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How reorganizing a company within a company creates value
Faced with an enigmatic short-term economic outlook, companies are preparing for a potential wave of dealmaking with an innovative tactic: reorganizing business units to create a company within a company to be prepared to quickly create deal value and strike while the iron is hot.
We are seeing an uptick in internal reorganization initiatives such as consumer companies becoming more category-focused, pharmaceutical companies separating business units to position for global opportunities, and media companies aligning their B2C and B2B businesses with marketplace dynamics.
The ability to operate independently while still under the parent company’s umbrella boosts the opportunity for value creation by increasing speed to market — when the time is right — and improving the chances of regulatory approval.
The approach allows executives to prepare for a potential divestiture by preemptively disentangling knotty legal structures and core operations, while leaving in place key shared services like finance, IT and HR. In baseball terms, it would be a bit like dealmakers putting the business unit in the on-deck circle for a divestiture but waiting until the economy stabilizes to get in the batter's box, while also giving the business unit the attention it needs to thrive.
This strategy can create optionality for companies. If the company has an immediate need for capital, this tactic can make it easier to launch a joint venture (JV), liquidate the equity or leverage it in debt financing.
What companies should keep in mind
Successfully transforming the business to operate as a company within a company starts with establishing a clear set of objectives and the guiding principles needed to accomplish them. The business will then need to be reorganized to enable each standalone business to operate under a distinct legal structure, establishing arms-length agreements to govern the future relationship between the businesses.
Each standalone business should be financially separated so that it can measure its own financial performance and key metrics. There is no one-size-fits-all approach; the extent of the changes will need to be tailored to meet each company's objectives. The primary goal in this type of reorganization is to enable a capital markets transaction (vs. cost-cutting and/or headcount reductions), so internal messaging will need to be carefully managed, along with an appropriate change management program to align employees with the strategy.
Benefits of a “company within a company”
Restructurings are often considered a reaction to company distress. But leveraging this reorganization strategy as a proactive tool to transform your business to meet the market with agility can help create long-term value, unlock opportunities and provide access to capital more quickly.
- Allows companies to raise debt or liquidate equity at better valuation against core businesses if needed, as lenders see operations between core and non-core business
- Makes non-core business units (BUs) more attractive for potential buyers, given the reduced time between signing and closing the deal since the BU is legally and logically separated
- Reduces the burden of squeezing in significant operational and legal restructuring changes by front-loading some of the planning and execution. This can lead to smoother execution and reduced stress on the remaining company’s operations and employees
- Creates optical separation from regulatory standpoint if businesses are legally and operationally separated
Next steps for company leaders
Here are some considerations we recommend to leaders that are evaluating proactive alternatives:
Don’t lose sight of the big picture
The success of any business depends heavily on its positioning within the overall economy. The current increased uncertainty related to recession concerns, relatively high inflation and rising interest rates puts focus on the important ability to react to the changing economic trends. By logically organizing a business to operate as a company within a company, executives who decide to raise capital or increase their leverage significantly shorten the lead time required to execute. The reorganization decision should be made as part of a regular portfolio review.
Prioritize flexibility
Change is never easy but can represent an opportunity for transformation. An internal restructuring does not change the way your business operates as a whole. It is intended to change the way your business operates within itself, positioning it to take advantage of innovation and strategic opportunities. Focus on which aspects of the business are logically separate and which aspects provide synergies by continuing to operate together. Rather than changing these processes, the goal will be to develop innovative solutions for preserving the existing business process while redefining the overall structure.
Reduce operational impact
This is truly a cross-functional initiative incorporating both legal and operational milestones. Rather than prioritizing the typical divestiture activities (employee movement, transition service agreement, contract assignment, etc.), the business’s main objective is to develop a blueprint for how the various BUs will operate independently going forward. This blueprint will likely include some version of the typical divestiture activities but it will also challenge the status quo by allowing the BUs to operate independently within the overall company’s commingled ecosystem.
A path to future deals
Preparing your company can set the runway for each of these options:
- Divestitures
- Joint ventures and alliances
- Capital markets
- Turnarounds
Divestitures
Timely consideration and planning can be the key to recognizing valuable opportunities. Considering that the acquisition-to-divestiture ratio is at a 20-year high, businesses who take meaningful steps now will likely be more prepared as the market shifts.
Joint ventures and alliances
In a time where capital discipline is key, JVs and alliances can provide companies with access to new markets, resources and customers without the same financial and integrative pressures of an outright acquisition. Reorganizing your company internally sets the stage for this deal route and a future exit — through selling the remaining stake, going public or acquiring the remaining ownership.
Capital markets
Paths to liquidity ebb and flow with the market. While companies may be considering a special purpose acquisition company (SPAC) or initial public offering (IPO) in the future, reorganizing the business now can help business units access debt options more quickly. Readiness is key with the capital markets — as windows of opportunity tend to be brief.
Turnarounds
Many companies consider turnarounds and restructurings as a way to combat distress. But proactive assessments of business units and portfolios can help companies retain control and steer away from insolvency in a market downturn.
How current deal drivers factor in
In our latest deals outlook, we noted five drivers in dealmaking:
Navigating economic and geopolitical uncertainty
Changing regulatory, supply chain and market factors are leading to uncertainty for dealmakers. While some companies have a clear path to deals, others need to stay agile in the current market.
Increasing resilience and security
The pandemic forced many companies to consider just how resilient their operations were. Building both security and resilience in a rapidly changing environment involves understanding current deficiencies and making plans to actively address them.
A return to capital discipline
Companies considering an internal restructuring are aware of the need to be deliberate with their capital choices. In this new environment, they know that they can gain a strategic advantage by reassessing their business units and portfolios against their core strategy.
Speed to unlocking value from transformational deals
Access to new capabilities and talent is critical to creating value over a shorter time frame. Restructurings set the stage by opening the path to JVs, debt raisings or future divestitures.
Hurry up and wait?
Private companies eyeing a move to the public markets are finding a more challenging environment than they would have a year ago. For dealmakers who prefer to wait out the storm, internal restructurings are a way to be proactive while waiting for the market to shift.
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