A wave of corporate breakups has swept through the United States in recent years as investors recognize that smaller companies focused on single businesses are outperforming their more diversified peers.
Many of these breakups have been spinoffs, whereby a publicly-traded parent company (parent) distributes the shares of the spinoff company (spinco) to its own shareholders, creating a new, independent, publicly-traded entity.
Companies often spin off businesses or divisions to unlock value when those entities are trapped in larger corporate bureaucracies or holding-company structures that offer inadequate capital, encumber decision-making and dilute equity incentives for division management.
While they’re popular, spinoffs are complicated and require a great deal of planning. Although CFOs must remain highly focused on preventing parent company and shareholder tax exposure, they must also keep in mind many critical non-tax considerations when embarking on spinoffs.
1. Separation (and Potential Sharing) of Assets
Before a business or a division can be spun off, both its assets and liabilities must be separated from the parent. Large companies with long operating histories may struggle in the separation process. Often that’s because the entities that house the business may also house others that share assets, services, products, employees, vendors and customers.
Pre-spin separation transactions should avoid triggering contractual defaults and remedies under commercial, financing, intellectual property licensing and collective bargaining agreements, as well as employment contracts, benefit plans, and more. Often spinco and parent or other legacy businesses must enter into complex sharing or licensing agreements or joint ventures relating to valuable IP, like trade names, trademarks or patents, as well as employee matters.
2. Separation of Liabilities and Solvency Concerns
Pre-spinoff liability-sharing is often extremely complicated in the spinoff because it provokes many legal obligations. When allocating liabilities to the spinco, CFOs and outside advisors should evaluate the potential impact they will have on the solvency of both parent and spinco. Parent directors may face personal liability under state law for making an unlawful dividend if the parent company lacks sufficient capital to do so or if the dividend renders the parent insolvent.
The parent may also face constructive fraudulent conveyance claims. For example, the parent may receive less than equivalent value when it spins a business off, and either is rendered insolvent (its assets do not exceed its liabilities), is left with unreasonably small capital to operate, or is left with debts that exceed its ability to pay them as they become due.