Merger and Acquisition

Meaning and Definition of Mergers

The merger refers to combining two or more companies into one company. It can either be done
by merging of one or more companies into the existing company or framing a new company by
merging two or more existing company. The word 'amalgamation' is used for merger by Income
Tax Act, 1961 of India.
According to the Companies Act, 1956, the term amalgamation includes 'absorption'. In S.S
Somayajula vs. Hop Prudhommee and Co. Ltd., the learned Judge refers to amalgamation as "A
state of things under which dither two companies are joined so as to form a third entity or one is
absorbed into or blended with another".
The merger is done in the following two types:
1) Merger by absorption
2) Merger by consolidation
1. Absorption: Combining two or more companies into the existing company is known as
absorption. In this kind of merger, one company loses its entity and goes into liquidation
and all other companies remain the same. For example, there are two companies A Ltd.
and B Ltd., company B Ltd. is merged into A Ltd: All, the assets and liabilities of the
company B Ltd will be acquired by company A Ltd. and company B Ltd. will be liquidated.
For example, in India there was merger by absorption of Reliance Polypropylene Ltd.
(RPPL) by Reliance Industries Ltd. (RIL) due to which RPPL was liquidated and the
shareholders were given 20 shares of RIL for every 100 shares of RPPL presented with
them.
2. Consolidation: The combination of two or more companies for forming one new company
is known as consolidation. This is also called as triangular merger. Amalgamation is
sometimes used in place of consolidation. In this merger, all the existing, companies loss
their identity and is liquidated for making the new company. All the assets and liabilities
of the consolidating company are acquired by the new company or cooperation. The old
assets are sold to the new company and the control and management is given to the new
company. Like the two companies A Ltd. And B Ltd. are merged to form a new company
known as AB Ltd. or C Ltd. There is difference between merger through absorption and
merger through consolidation. In absorption, one company acquire another company, no
 new company is made while in consolidation, both the companies are merged to make a
new company. In consolidation, the companies are of same size while in absorption the
size of the companies is different. Usually the small company is merged into big company.
Both absorption and consolidation are used correspondently while the ways and issues of
both the forms of mergers are the same.

Why do Mergers Happen?

 After the merger, companies will secure more resources and the scale of operations will
increase.
 Companies may undergo a merger to benefit their shareholders. The existing shareholders
of the original organizations receive shares in the new company after the merger.
 Companies may agree to a merger to enter new markets or diversify their offering
of products and services, consequently increasing profits.
 Mergers also take place when companies want to acquire assets that would take time to
develop internally.
 To lower the tax liability, a company generating substantial taxable income may look to
merge with a company with significant tax loss carry forward.
 A merger between companies will eliminate competition among them, thus reducing the
advertising price of the products. In addition, the reduction in prices will benefit customers
and eventually increase sales.
 Mergers may result in better planning and utilization of financial resources.

Types of Merger
1. Congeneric/Product extension merger: Such mergers happen between companies
operating in the same market. The merger results in the addition of a new product to the
existing product line of one company. As a result of the union, companies can access a
larger customer base and increase their market share.
2. Conglomerate merger: Conglomerate merger is a union of companies operating in
unrelated activities. The union will take place only if it increases the wealth of the
shareholders.
3. Market extension merger: Companies operating in different markets, but selling the same
products, combine in order to access a larger market and larger customer base.
 4. Horizontal merger: Companies operating in markets with fewer such businesses merge
to gain a larger market. A horizontal merger is a type of consolidation of companies selling
similar products or services. It results in the elimination of competition; hence, economies
of scale can be achieved.
5. Vertical merger: A vertical merger occurs when companies operating in the same
industry, but at different levels in the supply chain, merge. Such mergers happen to increase
synergies, supply chain control, and efficiency.

Advantages of a Merger
1. Increases market share: When companies merge, the new company gains a larger market
share and gets ahead in the competition.
2. Reduces the cost of operations: Companies can achieve economies of scale, such as bulk
buying of raw materials, which can result in cost reductions. The investments on assets are
now spread out over a larger output, which leads to technical economies.
3. Avoids replication: Some companies producing similar products may merge to avoid
duplication and eliminate competition. It also results in reduced prices for the customers.
4. Expands business into new geographic areas: A company seeking to expand its business
in a certain geographical area may merge with another similar company operating in the
same area to get the business started.
5. Prevents closure of an unprofitable business: Mergers can save a company from going
bankrupt and also save many jobs.

Disadvantages of a Merger
1. Raises prices of products or services: A merger results in reduced competition and a
larger market share. Thus, the new company can gain a monopoly and increase the prices
of its products or services.
2. Creates gaps in communication: The companies that have agreed to merge may have
different cultures. It may result in a gap in communication and affect the performance of
the employees.
3. Creates unemployment: In an aggressive merger, a company may opt to eliminate the
underperforming assets of the other company. It may result in employees losing their jobs.
 4. Prevents economies of scale: In cases where there is little in common between the
companies, it may be difficult to gain synergies. Also, a bigger company may be unable to
motivate employees and achieve the same degree of control. Thus, the new company may
not be able to achieve economies of scale.

Process of Merger/Steps in Merger

The process of merger is as follows:
1. Defining the Corporate Strategy: In the first step, the company defines the strategy for
their various departments in the company.
2. Implementing the Corporate Strategy: In the second step, the company defines the ways
by which their strategies can be implemented. It also decides whether the merger, joint
venture, strategic alliances or internal development is to be done as the strategy for growing
and diversifying. In this step, there is proper analysis of various alternatives available in
the firm in terms of merger and amalgamation.
3. Target Identification: If the firm finds merger as the better method, then the firm should
put the required efforts to choose the target firm to merge with. It will depend on the factors
like financial conditions, business strengths and weaknesses, the specific resources,
competencies and capabilities of the target firms. It will help in increasing the market areas
by merging two different firms. It also helps in integrating the two different firms with
structures, strategies, culture and processes.
4. Valuation of the Merger: In this step, the financial valuation of the merger is done. The
specific cost - and the premium paid by the firm for acquiring share and management
control should depend on projected synergies which the merger will bring.
5. Merger Implementation: In this step, tax regulation and market issue is analyzed. The
merger is implemented according to the local laws, conditions and share preferences. The
merger is done by the help of stock swap, a tender offer, a cash offer, etc. There are various
problems of merger like obtaining board of directors and shareholder approvals, public
announcement and informing the stock exchanges.
6. Post-Merger Integration: In the last stage, various activities after the merger is done like
selling off those assets in the target company which will be of no use to the merged firm
which is known as stripping, the various methods should be used for enhancing the
operational efficiency and also framing the proper management system at the acquired
 firm. There are forces which is leading to rearrange the operations of the combined firm
for making sure that the projected synergies are gained and various strategies should be
framed for improving corporate culture, providing the right management direction and
leadership and also increasing the competitiveness among the combined firms.

Meaning and Definition of Acquisitions

An acquisition is also known a takeover. It is when one company buys another company. In other
words, an acquisition is when the buyer company purchases the assets or shares of the seller by
paying cash, the securities of the buyer and other assets of value to the seller. When there is stock
purchase transaction then the shares of seller are not going to be combined with existing company
of the buyer and may be kept separately as the new subsidiary or operating division while in asset
purchase transaction, the assets taken by the seller to the buyer becomes an extra asset for the
company of buyer. It believes that the value of assets purchased will be more than the price paid
over the time period. It will increase the value of the shareholder as a result of strategic or financial
advantages of the transaction.
It is friendly or hostile process. In friendly takeover, the companies negotiate about the cooperation
to be done by each other while in hostile the takeover is not informed to the target company and
they are forced to go for a takeover. Thus, acquisition refers to when the large firm purchases small
firm.

Characteristics of Acquisitions
The major characteristics of acquisitions are as follows:
1. Takeover of Firm: In acquisitions, a large company purchases or takes over a small
company by acquiring all its assets which are combined with the large company.
2. Original Identity: The original identities are retained by all the businesses who are
involved in the acquisition process. They do not lose their original identity.
3. Removal of Workforce: When a small entity is acquired by a large company departments
may get closed, and this may also lead to layoffs and forced retirements. Along with this,
major changes take place in the corporate culture.
4. Firm Gets New Name: The name and brand of an acquired company are often eliminated
by the larger company and a new name is given to the firm.
 5. Transfer of Ownership: In acquisition process, the assets, processes and marketing of the
acquired company are been controlled and owned by the larger company.
Types of Acquisitions
There are various takeovers according to the type of acquiring business and the business being
acquired and also the method required for acquiring business to purchase the other. The various
types of acquisition are as follows:
1. Friendly Takeover: The takeover when both the companies agree for the takeover is
known as friendly takeover. The shareholder of the acquired company gets cash or may
receive some number of shares from the acquiring company.
2. Hostile Takeover: In this takeover, one company acquires the other company without
agreement. It is done only in public business because the acquiring companies take the
control of shares in stock of target company.
3. Reverse Takeover: In the reverse type of takeover, the small company buys the bigger
company or private company buys the public company for avoiding the security regulation
required to become a public company.
4. Back-Flip Takeovers: This is a rather uncommon type of takeover in which the acquirer
company becomes a subsidiary of the target company. After the takeover the business is
carried out in the name of the acquired company.

Benefits of Acquisitions
Acquisitions offer the following advantages for the acquiring party:
1. Reduced entry barriers: With M&A, a company is able to enter into new markets and
product lines instantaneously with a brand that is already recognized, with a good
reputation and an existing client base. An acquisition can help to overcome market entry
barriers that were previously challenging. Market entry can be a costly scheme for small
businesses due to expenses in market research, development of a new product, and the time
needed to build a substantial client base.
2. Market power: An acquisition can help to increase the market share of your company
quickly. Even though competition can be challenging, growth through acquisition can be
helpful in gaining a competitive edge in the marketplace. The process helps achieves
market synergies.
 3. New competencies and resources: A company can choose to take over other businesses
to gain competencies and resources it does not hold currently. Doing so can provide many
benefits, such as rapid growth in revenues or an improvement in the long-term financial
position of the company, which makes raising capital for growth strategies easier.
Expansion and diversity can also help a company to withstand an economic slump.
4. Access to experts: When small businesses join with larger businesses, they are able to
access specialists such as financial, legal or human resource specialists.
5. Access to capital: After an acquisition, access to capital as a larger company is improved.
Small business owners are usually forced to invest their own money in business growth,
due to their inability to access large loan funds. However, with an acquisition, there is an
availability of a greater level of capital, enabling business owners to acquire funds needed
without the need to dip into their own pockets.
6. Fresh ideas and perspective: M&A often helps put together a new team of experts with
fresh perspectives and ideas and who are passionate about helping the business reach its
goals.

Challenges with Acquisitions

M&A can be a good way to grow your business by increasing your revenues when you acquire a
complimentary company that is able to contribute to your income. Nevertheless, M&A deals can
also create some hitches and disadvantage your business. You must take these potential pitfalls
into consideration before pursuing an acquisition.
1. Culture clashes: A company usually has its own distinct culture that has been
developing since its inception. Acquiring a company that has a culture that conflicts with
yours can be problematic. Employees and managers from both companies, as well as
their activities, may not integrate as well as anticipated. Employees may also dislike the
move, which may breed antagonism and anxiety.
2. Duplication: Acquisitions may lead to employees duplicating each other’s duties. When
two similar businesses combine, there may be cases where two departments or people do
the same activity. This can cause excessive costs on wages. M&A transactions, therefore,
often lead to reorganization and job cuts to maximize efficiencies. However, job cuts can
reduce employee morale and lead to low productivity.
 3. Conflicting objectives: The two companies involved in the acquisition may have distinct
objectives since they have been operating individually before. For instance, the original
company may want to expand into new markets, but the acquired company may be
looking to cut costs. This can bring resistance within the acquisition that can undermine
efforts being made.
4. Poorly matched businesses: A business that doesn’t look for expert advice when trying
to identify the most suitable company to acquire may end up targeting a company that
brings more challenges to the equation than benefits. This can deny an otherwise
productive company the chance to grow.
5. Pressure on suppliers: Following an acquisition, the capacity of the suppliers of the
company may not be enough to provide the additional services, supplies, or materials that
will be needed. This may create production problems.
6. Brand damage: M&A may hurt the image of the new company or damage the existing
brand. An evaluation of whether the two different brands should be kept separate must be
done before the deal is made.

Exchange Ratio (Swap Ratio)

Settlement of an acquisition deal may be finalized either through the cash payment to the acquired
company by the acquiring company, or through the process of share exchange. In case the second
option is resorted to, the valuation exercise in respect of both the companies is required to be
undertaken. Once the valuation of both the companies is finalized and accepted, the next step is to
calculate the Share Exchange Ratio (SER) or Swap Ratio, which specifies the number of shares
the acquiring company would be required to give to the acquired company's shareholders in lieu
of their shareholdings in that company.

Advantages of Share Exchange

The 'Exchange of Shares' method is advantageous to the acquiring company in following manners:
1) A share-for-share exchange is the effect of the relatively high price-to-earnings ratio of the
acquiring company on the earnings of the acquired company;
2) Delayed of the capital gains tax; and
3) The shareholders of the erstwhile acquired company continue to have financial interest in
that company. They are still able to get a share out of the profits made by the company.
 Although they do not exercise any control over the company, but if they hold the shares of
the original company, they can still anticipate a reasonable return.

Disadvantages of Share Exchange

1) The 'Exchange of Shares' method is unfavorable to the acquiring company in following
manners:
2) This method involves issue of additional equity shares, which is an expensive form of
raising capital;
3) Share exchange is likely to bring down the gearing of the group company at the time of
purchase The impact of the increased number of shares on the share price of the acquiring
company is unpredictable. Any possibility of immediate/future fall in share price needs to
be taken into consideration by the acquiring company while taking a final decision, with a
view to ensuring that the interests of its existing shareholders are protected.

Post-Merger EPS
Many of the publicly traded acquiring companies are taking decisions to get merged on the basis
of the impact of acquis ion on EPS. Post-merger EPS is one of the easiest summary measure used
for depicting the economic impact of acquisition or merger on the acquirer. Thus, many of the
market analysts or the investors are using this measure. A condition of earnings dilution, even
temporary in nature, may adversely affect the market value for the acquiring company:
Post-merger EPS is computed as the Combined EPS, where the total earning after merger is divided
by the total number of shares after merger (including the number of shares of acquirer and the
target stock outstanding).
The formula for post-merger is as follows:
Post-Merger EPS = Total Earning After Merger/ Total Number of Shares after Merger
Or
Post-Merger EPS = Total Earning after Merger/ (Number of Shares of Acquirer + Number
of Target Outstanding Shares)

Post-Merger Price of Shares

Post-merger price of shares or the share price of combined firms is the other common measure
used for depicting the anticipated EPS for combined firms and the P/E ratio at which the investors
are ready to pay for the anticipated per-share earnings. Normally, the process of post-merger price
of shares can be well understood under three situations:
1) A share for share Exchange
2) All cash purchase
3) Combination of cash and stock
In many cases, the post-merger share price is computed by multiplying the post-merger EPS with
the applicable P/E ratio, where the prevailing P/E is assumed to be the P/E ratio of the acquiring
firm.
The formula for computing the Post merger EPS is as follows:
Post-Merger Share Price = Post Merger EPS x Pre-merger P/E of acquiring firm
1) Share for Share Exchange: Under this situation, the acquiring company acquires the
target company by involving in a share for share transaction, where the target company
receives specific amount for each shares of its common stock.
2) All Cash Purchase: Under this situation, the target company agrees to receive cash instead
of shares from the acquiring company. Thus, it receives cash payment of 100 percent of its
outstanding stock at the agreed price for each of its share of common stock outstanding.
The shares of common stock held by the target company will get terminated when the
transaction of all purchase gets completed. In this case, the acquiring company is using its
pre-merger P/E ratio for the computation of post-merger share price. In addition to this, the
purchase price paid by the acquiring company, is made out of the cash balances held by it
after meeting its normal cash requirements.
3) Combination of Cash and Stock: Under this situation, the target company agrees to
receive purchase consideration partly in cash and partly in stock.

Meaning of Synergy
The term 'Synergy' is taken from the Greek word 'sunergos' which means 'separate parts works
together'. Originally, this term is used for representing the relationship between the two separate
parts.
However, the expectations from Merger and Acquisition synergies in today's scenario are quite
different from the original meaning of synergy because the former focuses more on representing
the relationships between the actual results generated by the two parts collectively.
As a concept of mergers and acquisitions, synergy is defined as the value and performance of two
combined companies, which is always intended to be greater than the aggregate value and
performance of individual companies or parts separately.

 Operating/Business Synergies: Business synergies have enough potential to be realized in all

direct as well as indirect functions along the value chain of company. Direct functions can be
related to sourcing, production, distribution, sales etc., whereas the indirect functions can be
related to research and development, marketing, human resources etc. The primary sources
that derive operating synergies are as follows:
1) Economies of Scale
2) Economies of Scope
3) Multi-Plant Economies
 Financial Synergies: As compared to the business and marketing synergies, the existence of
financial synergies, is a matter of controversy among various academics and practitioners.
Normally, the capital cost can be decreased under the following conditions:
1) When the merged companies have such cash flows that are not correlated (like in
case of co-insurance); or
2) When the financial economies of scale is realized from lower securities and
transaction cost, or
3) When a better match of investment opportunities is realized with funds generated
internally.
The cost of borrowing can be lowered, if a company facing the problems of insufficient
funds is combined with a financially sound company. Financial synergies may result in:
1) Reduced Cost of Capital Procurement
2) Higher Market Valuation
 Managerial Synergies: There is no direct impact of managerial synergies on revenues, costs
and investments of merging companies.
Moreover, such synergies are also not useful for value creation. Nevertheless, their
importance cannot be overlooked because the business, market and financial synergies are
indirectly facilitated by the managerial synergies.
Such synergies are derived when a company with inferior management is merging with the
company having superior ability management. This helps the inferior management
company to make profit. In some cases, such companies can decrease their managerial
overheads because of managerial synergies.
 Market Synergies
The companies can attain market synergies based on the following sources:
1) Market Power Synergies: This source is primarily derived through size when a
small company merges with a large company. In this case, the large company can
influence the prices, quantity, and also the nature of product in market place.
The economies related to monopoly and to monopsony are different from each
other. Monopoly economies are associated to the market power of seller over the
buyers. On the other hand, monopsony economies are related to the market power
of seller over the suppliers. Although such synergies are beneficial for merging
companies, but they adversely affect the entire economy as it transfers more volume
of wealth to the owners of merging companies from the customers or the suppliers.
2) Market Expansion Synergies: After merger, the combined companies can cover
additional demand of customers by cross-selling their products. On the other hand,
it also enables them to increase their supplier base for optimizing the quantity and
cost of the inputs. Thus, they have market expansion synergies on customer side as
well as on supplier side.

Synergy Benefits
The synergy benefits are as follows:
1) Increase in Revenue: The merged companies have a strong customer base because they
are able to sell more goods and services through broadened product distribution and thus
after merger the revenue of merged companies is significantly increased.
 2) Reduction in Expenses: After merger, the combined companies can reduce their expenses
by optimizing their internal positions and by allotting additional responsibilities to the
existing roles.
3) Optimization of Process: After merger, the combined companies can optimism the
production or distribution process by considering the improved marketing tactics and
strategies, branding, advance technologies, and by implementing more effective
distribution methods.
4) Financial Economy: Based on the legal perspective, the combined companies can avail
tax benefits or support from the government. However, the acquiring company cannot
optimize the strategic position of the company just based on the financial economy. Thus,
financial economy cannot be a single value driver for accepting the deal of merger and
acquisitions.
5) Combined Workforces: After merger, the combined companies can improve their
efficiency and they can increase the volume of business by recognizing and eradicating the
terminations or by restructuring the flow of work.
6) Combined Technologies: After merger, the combined companies can combine their
technologies, which are alike in nature for attaining the strategic advantages in domestic as
well as in foreign market.
7) Market Expansion: After merger, the combined companies can enlarge the base of
customers and suppliers. This enables them to avail all opportunities present in a specific
market as well as to enter into a new market.
8) Reduction in Costs: After merger, combined companies can increase their purchasing
power and reduce the costs. Such reduction in costs is possible when the negotiation of the
company with the vendors is made on better terms, depending upon the demand for more
raw materials due to increase in output.

Concept of 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 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 unit 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 demerger is to divide a company into various units for achieving the
specialization in a particular segment.
Demerger or spin-off is just reverse strategy of merger which implies the strategy to join number
of companies so that the firms intend to work together under the same roof.
Alternatively, demerger is the opposite of 'uniting of interest' or 'amalgamation in the nature of
merger'. The shares are issued to the shareholder of demerged company by the new company that
is having individual economic and legal identity distinct from the demerged company.
Consequently, the large numbers of shareholders of 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 period. 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 The following are the reasons for demerger:
1) Rearrangement of the current business by way of separating various activities into several
segments.
2) In order to divide the management into various smaller units.
3) To use the concept of responsibility accounting and accountability.
4) In order to safeguard from the business units which experience a regular cash loss and also
to safeguard from the activities which consist of high risk.
5) To have efficient management system in the units.
6) To provide a security against the valuable assets from the predator through hostile takeover.
7) Evasion of repetitive interruption by the government and its agencies in the business.
8) To segregate the business owned and controlled by a family.
9) To acquire additional opportunities and to provide a security for danger.
10) Division of undesirable activities and focusing on the main activities.
11) Facilitating management buy-out.
Types of Demerger
There are two main types of demerger which are discussed below:

Types of Demerger

Split-Off Split-Up

 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 shareholder of the parent company in lieu of the same
amount of stock to be traded in the latter period of time is 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-off is a method in which the subsidiary unit is structured by the parent company and the
parent company gives some portion of their share to the subsidiary unit in lieu of all the capital
stock of the subsidiary unit transferred to the shareholders of the parent company.
A new company is formed in split-off to take over the operations of an existing unit.

Reasons for Split-Offs

The strategy of split-off is profitable due to the following reasons:
1) Exchange Premium: The premium for transferring the share can be earned by split-off.
The exchange premium that is provided enhances the return or profits of the companies.
2) Odd-Lot Preference: It is expected that there is a restriction imposed on the transfer of
shares in split-off situation. In order to escape from oversubscription to offer, the amount
of shares exchanged will be prorated only when large number of shareholder in the parent
company decide to transfer their shares for the division of stock. On the contrary, before
the occurrence of any prorating all the stocks are to be transferred first which are offered
by the shareholder holding 99 shares in case when split-off opportunities offers an odd-lot
preference.
 3) Focus: The concentration on parent company's business is raised in split-off and thereby
they are able to focus on core activities of business. Hence, it is said that they focus on
single line of business. The business that is simplified is given more importance as
compared to the any parent company. There are investors who judge value the corporations
or units by aggregating the different activities performed in the company.
4) Require Action: The shareholder cannot take - benefit of split-offs by presenting
themselves as passive investor. There is a requirement to buy shares from the parent
company and then request the broker to tender his shares by providing necessary
guidelines. This is done to get the exchange premium.

 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 other two or more companies. The parent company in this situation
gives up the total amount of their stock in exchange for the stock of transferee company.
In other words, split-up demerger is a method where the parent company is divided into two or
more independent or separate company and parent company exists. In every situation, the shares
of parent company are transferred to the new or subsidiary companies with the precise division of
share in each independent company. This is an efficient method of splitting-up of a single company
into numerous segments.
In order to cease the parent company and to form a new units or offspring's, the whole company is
divided into the sequence of spin-offs in split-up demerger.

Advantages of Demerger
The advantages of demerger are as follows:
1) Separation of Management of Divisions: The main advantage is separation of
management to division to determine the responsibility and accountability of each
individual company. Thus, to have a proper management structure. As a result, the
efficiency and productivity of the company is increased.
2) Safeguard against Cash Loss Risks/Non-Profitability due to High Risk: In order to
minimize the risk in the company mainly at the time of high risk is expected in the business
then each individual unit is separated having a separate entity form the parent company
and with specialized responsibility centres such as profit centre.
 3) 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.
4) 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
aid in restructuring the processes and also aid in decluttering. • Hence, leads to increase in
productivity and optimum utilization of resources are available in the parent company as
well as in its segments.
5) Defence against Hostile Takeover: Spin-off is a very important defensive strategy. Spin-
off aid in protecting the valuable assets from the predator is most profitable portion of the
business. In order to acquire the benefits the companies displays the risky and non-
attractive situation in front of the predator.

Disadvantages of Demerger
The disadvantages of demerger are as follows:
1) Loss of Economies of Scale: The cost of production might increase and profitability may
be reduced when a demerger is done in a situation of diseconomies of scale when the
company does not undergo the situation of diseconomies of scale
2) Increased Costs and Overheads: Demerger is a quite expensive process as a single
company is breakdown into numerous companies which will incur cost. Therefore, the
costs are increased by creating a separate entity which will affect the profitability of the
company. As a result, there will be a need of repetitive allocation of resources of equipment
which automatically raises the cost of production. Hence, the additional expenditure
incurred should be carefully analyzed.
3) Difficulty in Raising Additional Funds: The reliability of the demerged company as a
new entity is very less with the lenders of funds because parent company has portrayed risk
for the investors against the demerged or the subsidiary company. Therefore, it becomes
very difficult to raise additional funds form the new company.
4) Lower Turnover and Profits: The overall profits and turnover may be reduced for the
new companies as it was anticipated because of increase in costs, scarcity of resources and
 funds. One other important reason for lowering of profit is that it is a very challenging task
to form a company as a new entity.
5) 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 where 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.