

Very often, small and medium scale businesses have informal structures and reporting
relationships, and an ad-hoc style of decision-making. When such companies grow and want to

raise fresh funds, venture capitalists and regulations might demand a more professional set up,
with formal written-down structures and policies. A listed company may undertake a
restructuring exercise to improve its efficiency and unlock hidden value, and thereby show more
profits to attract fresh investors.
Bankruptcy may force the business to shed excess flab such as workforce, land, or other
resources, sell some business lines to raise cash, and become lean and mean, to attract bail-outs
or some other rescue package. Companies may try to restructure out of court to avoid the high
costs of a formal bankruptcy.
9. Buy Outs
At times, the restructuring exercise may be the result of the whims and fancies of the owners. For
instance, the company may have a new owner who wants to stamp his or her personal authority
and style onto the business. Restructuring allows the new owner to:
 Reshuffle key personnel and provide power to trusted lieutenants.
 Start with a clean state and thereby exert greater control.
 Preempt any inefficiencies that caused the previous owner to sell-out, and more.
With or without ownership change acting as a trigger, company owners may appoint a
management consultant to review the company and suggest macro-level changes, as a routine
exercise.
10. Statutory and Legal Compliance

At times, restructuring may be a forced exercise, to conform to some legal or statutory
requirements. For instance, the government may mandate financial and healthcare institutions
that deal with sensitive personal data to monitor their computer networks. A new bill may require
that private computer networks adopt the same security measures that government networks
adopt, to gain immunity from liability lawsuits in the eventuality of cyber attacks.
Any organizational restructuring is basically a change initiative. Success depends on managing
resistance to change by convincing the remaining workforce of the need for change and the
possible benefits, an effective communication system to lend clarity to the change process, and
effective leadership.
Absolute and relative return
Knowing whether a fund manager or broker is doing a good job can be a challenge for some
investors. It's difficult to define what good is, because it depends on how the rest of the market
has been performing. For example in a bull market, 2% is a horrible return. But in a bear market,
when most investors are down 20%, just preserving your capital would be considered a triumph.
In that case, 2% doesn't look so bad.
So, the absolute return is simply whatever an asset or portfolio returned over a certain period. In
the paragraph above, the 2% we mentioned would be the absolute return. If a mutual fund

returned 8% last year, then that 8% would be its absolute return. Pretty simple stuff.
Relative return, on the other hand, is the difference between the absolute return and the
performance of the market (or other similar investments), which is gauged by a benchmark, or
index, such as the S&P 500. Relative return is the reason why a 2% return is bad in a bull market
and good in a bear market. (If you aren't familiar with indexes, read more on them in our Index
Investing tutorial).
Relative return is important because it is a way to measure the performance of actively managed
funds, which should get a return greater than that of the market. After all, you can always buy an
index fund that has a low management expense ratio (MER) and will guarantee the market
return. If you're paying a manager to perform better than the market and the investment doesn't
have a positive relative return over a long period of time, it may be worth your time shopping
around for a new fund manager.
Absolute return does not say much on it's own. You need to look at the relative return to see how
an investment's return compares to other similar investments. Once you have a comparable
benchmark in which to measure your investment's return, you can then make a decision of
whether your investment is doing well or poorly and act accordingly. (For further reading on
returns, check out our article The Truth Behind Mutual Fund Returns.)
Valuation and analysis of corporate restructuring
A leveraged buyout (LBO) is a transaction when a company or single asset (e.g., a real estate
property) is purchased with a combination of equity and significant amounts of borrowed money,
structured in such a way that the target's cash flows or assets are used as the collateral (or
"leverage") to secure and repay the borrowed money. Since the debt (be it senior or mezzanine)
has a lower cost of capital (until bankruptcy risk reaches a level threatening to the lender[s]) than
the equity, the returns on the equity increase as the amount of borrowed money does until the
perfect capital structure is reached. As a result, the debt effectively serves as a lever to increase
returns-on-investment.
The term LBO is usually employed when a financial sponsor acquires a company. However,
many corporate transactions are partially funded by bank debt, thus effectively also representing
an LBO. LBOs can have many different forms such as management buyout (MBO), management
buy-in (MBI), secondary buyout and tertiary buyout, among others, and can occur in growth
situations, restructuring situations, and insolvencies. LBOs mostly occur in private companies,
but can also be employed with public companies (in a so-called PtP transaction – Public to
Private).
As financial sponsors increase their returns by employing a very high leverage (i.e., a high ratio
of debt to equity), they have an incentive to employ as much debt as possible to finance an
acquisition. This has, in many cases, led to situations, in which companies were "over-
leveraged", meaning that they did not generate sufficient cash flows to service their debt, which
in turn led to insolvency or to debt-to-equity swaps in which the equity owners lose control over
the business and the debt providers assume the equity.

Characteristics
LBOs have become very attractive as they usually represent a win-win situation for the financial
sponsor and the banks: the financial sponsor can increase the rate of returns on his equity by
employing the leverage; banks can make substantially higher margins when supporting the
financing of LBOs as compared to usual corporate lending, because the interest chargeable is
that much higher.
The amount of debt banks are willing to provide to support an LBO varies greatly and depends,
among other things, on:
 The quality of the asset to be acquired (stability of cash flows, history, growth prospects,
hard assets, etc.)
 The amount of equity supplied by the financial sponsor
 The history and experience of the financial sponsor
 The overall economic environment
For companies with very stable and secured cash flows (e.g., real estate portfolios with rental
income secured with long-term rental agreements), debt volumes of up to 100% of the purchase
price have been provided. In situations of "normal" companies with normal business risks, debt
of 40–60% of the purchase price are usual figures. The possible debt ratios vary significantly
among the regions and the target industries.
Depending on the size and purchase price of the acquisition, the debt is provided in different
tranches.
 Senior debt: This debt is secured with the assets of the target company and has the lowest
interest margins
 Junior debt (usually mezzanine): this debt usually has no securities and thus bears higher
interest margins
In larger transactions, sometimes all or part of these two debt types is replaced by high yield
bonds. Depending on the size of the acquisition, debt as well as equity can be provided by more
than one party. In larger transactions, debt is often syndicated, meaning that the bank who
arranges the credit sells all or part of the debt in pieces to other banks in an attempt to diversify
and hence reduce its risk. Another form of debt that is used in LBOs are seller notes (or vendor
loans) in which the seller effectively uses parts of the proceeds of the sale to grant a loan to the
purchaser. Such seller notes are often employed in management buyouts or in situations with
very restrictive bank financing environments. Note that in close to all cases of LBOs, the only
collateralization available for the debt are the assets and cash flows of the company. The
financial sponsor can treat their investment as common equity or preferred equity among other
types of securities. Preferred equity can pay a dividend and has payment preferences to common
equity.
As a rule of thumb, senior debt usually has interest margins of 3–5% (on top of Libor or Euribor)
and needs to be paid back over a period of 5 to 7 years, junior debt has margins of 7–16%, and

needs to be paid back in one payment (as bullet) after 7 to 10 years. Junior debt often
additionally has warrants and its interest is often all or partly of PIK nature.
In addition to the amount of debt that can be used to fund leveraged buyouts, it is also important
to understand the types of companies that private equity firms look for when considering
leveraged buyouts.
While different firms pursue different strategies, there are some characteristics that hold true
across many types of leveraged buyouts:
 Stable cash flows - The company being acquired in a leveraged buyout must have
sufficiently stable cash flows to pay its interest expense and repay debt principal over
time. So mature companies with long-term customer contracts and/or relatively
predictable cost structures are commonly acquired in LBOs.
 Relatively low fixed costs - Fixed costs create substantial risk for Private Equity firms
because companies still have to pay them even if their revenues decline.
 Relatively little existing debt - The "math" in an LBO works because the private equity
firm adds more debt to a company's capital structure, and then the company repays it over
time, resulting in a lower effective purchase price; it's tougher to make a deal work when
a company already has a high debt balance.
 Valuation - Private equity firms prefer companies that are moderately undervalued to
appropriately valued; they prefer not to acquire companies trading at extremely high
valuation multiples (relative to the sector) because of the risk that valuations could
decline.
 Strong management team - Ideally, the C-level executives will have worked together for
a long time and will also have some "skin in the game" by participating in the LBO by
rolling over their shares when the deal takes place.
Divestment/ Divestiture
In finance and economics, divestment or divestiture is the reduction of some kind of asset for financial,
ethical, or political objectives or sale of an existing business by a firm. A divestment is the opposite of an
investment.
Motives
Firms may have several motives for divestitures:
1. A firm may divest (sell) businesses that are not part of its core operations so that it can
focus on what it does best. For example, Eastman Kodak, Ford Motor Company, Future
Group and many other firms have sold various businesses that were not closely related to
their core businesses.
2. To obtain funds. Divestitures generate funds for the firm because it is selling one of its
businesses in exchange for cash. For example, CSX Corporation made divestitures to

focus on its core railroad business and also to obtain funds so that it could pay off some
of its existing debt.
3. A firm's "break-up" value is sometimes believed to be greater than the value of the firm
as a whole. In other words, the sum of a firm's individual asset liquidation values exceeds
the market value of the firm's combined assets. This encourages firms to sell off what
would be worth more when liquidated than when retained.
4. Divesting a part of a firm may enhance stability. Philips, for example, divested its chip
division - NXP - because the chip market was so volatile and unpredictable that NXP was
responsible for the majority of Philips's stock fluctuations while it represented only a very
small part of Philips NV.
5. Divesting a part of a company may eliminate a division which is under-performing or
even failing.
6. Regulatory authorities may demand divestiture, for example in order to create
competition.
7. Pressure from shareholders for social reasons (sometimes also called disinvestment).
Examples include disinvestment from South Africa in the former era of apartheid (now
ended), and more recent calls for fossil fuel divestment in response to global warming.
Divestment for financial goals
Often the term is used as a means to grow financially in which a company sells off a business
unit in order to focus their resources on a market it judges to be more profitable, or promising.
Sometimes, such an action can be a spin-off.
Method of divestment
Some firms are using technology to facilitate the process of divesting some divisions. They post
the information about any division that they wish to sell on their website so that it is available to
any firm that may be interested in buying the division. For example, Alcoa has established an
online showroom of the divisions that are for sale. By communicating the information online,
Alcoa has reduced its hotel, travel, and meeting expenses.
Firms use transitional service agreements to increase the strategic benefits of divestitures.
Divestment execution includes five critical work streams: governance, tax, carve-out financial
statements, deal-basis information, and operational separation.
Strategic alliance
A strategic alliance is an agreement between two or more parties to pursue a set of agreed upon
objectives needed while remaining independent organizations. This form of cooperation lies
between mergers and acquisitions and organic growth. Strategic alliances occurs when two or
more organizations join together to pursue mutual benefits.

Partners may provide the strategic alliance with resources such as products, distribution
channels, manufacturing capability, project funding, capital equipment, knowledge, expertise, or
intellectual property. The alliance is a co-operation or collaboration which aims for a synergy
where each partner hopes that the benefits from the alliance will be greater than those from
individual efforts. The alliance often involves technology transfer (access to knowledge and
expertise), economic specialization, shared expenses and shared risk.
Definitions and Discussion
There are several ways of defining a strategic alliance. Some of the definitions emphasize the
fact that the partners do not create a new legal entity, i.e. a new company. This excludes legal
formations like Joint ventures from the field of Strategic Alliances. Others see Joint Ventures as
possible manifestations of Strategic Alliances. Some definitions are given here:
Definitions including Joint Ventures
 A strategic alliance is an agreement between two or more players to share resources or

knowledge, to be beneficial to all parties involved. It is a way to supplement internal
assets, capabilities and activities, with access to needed resources or processes from
outside players such as suppliers, customers, competitors, companies in different
industries, brand owners, universities, institutes or divisions of government.
 A strategic alliance is an organizational and legal construct wherein “partners” are
willing-in fact, motivated-to act in concert and share core competencies. To a greater or
lesser degree, most alliances result in the virtual integration of the parties through partial
equity ownership, through contracts that define rights, roles and responsibilities over a
span of time or through the purchase of non-controlling equity interests. Many result
eventually in integration through acquisition.
Definitions excluding Joint Ventures
 An arrangement between two companies that have decided to share resources to

undertake a specific, mutually beneficial project. A strategic alliance is less involved and
less permanent than a joint venture, in which two companies typically pool resources to
create a separate business entity. In a strategic alliance, each company maintains its
autonomy while gaining a new opportunity. A strategic alliance could help a company
develop a more effective process, expand into a new market or develop an advantage
over a competitor, among other possibilities.
 Agreement for cooperation among two or more independent firms to work together
toward common objectives. Unlike in a joint venture, firms in a strategic alliance do not
form a new entity to further their aims but collaborate while remaining apart and distinct.
Terminology
Various terms have been used to describe forms of strategic partnering. These include
‘international coalitions’ (Porter and Fuller, 1986), ‘strategic networks’ (Jarillo, 1988) and, most
commonly, ‘strategic alliances’. Definitions are equally varied. An alliance may be seen as the

‘joining of forces and resources, for a specified or indefinite period, to achieve a common
objective’.
There are seven general areas in which profit can be made from building alliances.
Typology
Some types of strategic alliances include:
 Horizontal strategic alliances, which are formed by firms that are active in the same
business area. That means that the partners in the alliance used to be competitors and
work together In order to improve their position in the market and improve market power
compared to other competitors. Research &Development collaborations of enterprises in
high-tech markets are typical Horizontal Alliances. Raue & Wieland (2015) describe the
example of horizontal alliances between logistics service providers.[10] They argue that
such companies can benefit twofold from such an alliance. On the one hand, they can
"access tangible resources which are directly exploitable". This includes extending
common transportation networks, their warehouse infrastructure and the ability to
provide more complex service packages by combining resources. On the other hand, they
can "access intangible resources, which are not directly exploitable". This includes know-
how and information and, in turn, innovativeness.
 Vertical strategic alliances, which describe the collaboration between a company and it´s
upstream and downstream partners in the Supply Chain, that means a partnership
between a company it´s suppliers and distributors. Vertical Alliances aim at intensifying
and improving these relationships and to enlarge the company´s network to be able to
offer lower prices. Especially suppliers get involved in product design and distribution
decisions. An example would be the close relation between car manufacturers and their
suppliers.
 Intersectional alliances are partnerships where the involved firms are neither connected
by a vertical chain, nor work in the same business area, which means that they normally
would not get in touch with each other and have totally different markets and know-how.
 Joint ventures, in which two or more companies decide to form a new company. This
new company is then a separate legal entity. The forming companies invest equity and
resources in general, like know-how. These new firms can be formed for a finite time,
like for a certain project or for a lasting long-term business relationship, while control,
revenues and risks are shared according to their capital contribution.
 Equity alliances, which are formed when one company acquires equity stake of another
company and vice versa. These shareholdings make the company stakeholders and
shareholders of each other. The acquired share of a company is a minor equity share, so
that decision power remains at the respective companies. This is also called cross-
shareholding and leads to complex network structures, especially when several
companies are involved. Companies which are connected this way share profits and
common goals, which leads to the fact that the will to competition between these firms is
reduced. In addition this makes take-overs by other companies more difficult.
 Non-equity strategic alliances, which cover a wide field of possible cooperation between
companies. This can range from close relations between customer and supplier, to

outsourcing of certain corporate tasks or licensing, to vast networks in R&D. This
cooperation can either be an informal alliance which is not contractually designated,
which appears mostly among smaller enterprises, or the alliance can be set by a contract.
Michael Porter and Mark Fuller, founding members of the Monitor Group, draw a distinction
among types of strategic alliances according to their purposes:
 Technology development alliances, which are alliances with the purpose of improvement
in technology and know-how, for example consolidated Research&Development
departments, agreements about simultaneous engineering, technology commercialization
agreements as well as licensing or joint development agreements.
 Operations and logistics alliances, where partners either share the costs of implementing
new manufacturing or production facilities, or utilize already existing infrastructure in
foreign countries owned by a local company.
 Marketing, sales and service strategic alliances, in which companies take advantage of
the existing marketing and distribution infrastructure of another enterprise in a foreign
market to distribute its own products to provide easier access to these markets.
 Multiple activity alliance, which connect several of the described types of alliances.
Marketing Alliances most often operate as single country alliances, international
enterprises use several alliances in each country and Technology and Development
Alliances are usually multi-country alliances. These different types and characters can be
combined in a Multiple Activity Alliance
Further kinds of strategic alliances include:
 Cartels: Big companies can cooperate unofficially, to control production and /or prices
within a certain market segment or business area and constrain their competition
 Franchising: a franchiser gives the right to use a brand-name and corporate concept to a
frachisee who has to pay a fixed amount of money. The franchiser keeps the control over
pricing, marketing and corporate decisions in general.
 Licensing: A company pays for the right to use another companies´ technology or
production processes.
 Industry Standard Groups: These are groups of normally large enterprises, that try to
enforce technical standards according to their own production processes.
 Outsourcing: Production steps that do not belong to the core competencies of a firm are
likely to be outsourced, which means that another company is paid to accomplish these
tasks.
 Affiliate Marketing: Affiliate marketing is a web-based distribution method where one
partner provides the possibility of selling products via it´s sales channels in exchange of a
beforehand defined provision.
Goals of Strategic Alliances
 All-in-one solution
 Flexibility
 Acquisition of new customers

 Add strengths, reduce weaknesses
 Access to new markets and technologies
 Common sources
 Shared risk
Advantages
For companies there are many reasons to enter a Strategic Alliance:
 Shared risk: The partnerships allow the involved companies to offset their market
exposure. Strategic Alliances probably work best if the companies´ portfolio complement
each other, but do not directly compete.
 Shared knowledge: Sharing skills (distribution, marketing, management), brands, market

knowledge, technical know-how and assets leads to synergistic effects, which result in
pool of resources which is more valuable than the separated single resources in the
particular company.
 Opportunities for growth: Using the partner´s distribution networks in combination

with taking advantage of a good brand image can help a company to grow faster than it
would on its own. The organic growth of a company might often not be sufficient enough
to satisfy the strategic requirements of a company, that means that a firm often cannot
grow and extend itself fast enough without expertise and support from partners
 Speed to market: Speed to market is an essential success factor In nowadays competitive

markets and the right partner can help to distinctly improve this.
 Complexity: As complexity increases, it is more and more difficult to manage all

requirements and challenges a company has to face, so pooling of expertise and
knowledge can help to best serve customers.
 Costs: Partnerships can help to lower costs, especially in non-profit areas like Research
Development.
 Access to resources: Partners in a Strategic Alliance can help each other by giving
access to resources, (personnel, finances, technology) which enable the partner to
produce its products in a higher quality or more cost efficient way.
 Access to target markets: Sometimes, collaboration with a local partner is the only way
to enter a specific market. Especially developing countries want to avoid that their
resources are exploited, which makes it hard for foreign companies to enter these markets
alone.
 Economies of Scale: When companies pool their resources and enable each other to
access manufacturing capabilities, economies of scale can be achieved. Cooperating with

appropriate strategies also allows smaller enterprises to work together and to compete
against large competitors.
Further advantages
 Access to new technology, intellectual property rights,

 Create critical mass, common standards, new businesses,
 Diversification,
 Improve agility, R&D, material flow, speed to market,
 Reduce administrative costs, R&D costs, cycle time
 Allowing each partner to concentrate on their competitive advantage.
 Learning from partners and developing competencies that may be more widely exploited
elsewhere.
 To reduce political risk while entering into a new market
Disadvantages
Disadvantages of strategic alliances include:
 Sharing: In a Strategic Alliance the partners must share resources and profits and often
skills and know-how. This can be critical if business secrets are included in this
knowledge. Agreements can protect these secrets but the partner might not be willing to
stick to such an agreement.
 Creating a Competitor: The partner in a Strategic Alliance might become a competitor
one day, if it profited enough from the alliance and grew enough to end the partnership
and then is able to operate on its own in the same market segment.
 Opportunity Costs: Focusing and committing is necessary to run a Strategic Alliance
successfully but might discourage from taking other opportunities, which might be
beneficial as well.
 Uneven Alliances: When the decision powers are distributed very uneven, the weaker
partner might be forced to act according to the will of the more powerful partners even if
it is actually not willing to do so.
 Foreign confiscation: If a company is engaged in a foreign country, there is the risk that
the government of this country might try to seize this local business so that the domestic
company can have all the market on its own.
 Risk of losing control over proprietary information, especially regarding complex
transactions requiring extensive coordination and intensive information sharing.
 Coordination difficulties due to informal cooperation settings and highly costly dispute
resolution.
Success factors
The success of any alliance very much depends on how effective the capabilities of the involved
enterprises are matched and weather the full commitment of each partner to the alliance is
achieved. There is no partnership without trade-offs, but the benefits of it must preponderate the
disadvantages, because alliances are made to fill gaps in each others ´capabilities and capacities.

Poor alignment of objectives, performance metrics, and a clash of corporate cultures can weaken
and constrain the effectiveness of the alliance effectiveness. Some key factors that have to be
considered to be able to manage a successful alliance include:
 Understanding: The cooperating companies need a clear understanding of the potential

partner´s resources and interests and this understanding should be the base of set the
alliance goals.
 No time pressure: During negotiations time pressure must not have an influence on the
outcome of the process. Managers need time to establish a working relationship with each
other, develop a time plan, set milestones, and design communication channels.
 Limited alliances: Some incompatibilities between enterprises might not be avoidable,
so the number of alliances should be limited to a necessary amount, which enables the
companies to achieve their goals.
 Good connection: Negotiations need experienced managers. The managers from large
firms need to be connected very well so they have the possibility to integrate different
departments and business areas over internal borders, and they need legitimations and
support from the top management.
 Creation of trust and goodwill: The best basis for a profit-yielding cooperation between
enterprises is the creation of trust and goodwill, because it increases tolerance, intensity
and openness of communication and makes the common work easier. Further it leads to
equal and satisfied partners.
 Intense Relationship: Intensifying the partnership leads to the fact that partners get to
know each other better, each other's interests and operating styles and increases trust.
Further important factors
 Ability to meet performance expectations

 Clear goals
 Partner compatibility
 Commitment to long term relationship
 Alignment
Risks
Using and operating Strategic Alliances does not only bring chances and benefits. There are also
risks and limitations that have to be taken in consideration. Failures are often attributed to
unrealistic expectations, lack of commitment, cultural differences, strategic goal divergence and
insufficient trust. Some of the risks are listed below:
 Partner experiences financial difficulties

 Hidden costs
 Inefficient management
 Activities outside scope of original agreement
 Information leakage
 Loss of competencies
 Loss of operational control

 Partner lock-in
 Partner product or service failure
 Partner unable or unwilling to supply key resources
 Partner's quality performance
 Partner takes advantage of its position
Common Mistakes
Many Companies struggle to operate their alliances in the way they imagined it and many of
these partnerships fail to reach their defined goals. There are some very “popular” mistakes
which can be seen again and again. Some are mentioned here:
 Low commitment
 Poor operating/planning integration
 Strategic weakness
 Rigidity/ poor adaptability
 Too strong focus on internal alliance issues instead on customer value
 Not enough preparation time
 Hidden agenda leading to distrust
 Lack of understanding of what is involved
 Unrealistic expectations
 Wrong expectation of public perception leading to damage of reputation
 Underestimated complexity
 Reactive behavior instead of prepared, proactive actions
 Overdependence
 Legal problems
Life cycle of a Strategic Alliance
Formation
Forming a Strategic Alliance is a process which usually implies some major steps that are
mentioned below.
 Strategy Development: In this stage the possibility of a Strategic Alliance is examined

with respect to objectives, major issues, resource strategies for production, technology
and people. It is necessary that objectives of the company and of the alliance are
compatible.
 Partner Assessment: In this phase potential partners for the Strategic Alliance are
analyzed, in order to find an appropriate company to cooperate with. A company must
know the weaknesses and strengths and the motivation for joining an alliance of another
company. Besides that appropriate criteria for the partner selection are defined and
strategies are developed how to accommodate the partner´s management style.
 Contract Negotiations: After having selected the right partner for a Strategic Alliance
the contract negotiations start. At first all parties involved discuss if their goals and
objectives are realistic and feasible. Dedicated negotiation teams are formed which

determine each partner´s role in the alliance like contribution and reward, penalties and
retaining companies´ interests.
Operation
In this phase in the life of a Strategic Alliance, an internal structure occurs under which it´s
functions develop. While operating it, the alliance becomes an own new organization itself with
members from the origin companies with the aim of meeting all previously set objectives and
improving the overall performance of the alliance which requires effective structures and
processes and a good, strong and reliable leadership. Budges have to be linked, as well as
resources which are strategically most important and the performance of the alliance has to be
measured and assessed.
End/ Development
There are several ways how a Strategic Alliance can come to an end.
 Natural End: When the objectives, the Strategic Alliance was founded for have been
achieved, and no further cooperation is necessary or beneficial for the involved
enterprises the alliance can come to a natural end.
 Extension: After the end of the actual reason for the alliance, the cooperating enterprises
decide to extend the cooperation for following generations of a respective product or
expand the alliance to new products or projects.
 Premature Termination: In this case the Strategic Alliance is ended before the actual
objectives of its existence have been achieved.
 Exclusive Continuation: If one partner decides to get out of the alliance before the
common goals have been achieved, the other partner can decide to continue the project
on its own.
 Takeover of Partner: Strong companies sometimes have the opportunity to take over
smaller partners. If one firm acquires another the Strategic Alliance comes to an end.
Liquidation
In law and business, liquidation is the process by which a company (or part of a company) is
brought to an end, and the assets and property of the company are redistributed. Liquidation is
also sometimes referred to as winding-up or dissolution, although dissolution technically refers
to the last stage of liquidation. The process of liquidation also arises when customs, an authority
or agency in a country responsible for collecting and safeguarding customs duties, determines the
final computation or ascertainment of the duties or drawback accruing on an entry.
Liquidation may either be compulsory (sometimes referred to as a creditors' liquidation) or

voluntary (sometimes referred to as a shareholders' liquidation, although some voluntary
liquidations are controlled by the creditors

Compulsory liquidation
The parties who are entitled by law to petition for the compulsory liquidation of a company vary
from jurisdiction to jurisdiction, but generally, a petition may be lodged with the court for the
compulsory liquidation of a company by:
 The company itself

 Any creditor who establishes a prima facie case
 Contributories: Those shareholders who may be required to contribute to the company's
assets on liquidation
 The Secretary of State (or equivalent)
 The Official Receiver
Grounds
The grounds upon which one can apply for a compulsory liquidation also vary between
jurisdictions, but the normal grounds to enable an application to the court for an order to
compulsorily wind-up the company are:
 The company has so resolved

 The company was incorporated as a corporation, and has not been issued with a trading
certificate (or equivalent) within 12 months of registration
 It is an "old public company" (i.e. one that has not re-registered as a public company or
become a private company under more recent companies legislation requiring this)
 It has not commenced business within the statutorily prescribed time (normally one year)
of its incorporation, or has not carried on business for a statutorily prescribed amount of
time
 The number of members has fallen below the minimum prescribed by statute
 The company is unable to pay its debts as they fall due
 It is just and equitable to wind up the company
In practice, the vast majority of compulsory winding-up applications are made under one of the
last two grounds.
An order will not generally be made if the purpose of the application is to enforce payment of a
debt which is bona fide disputed.
A "just and equitable" winding-up enable the ground to subject the strict legal rights of the
shareholders to equitable considerations. It can take account of personal relationships of mutual
trust and confidence in small parties, particularly, for example, where there is a breach of an
understanding that all of the members may participate in the business, or of an implied obligation
to participate in management. An order might be made where the majority shareholders deprive
the minority of their right to appoint and remove their own director.

The order
Once liquidation commences (which depends upon applicable law, but will generally be when
the petition was originally presented, and not when the court makes the order), dispositions of
the company's property are generally void, and litigation involving the company is generally
restrained.
Upon hearing the application, the court may either dismiss the petition, or make the order for
winding-up. The court may dismiss the application if the petitioner unreasonably refrains from
an alternative course of action.
The court may appoint an official receiver, and one or more liquidators, and has general powers
to enable rights and liabilities of claimants and contributories to be settled. Separate meetings of
creditors and contributories may decide to nominate a person for the appointment of liquidator
and possibly of supervisory liquidation committee.
Voluntary liquidation
Voluntary liquidation occurs when the members of a company resolve to voluntarily wind up its
affairs and dissolve. Voluntary liquidation begins when the company passes the resolution, and
the company will generally cease to carry on business at that time (if it has not done so already).
A creditors’ voluntary liquidation (CVL) is a process designed to allow an insolvent company to

close voluntarily. The decision to liquidate is made by a board resolution, but instigated by the
director(s). If a limited company’s liabilities outweigh its assets, or the company cannot pay its
bills when they fall due, the company becomes insolvent.
If the company is solvent, and the members have made a statutory declaration of solvency, the
liquidation will proceed as a members' voluntary winding-up. In that case the general meeting
will appoint the liquidator(s). If not, the liquidation will proceed as a creditors' voluntary
winding-up, and a meeting of creditors will be called, to which the directors must report on the
company's affairs. Where a voluntary liquidation proceeds as a creditors' voluntary liquidation, a
liquidation committee may be appointed.
Where a voluntary winding-up of a company has begun, a compulsory liquidation order is still
possible, but the petitioning contributory would need to satisfy the court that a voluntary
liquidation would prejudice the contributors.
In addition, the term "liquidation" is sometimes used when a company wants to divest itself of
some of its assets. This is used, for instance, when a retail establishment wants to close stores.
They will sell to a company that specializes in store liquidation instead of attempting to run a
store closure sale themselves.

Misconduct
The liquidator will normally have a duty to ascertain whether any misconduct has been
conducted by those in control of the company which has caused prejudice to the general body of
creditors. In some legal systems, in appropriate cases, the liquidator may be able to bring an
action against errant directors or shadow directors for either wrongful trading or fraudulent
trading.
The liquidator may also have to determine whether any payments made by the company or
transactions entered into may be voidable as a transaction at an undervalue or an unfair
preference.
Priority of claims
The main purpose of a liquidation where the company is insolvent is to collect its assets,
determine the outstanding claims against the company, and satisfy those claims in the manner
and order prescribed by law.
The liquidator must determine the company's title to property in its possession. Property which is
in the possession of the company, but which was supplied under a valid retention of title clause
will generally have to be returned to the supplier. Property which is held by the company on trust
for third parties will not form part of the company's assets available to pay creditors.
Before the claims are met, secured creditors are entitled to enforce their claims against the assets
of the company to the extent that they are subject to a valid security interest. In most legal
systems, only fixed security takes precedence over all claims; security by way of floating charge
may be postponed to the preferential creditors.
Claimants with non-monetary claims against the company may be able to enforce their rights
against the company. For example, a party who had a valid contract for the purchase of land
against the company may be able to obtain an order for specific performance, and compel the
liquidator to transfer title to the land to them, upon tender of the purchase price.
After the removal of all assets which are subject to retention of title arrangements, fixed security,
or are otherwise subject to proprietary claims of others, the liquidator will pay the claims against
the company's assets. Generally, the priority of claims on the company's assets will be
determined in the following order:
1. Liquidators costs
2. Creditors with fixed charge over assets
3. Costs incurred by an administrator
4. Amounts owing to employees for wages/superannuation
5. Payments owing in respect of workers's injuries
6. Amounts owing to employees for leave
7. Retrenchment payments owing to employees
8. Creditors with floating charge over assets

9. Creditors without security over assets
10. Shareholders
Unclaimed assets will usually vest in the state as bona vacantia.
Dissolution
Having wound-up the company's affairs, the liquidator must call a final meeting of the members
(if it is a members' voluntary winding-up), creditors (if it is a compulsory winding-up) or both (if
it is a creditors' voluntary winding-up). The liquidator is then usually required to send final
accounts to the Registrar and to notify the court. The company is then dissolved.
However, in common jurisdictions, the court has discretion for a period of time after dissolution
to declare the dissolution void to enable the completion of any unfinished business.
Striking off the Register
In some jurisdictions, the company may elect to simply be struck off the Register as a cheaper
alternative to a formal winding-up and dissolution. In such cases an application is made to the
Registrar, who may strike off the company if there is reasonable cause to believe that the
company is not carrying on business or has been wound-up and, after enquiry, no case is shown
why the company should not be struck off.
However, in such cases the company may be restored to the Register if it is just and equitable so
to do (for example, if the rights of any creditors or members have been prejudiced).
In the event the company does not file an annual return or annual accounts, and the company's
file remains inactive, in due course, the Registrar at Companies House will strike the company
off the register.
Recapitalization
Recapitalization is a type of corporate reorganization involving substantial change in a

company's capital structure. Recapitalization may be motivated by a number of reasons. Usually,
the large part of equity is replaced with debt or vice versa. In more complicated transactions,
mezzanine financing and other hybrid securities are involved.
Types of Recapitalization
Leveraged Recapitalization
One example of recapitalization is a leveraged recapitalization, wherein the company issues

bonds to raise money, and then buys back its own shares. Usually, current shareholders retain
control. The reasons for this sort of recapitalization include:

 Desire of current shareholders to partially exit the investment
 Providing support of falling share price
 Disciplining the company that has excessive cash
 Protection from a hostile takeover
 Rebalancing positions within a holding company
 Help to improve the stock of the company during a time of poor economic marker
Leveraged Buyout
Another example is a leveraged buyout, essentially a leveraged recapitalization initiated by an

outside party. Usually, incumbent equityholders cede control. The reasons for this transaction
may include:
 Getting control over the company via a friendly or hostile takeover

 Disciplining the company with excessive cash
 Creating shareholder value via gradual debt repayment
Nationalization
Another example is a nationalization, wherein the nation in which the company is headquartered
buys sufficient shares of the company to obtain a controlling interest. Usually, incumbent equity
holders lose control. The reasons for nationalization may include:
 Saving a very valuable company from bankruptcy

 Confiscation of assets
 Executing the eminent domain right
Financial Distress: Definition and Dimensions

Financial distress is a term in corporate finance used to indicate a condition when promises to
creditors of a company are broken or honored with difficulty. If financial distress cannot be
relieved, it can lead to bankruptcy. Financial distress is usually associated with some costs to the
company; these are known as costs of financial distress.
Financial distress is a situation, which makes the company’s survival difficult. A firm, which is
exposed to higher business risk, faces a greater chance of financial distress. A firm experiences
financial distress when it defaults the external obligations. Though a livered firm has the tax
advantage, a highly levered firm is always under the threat of distress because of the high cost of
debt. A firm in distress condition reduces the value of the firm because:
Value of the firm = Value of equity finance + PV of tax shield - PV of cost of financial distress
Therefore as the PV cost of financial distress increases, the value of the firm declines. Financial
distress leads to incipient sickness, ultimately resulting into closure of the unit, unless a revival
programme is effectively put into operation.
Causes of Distress

A company move to distress condition due to a number of reasons. Broadly these reasons can be
classified into internal causes and external causes.
Internal Causes
1. Managerial incompetencies
2. Heavy debt burden and resultant service cost
3. Improper location
4. Lack of financial discipline
5. Technological failures
6. Uneconomic plant size
7. Over investments in fixed assets
8. Unsuitable plant and machinery
9. Poor emphasis on research and development
10. Weak production and quality control
11.Poor maintenance system
12.Lack of marketing policy
13.Weak demand projection
14.Wrong product mix
15. Improper product positioning
16. Irrational price structure
17. Inadequate sales promotion
18. High distribution cost
19. Poor customer service
20. Wrong capital structure
21. Wrong investment decisions
22. Lack of financial policies
23. Weak budgetary control
24. Absence of responsibility accounting
25. Inadequate management information system
26. Poor management of receivables
27. Bad cash planning and control
28. Strained relationship with suppliers of capital
29. Improper tax planning
30. Ineffective leadership
31.Poor labour relations
32. Inadequate human resources
33. Over staffing
34. Lack of commitment on the part of employees
35. Irrational compensation structure
36. Lack of expenditure control system
37. Excessive borrowings
38. Conflict among key personnel
39. Deteriorating quality

External Environment: The external environment may also affect the operations of a company
adversely. Some of the major issues, which are generated by the external environment, are:
1. Government policies regarding taxation, power tariff, power supply, customs duties and
import duties, restrictions on imports and exports etc.
2.Quota system imposed by the government on raw materials/ finished goods
3. Entry of large number of firms thereby sudden increase in the capacity
4. Development of new technology
5. Sudden withdrawal by some of the major customers resulting into decline in orders
6. A change in the consumers’ tastes and preferences
7. Strained relationship with the external government
8. A change in the lending policies of the financial institutions
predicting organizational failure

The financial distress is not developed overnight. Distress is the culmination of various factors.
The symptoms of distress are visible in an organization when the unit shows incipient sickness.
Some of these symptoms are:
1. Declining sales revenue coupled with large number of rejections of consignments by the
customers.
2. Delayed payment to suppliers resulting into withdrawal of credit facilities by them
3. High leverage because of over borrowings
4. Continuous overdrawing of the credit limits sanctioned by banks resulting into
suspension/withdrawal of facilities by banks
5. Default in repayment of interest and principal to financial institutions, bondholders etc.
6. Declining capacity utilization
7. Lack of proper maintenance of plant, machinery and equipments
8. Poor asset turnover
9. Large accumulation of inventories
10. Suppliers showing reluctance to offer trade discounts
11. High labour turnover
12. Extension of accounting period
13. Value erosion in respect of shares and debentures
14. Declining market reputation
15. Default in payment of statutory dues
COST OF FINANCIAL DISTRESS
In finance, a company is considered to be in financial distress when it is having difficulty making

payments to creditors. Financial distress may lead to bankruptcy. The more debt a company uses
to finance its operations the more it is at risk of experiencing financial distress. There are several
costs associated with financial distress, including bankruptcy costs, distressed asset sales, a
higher cost of capital, indirect costs, and conflicts of interest.

Bankruptcy Costs
The more debt a company takes on, the more it risks being unable to meet its financial
obligations to creditors. A highly leveraged firm is more vulnerable to a decrease in profitability.
Therefore, a highly levered firm has a higher risk of bankruptcy.
Bankruptcy costs vary for different types of firms, but they typically include legal fees and,
losses incurred from selling assets at distressed fire-sale prices, and the departure of valuable
human capital. The way to measure bankruptcy cost is to multiply the probability of bankruptcy
by the expected cost of bankruptcy. A company should consider the expected cost of bankruptcy
when deciding how much debt to take on.
Indirect Costs of Financial Distress
There are also several indirect costs associated with financial distress. When a company is
experiencing financial distress, conservative managers may cut down on research and
development, marketing research, and other investments to spare cash. The firm may also incur
opportunity costs if trepid managers pass on risky corporate projects.
Also, financial distress can affect a firm’s reputation. A company in financial distress may lose
customers, be forced to pay a higher cost of capital, receive less favorable trade credit terms from
suppliers, and be vulnerable to tactics from aggressive industry competitors.
Financial Distress and Conflicts of Interest
Financial distress can incur costs associated with the conflicting self-interests of creditors,
managers, and owners.
When a company in financial distress is confronted with a risky investment opportunity,

creditors would prefer the company not engage in the risky investment – they would rather the
company preserve its assets so they will be able to collect what’s owed to them in the event of
default or bankruptcy.
Investors, or owners, on the other hand, would prefer the company to go forward with the risky
investment. If the company foregoes the investment, owners don’t benefit. If the company does
go for the risky investment, owners have at least some upside gain potential.
While managers may be either conservative in the face of a risky opportunity in order to try to
preserve their jobs, or they may be more inclined to take the risk if they side with the
shareholders or see the opportunity as a chance to increase personal gain

Options for relieving financial distress
If high debt burden is the cause of financial distress, the company can solve it by:
 Turnaround Management – Working with the directors to identify the causes of the
financial distress and the development of a strategy to return the company to financial
health.
 Debt Refinancing – the review of a company’s debt finance to arrange a more appropriate
type of finance or a rescheduling of the current terms.

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TOPIC NINE

ANALYSIS OF CORPORATE GROWTH AND

THE CHALLENGE OF ATTAINING SUSTAINABLE GROWTH

USING THE SUSTAINABLE GROWTH RATE

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Mature firms often have

I. Return on Assets (ROA) and Return on Capital (ROC)

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A more useful measure of return relates the operating

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II. Return on Equity

1. Changed Nature of Business

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3. New Work Methods

4. New Management Methods

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7. Mergers and Acquisitions

8. Finance Related Issues

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10. Statutory and Legal Compliance

Absolute and relative return

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Valuation and analysis of corporate restructuring

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Firms may have several motives for divestitures:

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Divestment for financial goals

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Definitions and Discussion

Definitions including Joint Ventures

 A strategic alliance is an agreement between two or more players to share resources or

Definitions excluding Joint Ventures

 An arrangement between two companies that have decided to share resources to

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Some types of strategic alliances include:

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Further kinds of strategic alliances include:

Goals of Strategic Alliances

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For companies there are many reasons to enter a Strategic Alliance:

 Shared knowledge: Sharing skills (distribution, marketing, management), brands, market

 Opportunities for growth: Using the partner´s distribution networks in combination

 Speed to market: Speed to market is an essential success factor In nowadays competitive

 Complexity: As complexity increases, it is more and more difficult to manage all

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 Access to new technology, intellectual property rights,

Disadvantages of strategic alliances include:

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 Understanding: The cooperating companies need a clear understanding of the potential

Further important factors

 Ability to meet performance expectations

 Partner experiences financial difficulties

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Life cycle of a Strategic Alliance

 Strategy Development: In this stage the possibility of a Strategic Alliance is examined

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Liquidation may either be compulsory (sometimes referred to as a creditors' liquidation) or

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 The company itself