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Lecture 4

A capital reconstruction involves reorganizing a company's capital structure, such as by converting debt to equity or eliminating accumulated losses, when the company is facing financial difficulties and inability to pay shareholders or creditors. There are two main types of reconstructions: internal reconstructions restructure the statement of financial position, while external reconstructions set up a new entity to take over the old entity's assets and business. When appraising a proposed reconstruction scheme, each investor group is analyzed to determine if they would benefit more from the reconstruction or from liquidation without it.

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57 views

Lecture 4

A capital reconstruction involves reorganizing a company's capital structure, such as by converting debt to equity or eliminating accumulated losses, when the company is facing financial difficulties and inability to pay shareholders or creditors. There are two main types of reconstructions: internal reconstructions restructure the statement of financial position, while external reconstructions set up a new entity to take over the old entity's assets and business. When appraising a proposed reconstruction scheme, each investor group is analyzed to determine if they would benefit more from the reconstruction or from liquidation without it.

Uploaded by

ptnyagortey91
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Capital reconstruction and

reorganisation

Mawuena Akosua Cudjoe (PhD)


Learning Objectives
• Explain a capital reconstruction.
• Carry out a capital reconstruction based on information
provided.
• Appraise a proposed capital reconstruction.
Capital reconstruction

• A capital reconstruction is a reorganisation of the capital


structure of a company, thus changing shareholder rights
and perhaps creditors.

• The usual reason for a capital reconstruction is that a


company is in financial difficulties.
Large
Inability to pay
accumulated
dividends to
losses
pref/ord
shareholders

Declining Declining
operational issues
share
price

Large arrears
of debenture
interest Add a Slide Title - 1

Financial
collapse/liquidation

When scaling, group all elements to be scaled. Scale as needed. Use the “Increase Font Size,” “Decrease Font Size” buttons or manually change the font size for the editable text.
Capital reconstruction
• A reconstruction is only worth considering if:
• the reconstructed company has a good chance of
surviving and restoring itself to profitability; and

• the reconstruction puts all parties concerned into a


situation which is at least as good if not better than their
situation if the company were to be wound up.
Types of schemes
• A capital reconstruction scheme might involve:
• An internal reconstruction

• An external reconstruction
Internal reconstruction
• An internal reconstruction involves a scheme designed to
restructure the statement of financial position of a
company.

• A reconstruction might involve:


• revaluation of assets;
• raising new capital;
• the conversion of debt capital into equity;
Internal reconstruction cont’d
• deferment of debt repayment;
• the conversion of equity shares from one form to another
and
• the elimination of accumulated losses.

• Existing equity shareholders might be required to


relinquish all their shares and accept a much smaller
quantity of new shares in the reconstructed company.
Internal reconstruction cont’d
• Majority of the new shares in the reconstructed company
might be held by lending banks or bond investors, who
agree to exchange their loans or bonds for new shares in
the reconstructed company.
External reconstructions
• This involves setting up a new entity to take over the net
assets and business of the old entity. The old entity is in
fact making a disposal of its interests to the new entity.
Illustration: Internal reconstruction
Illustration: Internal reconstruction
Solution: Internal reconstruction
Solution: Internal reconstruction
Solution: Internal reconstruction
Appraising a reconstruction scheme
• The appraisal of a scheme involves comparing the financial position of
each party:
- if the construction scheme is agreed; and
- if the scheme is rejected and liquidation occurs.
• To perform the comparison, construct a working:
• - showing how much cash could be raised in the event of
liquidation and
• - to whom that cash would be paid.
Appraising a proposed reconstruction
• A company cannot impose a scheme of reconstruction on
the different parties which have a financial interest in the
company. Each could reject the scheme as being unfair.

• If a court approves a scheme, it becomes binding on all


parties.
Appraising a proposed reconstruction
Step 1
• -Ensure that you understand what the capital of the
reconstructed company will be. How many shares will be
in issue and who will own them?
• -How much debt capital will the company have, and what
will be the rate of interest payable on the debt?
Appraising a proposed reconstruction
• Step 2
• If any investor group is unlikely to benefit from the
reconstruction, it will not support the reconstruction
proposals.
• For each investor group – ordinary shareholders,
preference shareholders, bondholders and banks –
consider what will happen to them:
• - if there is no reconstruction (which usually means the
company being wound up); and
• - if the company is reconstructed.
Appraising a proposed reconstruction
• Note: Those with most to lose should give up more in the
capital reconstruction, i.e creditors would not be willing to
reduce their rights unless they see that the shareholders
are contributing to a greater extent.
Illustration: Appraising a scheme of
reconstruction
Illustration: Appraising a scheme of
reconstruction
Illustration: Appraising a scheme of
reconstruction
Slide 25

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