Companies often reach a point where they decide to restructure in some form. While corporate restructuring can be associated with failing performance and a need to cut back, there are many types of restructuring that can be beneficial when done with care, accuracy and transparency. Spin-offs are a good example.
Spin-offs allow a company to create a new organization out of an existing business unit or subsidiary. Unlike divestitures or private equity buyouts, spin-offs allow the company to retain some control over the process by creating the new business and often filling the board with existing company stakeholders. They also pave the way for current shareholders to increase their value by receiving distributed shares in the new company.
What is a Company Spin-Off?
Some companies realize that their functions are too numerous to dedicate attention to all of them. Businesses that expand very quickly may ultimately decide that certain aspects of daily operations provide value but create complication for the whole. In these cases, the company may decide to spin off a division or subsidiary. The spin-off will become an independent company.
Unlike an equity carve-out or divestiture, the structure of the new company comes from within. The board of directors for the new business is often selected from the parent company, and many of the employees in the spun-off unit may remain in their jobs. Assets and liabilities are divided according to the parent company’s specifications, usually related to the necessary function of the spin-off. At the conclusion of the spin-off, the parent company creates shares in the new entity and distributes them to each existing shareholder on a pro-rata basis.
How a Company Spin-Off Works
A spin-off can take several months to complete, but it depends on the company’s organization and documentation. The right balance is key, because companies that take too long risk lowering the value of the parent company or the target unit due to distraction with the spin-off process. The process requires several steps, including:
Strategic planning and board approval of the spin-off
Structuring the transaction, including estimation of share value and division of shares
Carving out financial information for the spin-off and preparing documentation
Submitting regulatory filings and disclosures related to the spin-off
Distributing the shares
Launching the standalone entity
Finalizing operational and reporting independence after completion of the spin-off
As with corporate restructuring, companies must identify various operational dependencies related to the spin-off, so that they can be divided sensibly. This is key to ensuring that the parent company and spin-off can function independently.
Why Companies Pursue Spin-Offs
Organizations decide to pursue a corporate spin-off for a variety of reasons. In general, the goal is to increase value of the parent company and the spin-off. For example, a company selling various technologies and services may observe that a specific division is performing exceptional well. Company executives worry that the business unit will not grow sufficiently under the constraints of the whole, so they decide to spin it off. The spin-off allows the parent company to focus on its core functions, while unlocking shareholder value in the new entity in ways that they could not by simply selling off the unit.
Sometimes, company spin-offs are intended to provide strategic value to all units of the business. When one division is absorbing all the resources, spinning off that division could help the organization improve its operational accountability and create new growth strategies for each entity. A company may also choose to spin-off a division as a way of balancing competition or meeting regulatory requirements.
Financial and Accounting Considerations in a Spin-Off
Creating a spin-off requires extensive financial preparation and evaluation of various accounting considerations. These include:
Generating carve-out financial statements that focus entirely on the financials of the new entity
Preparing historical reporting to show financial performance of the business unit
Establishing pro forma financials to predict the performance of the new company under certain scenarios
Allocating costs, debt and assets between the parent company and the spin-off
Creating internal controls and audit trails to ensure audit readiness
Continuing with public company reporting obligations for the parent company
The ease of this aspect depends on the systems in place. Companies should have automated data collection and management to ensure accuracy across divisions and the centralization of data for document preparation. Incomplete or inaccurate records can slow the spin-off process dramatically or present inconsistent information to investors.
Regulatory and Compliance Requirements
During a spin-off, the parent company will need to continue meeting regulatory guidelines, such as submitting annual reports, maintaining data security, and managing documentation. The compliance requirements for a stock spin-off depends on whether the company is public or private. Public companies in the process of spinning off a division will need to file SEC Form 10-12B. This form functions as a registration statement of shares for the new entity, creating new securities that can be assigned to existing shareholders in the parent company. Accuracy, transparency and timeliness are critical aspects of the filing process, vital for regulatory approval.
Tax treatment depends on the way that the company structures the spin-off. Shareholders may not have to pay capital gains taxes on the distribution until they sell the new shares. This presumes that the company follows Section 355 in the spin-off, which requires that both companies remain functional and separate. If corporate governance is heavily shared between the two entities, the IRS may restrict the tax advantages of the distribution of new shares.
How Technology Supports Successful Spin-Off Execution
Technology paves the way for a successful spin-off with streamlined data collection and management, paired with secure collaboration. Compliance workflow automation involves the creation of systems and controls to ensure that the company has everything it needs to maintain routine compliance. The right tools can provide the following benefits:
Secure document management to contain proprietary knowledge and continue meeting SEC security requirements
Virtual data room software to encourage effective collaboration with multiple parties regardless of location
Workflow automation to simplify data collection and processing for filings
Version controls and comprehensive audit trails
Real-time data visibility for all stakeholders, internal and external
Support to maintain compliance before, during and after the spin-off
These tools can ensure greater accuracy for disclosures and reporting, which increases the likelihood of regulatory approval and improves investor confidence in the spin-off.
Spin-Offs as a Strategic Growth Tool
A spin-off is a big decision that requires careful, strategic analysis from the company before execution. Effective spin-offs can help the business consolidate its functions and improve focus on its strategic goals, while creating a new entity that provides additional value for shareholders. They can even improve regulatory compliance or simplify financial reporting for each entity. Ineffective spin-offs can put both entities at risk, leaving the spin-off without proactive governance or the parent company with too many loose ends.
Early planning and alignment are important for success. Companies must ensure that they have their documentation handled, to maintain compliance and ensure the accuracy of financials for the parent company and spin-off. Structured processes and reliable technology make the difference between streamlined preparation that speeds approval and significant inconsistencies that slow the process.
