What is Demerger ?

Introductions Demerger 

Demerger or Spin-off refers to a business strategy where a company particularly the larger company is divided or split into two or more units i.e., into the number of small units operating separately. The objective of all smaller units is the same. Thus, the shares are individually sold to the public. Generally, demerger is done so that each of the units can perform its business efficiently by focusing on the specific task which will contribute to the easy achievement of the objectives. 

In order to sell the subsidiaries and smaller units of the company, the demerger is adopted. The main objective of the demerger is to divide a company into various units for achieving the specialization in a particular segment. Demerger or spin-off is just the reverse strategy of merger which implies the strategy to join the number of companies so that the firms intend to work together under the same roof. 

Alternatively, the demerger is the opposite of 'uniting of interest' or 'amalgamation like merger'. The shares are issued to the shareholder of the demerged company by the new company that is having an individual economic and legal identity distinct from the demerged company. Consequently, the large numbers of shareholders of the larger company come up as a shareholder of the smaller companies of the new company.

Demerger is a method of corporate restructuring where the investor has the advantage of having direct ownership in the head entity which was indirectly owned in the previous time. There is no variation in ultimate ownership of the companies or trust which was formed as part of the group. The company or trust which come to an end to own the entity is called 'demerging entity.

Reasons For Demerger 

• Rearrangement of the current business by way of separating various activities into several segment.
• In order to divide the management into various smaller units.
• To use the concept of responsibility accounting and accountability.
• To have an efficient management system in the units.
• To provided security against the valuable assets from the predator through a hostile takeover.
• To provide security against the valuable assets from the predator through hostile takeover.
• Division of undesirable activities and focusing on the main activities.
• Facilitating management buy-out.

Types of Demerger

There are two main types of demerger which are discussed:-

• Split-Off:- Split-off refers to the restructuring of an existing corporate structure in which the stock of a smaller business unit or subsidiary is transferred to the parent company for shares. This transferring of share by the business unit or subsidiary to a shareholder of the parent company in place of the same amount of stock to be traded in the latter time is a very unusual situation. A split-off is also called as a "tender offer exchange". Hence, due to this reason the parent company is separated from its subsidiary units.

• Split-Up:- Split-up refers to a corporate strategy in which the parent company come to an end or closes  down after transferring all its assets to the other two or more companies. The parent company in this situation give up the total amount of their stock in exchange for the stock of the transferee company.

Advantages of Demerger

The advantages of demerger are as follows:-

• Separation of Management of Divisions:- The main advantage is the separation of management to division to determine the responsibility and accountability of we responsibility and accountability of each individual company. Thus, to have a proper management structure. As a result, the efficiency and productivity of the company are increased.

• Safeguard against Cash Loss Risks/Non-Profitability due to High Risk:- To minimize the risk in the company mainly at the time of high risk is expected in the business then each individual unit is separate a separate entity from the parent company and with specialized responsibility centres such as profit centre.

• Enhancing Responsibility and Accountability:- It becomes very easy to look after the performances of each unit very efficiently as each individual company has its distinct head. As a result, the employees of the company work very effectively without any disturbance which will yield a positive return for the company and also lead to better accountability and increased responsibility.

• Decluttering Management Processes:- The activities in the business processes which are useless and irrelevant can be removed by the help of the chance provided by spin-offs. It aids in restructuring the processes and also aid in decluttering. Hence, leads to an increase in productivity and optimum utilization of resources are available in the parent company as well as in its segments.

• Defence against Hostile Takeover:- Spin-off is a very important defensive strategy. Spin-off aid in protecting the valuable assets from the predator is the most profitable portion of the business. To acquire the benefits, the companies display the risky and non-attractive the situation in front of the predator.

Disadvantages of Demerger

The disadvantages of demerger are as follows:-  

• Loss of Economies of Scale:- The cost of production might increase scale: The cost of production might increase and profitability may be reduced when a demerger is done in a situation when the company does not undergo the situation of diseconomies of scale.

• Increased Costs and Overheads:- Demerger is a quite expensive process as a breakdown into numerous companies which will incur the cost. Therefore, the costs are increased by answer separate entity which will affect the profitability of the company. As a result, there will be a need for repetitive allocation of resources or equipment which automatically raises the cost of production. Hence, the additional expenditure incurred should be carefully analyzed.

• Difficulty in Raising Additional Funds:- The reliability of the demerged company as a new entity is very less with the lenders of funds because the parent company has portrayed risk for the investors against the demerged or the subsidiary company. Therefore, it becomes very difficult to raise additional funds to form the new company.

• Lower Turnover and Profits:- The overall profits and turnover may be reduced for the new companies as it was anticipated because of the increase in costs, scarcity of resources and funds. One other important reason for the lowering of profit is that it is very challenging the task to form a company as a new entity.

• Loss of Synergistic Operations:- The spirit of working together or synergies may be lost which was in existence at the time of incorporation of the parent company because of demerger was the single parent company is divided into several units. Hence, the resources might also not give effective result as it was supposed to give when the integrated output was produced.