What is behind recent market trends in corporate group reorganisations?
Published on 6th Nov 2023
Group reorganisations are on the increase and are inherently complex – often driven by a corporate group's desire to optimise tax and financing arrangements
Group reorganisations are on the increase as a result of economic instability, increased borrowing costs, a need to integrate acquisition targets following a period of lively M&A activity, an ever-more complex regulatory and tax environment and a drive towards business transformation, net zero, globalisation and digitalisation.
Reorganisations often involve changes to a corporate group's legal entity structure, intercompany financing arrangements and/or balance sheets of its entities through a series of transactions which are usually outlined in a steps plan: a road map to effecting the desired restructuring.
Common reorganisation transactions include buybacks of shares, reductions of share capital or the issuance of shares in order to restructure group entities' share capital, the waiver, assignment, novation or repayment of debt, the making distributions of capital, moving assets within a group, or the incorporation or dissolution of legal entities.
Drivers for reorganisation
Reorganisations are often driven by a corporate group's desire to optimise tax and financing arrangements, whether intra-group financing or facilitating third party debt financing. Other key drivers include:
- simplifying a group structure before or after an acquisition, or in connection with operating model transformation or the adoption of new group systems and processes;
- facilitating a disposal or intra-group transfer of assets in a tax-efficient manner;
- altering the group's capital structure to deleverage its balance sheet;
- facilitating distributions to, or an exit of, shareholders;
- aiding succession planning in family-owned groups;
- demerging businesses;
- ring-fencing risky assets or liabilities away from trading businesses;
- adjusting the legal entity structure to reflect the operational reality and geographical footprint of the group's business;
- reducing compliance costs and the cost of management time administering the group; and
- preparing for a stock exchange listing.
What factors have led to an increase in reorganisations?
The disruption caused by Covid-19, the war in Ukraine, high inflation and rapidly rising interest rates and energy costs, have presented corporate groups with a unique set of financial and operational issues.
In addition, businesses are facing the need to make material changes to their businesses, including their legal structures and organisational arrangements, to face future challenges such as net zero, digitalisation and globalisation.
The global turmoil and push for change has led companies to reconsider their group structures by increasingly focusing on costs savings, streamlining operations and organisational efficiency and divesting of non-core assets.
Many companies which have expanded through debt-fuelled acquisitions or received leveraged private equity backing are now looking to simplify their organisational structures or deleverage their balance sheets in a drive to cut costs and maintain margins and returns on investment. Highly acquisitive groups are also looking to bed their acquisition targets into optimal group structures through integration exercises.
To achieve business transformation and address ESG (environmental, social and governance) and CSR (corporate social responsibility) considerations, businesses are needing to move assets and operations and amend their operational structures.
Insolvency-driven reorganisations and balance sheet restructurings
The rapid rise in borrowing costs, an end to covid-era government stimulus, multi-decade high inflation, and escalating geopolitical tensions have led to a general risk-off sentiment amongst financial sponsors and lenders. This tightening of credit conditions is putting immense strain on company balance sheets, with corporate defaults ticking higher since the beginning of 2022.
It should therefore come as little surprise that insolvency-driven reorganisations have been growing as corporate groups, investors and lenders look to salvage the business. These may involve a formal restructuring process, perhaps through an insolvency or court procedure, but equally for a group in financial difficulties or struggling to service its debts, but not yet at the point of insolvency, this could also include the divestment of non-core assets or a costs rationalisation exercise.
For many companies receiving the financial backing of private equity funds which saddled the company with cheap pre-2022 debt, debt restructurings such as debt-for-equity swaps, renegotiating terms to extend maturity and reduce coupon payments under the facility, or disposing of unprofitable or underperforming businesses within the group have become necessary in order to stave off insolvency and continue servicing debt repayments.
Debt restructuring is likely only to increase as more and more loans approach maturity.
Group simplification and legal entity rationalisation
The drive to cut costs and protect margins narrowed by inflation has led to a steady stream of companies looking to simplify their group structures.
Group simplifications involve the dissolution of dormant or holding entities and the transfer of their assets and liabilities to another entity within the group. These simplification projects can help cut the administrative costs of filing accounts and tax returns, making returns to Companies House, fulfilling reporting obligations and time spent on corporate governance.
Where multiple entities are to be removed from the group structure, these projects are known as legal entity rationalisation or "LER" projects. LER projects are being used to consolidate operating companies within the group that have overlapping divisions or back office resources that can be run more efficiently as a single unit. As is the case with straightforward group simplifications, LER projects also aim to save administrative costs, management time and reduce risk by consolidating corporate governance oversight.
Operating model transformation
Popular in the past among financial services firms, we have noticed an increase in non-financial services groups utilising restructuring transactions to transform their operating models.
Some international corporate groups have decided to switch from operating multiple legal entities to a single or regional holding company with branches in their individual international jurisdictions. The benefits of this approach include tax simplification by reducing the burdens of transfer pricing rules and the requirement to prove economic substance, as well as eliminating the costs and complexities of subsidiary-level decision making.
Though the M&A bonanza of 2021 and 2022 has abated, M&A-driven reorganisations are still occurring and acquirers are focusing on restructuring their groups to integrate the assets they have purchased.
The use of hive-up structures is commonplace among serial acquirers that intend to integrate the target businesses. We are now seeing those acquirers streamline their processes and save costs by creating standard documents and precedents and adopting automated and technological solutions to help simplify hive-ups of acquired businesses to the parent and the subsequent dissolution of the target company.
Proactive planning for the group structure around an acquisitions allows purchaser groups to simplify the group and achieve synergies quickly, eliminating the need for complex projects later down the line.
On the sale side, assets may be transferred out of the target or liabilities assumed by a group entity not within the sale's scope, and dormant entities may be hived out or closed out to streamline the corporate structure being offered for sale to make it more attractive to a prospective buyer – this is key in the current buyer's market.
As divestments of non-core assets have increased, so has the need for pre-sale reorganisations including carving out and hiving down non-core businesses into a prepackaged entity ready for sale and unwinding group trading and transactions.
From a sector perspective, we are seeing portfolio companies of private equity houses seeking help restructuring their debt that has become unsustainable as interest rates have risen by several percentage points.
The continued tailwinds of the pandemic on the healthcare and life sciences sectors has been driving M&A reorganisations as companies separate low-value generic, over-the-counter drug businesses from their high-growth prescription drugs and vaccine businesses.
On the operational model transformation front, retail and consumer and professional services firms are the top contributors in this area of restructurings. New trade rules, tax regulations and regulatory requirements of trading and offering services within the EU single market, as well as the exodus of companies from Russia and growing hostilities between the West and China has made operational efficiency and resilience ever more important.
If you would like to discuss any of the issues raised in the Insight, please get in touch with your usual Osborne Clarke contact, or one of our experts below