Infinity | Corporate assets and workouts - asset-light operations
Preface
ZHIHENG
Mergers and acquisitions, as well as corporate restructuring, are very common among large companies. The primary objective of M&A is to achieve scale expansion, while the main purpose of restructuring is to reduce the company’s size. The methods of restructuring includeAsset sales, asset swaps, corporate spin-offs, debt-to-equity swaps, and debt forgivenessand various other methods. The light-asset operation described in this article encompasses one or more of the aforementioned approaches.
In traditional financial and corporate finance theory, a company’s total assets are one of the most important indicators of its size. Financial institutions place great emphasis on this metric when approving loans and assessing collateral, and upstream and downstream partners also take it into account in their collaborations. Consequently, firms often exhibit a strong incentive to expand their asset base as they grow.
Moreover, due to insufficient capital, most enterprises have opted for high-debt, high-leverage operations by relying on loans and delaying payments to upstream suppliers. When the economy is growing rapidly—when, as the saying goes, “even pigs can fly when the wind is strong”—high levels of debt and leverage can generate substantial profits for businesses. When the economy is in a downturn, high levels of debt and leverage can easily become the final straw that breaks the camel’s back.
No matter how many assets one holds, insufficient cash flow will ultimately lead to bankruptcy and closure—nothing more than a fleeting dream.
Case Assumption
ZHIHENG
Suppose Mr. Liu has 20 million yuan and plans to invest in an auto parts company. He has the following two options to choose from.
Option One:The auto parts company established by Liu purchased 50 acres of land in a certain industrial park through an investment promotion program, at a preferential price of RMB 200,000 per acre. The prevailing “five connections and one leveling” price for industrial land in the area is RMB 600,000 per acre. After obtaining the land, Liu used it as collateral to apply for a bank loan of RMB 15 million, with a term of three years and an annual interest rate of 5%.
Subsequently, the construction of the factory will proceed. In the first phase, a new 10,000-square-meter factory building will be constructed at a cost of RMB 15 million, with RMB 5 million allocated for the purchase of machinery and equipment, while the remaining funds will be used for day-to-day operations.
Option Two:The auto parts company established by Mr. Liu directly leased a 10,000-square-meter factory building in the local industrial park at a monthly rent of RMB 15 per square meter. The purchase of mechanical equipment amounts to RMB 5 million, with the remaining funds allocated to daily operating capital.
If we make a simple calculation, Mr. Liu would undoubtedly choose Option One, as under this option he immediately “earns” RMB 20 million from the land purchase; moreover, his company is required to pay annual interest of RMB 750,000, whereas under Option Two it must pay annual rent of RMB 1.8 million.
However, Plan One is not as ideal as one might imagine.If the economy experiences rapid growth and the land and industrial‑factory‑building markets are active, Liu could indeed make a profit. If the economy experiences a downturn or even a recession, Liu’s land and factory buildings will instead become a liability.
In Plan One, Mr. Liu’s company has liabilities of RMB 15 million and working capital of RMB 5 million. In Plan Two, Mr. Liu’s company has RMB 15 million in funds available for working capital. As the scale of operations expands, outstanding receivables and payables with upstream and downstream partners will continue to grow; it is certain that,In Plan One, the remaining RMB 5 million is insufficient; Liu’s company will have to either take out another bank loan or raise funds through private lending.
Debt can grow from 15 million to 20 million, then to 50 million, and even 100 million—like a snowball rolling downhill, it keeps getting bigger and bigger, leading down a path of no return.
This is not me exaggerating; in bankruptcy cases handled by the courts, the vast majority are caused by insufficient capital and either excessively high absolute or relative debt levels. For example, a major real estate developer with capital of several billion yuan can see its liabilities balloon to two trillion yuan through such compounding effects. In Scheme Two, the remaining RMB 15 million in funds is largely sufficient to meet day-to-day operating needs; even if external borrowing becomes necessary, the amount would not be substantial and would remain within a manageable range.
The above‑described plan is illustrated and analyzed using a newly established company as a case study. For enterprises already burdened with substantial debt, it remains possible to reduce liabilities and achieve light‑asset operations by divesting assets such as factory buildings and land. At this juncture, do not hesitate to divest non-essential assets such as land and factory buildings; even if it entails some losses, these assets should be sold decisively to free up cash. Otherwise, the company may face bankruptcy due to an excessive debt burden and insufficient cash flow.
The longer time passes, the lower the chance of survival. In cases where most loans require shareholders to provide personal guarantees and corporate and personal finances are intertwined, it can even lead to the loss of one’s entire fortune.
Of course, for companies in specialized industries such as chemicals, owning land and factory buildings is often a necessary choice; in such cases, it is essential to plan the investment and financing structure in advance.
Attorney Profile
ZHI HENG
Liu Taibo
Full-time lawyer at Zhiheng (Chongqing) Law Firm
Areas of Expertise:
Investment and Financing
Asset restructuring
Debt risk resolution
Commercial dispute
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