A corporate spin-off happens when a company separates part of its operations – such as a division or business unit – to form a new, independent entity. Following the spin-off, shareholders of the parent company receive shares in the spun-off subsidiary in proportion to their existing ownership.
Corporate spin-offs can have benefits for multiple stakeholders:
- Enables a divested business unit to be more profitable as an independent company than it was as a part of its parent.
- Investors may benefit from the flexibility, simplicity, and focus of spin-offs.
- The parent company can achieve greater value since executives are free to focus on key issues and improve margins, growth, and valuation across all lines of business.
As an added benefit, a spin-off can be achieved in a tax-free way to both the parent company and shareholders.
However, any spin-off is a complex undertaking, fraught with a range of legal, compliance, and tax responsibilities.
Potential impact of tariffs on spin-offs
The recent implementation of broad tariff measures – along with the possibility of further actions – has created a climate of uncertainty for businesses. This environment is pushing companies to devote more time to planning and developing contingency strategies.
In response to current pressures, some companies are looking into spin-offs or restructuring parts of their business. These actions aim to cut costs related to tariffs, make operations more efficient, focus on more profitable areas, and increase shareholder value. One key reason for a spin-off is the idea that the parent company is undervalued, often due to poor management or strategy. By separating certain business units, the hope is to achieve a higher overall market value.
As Axios reports, the scale of corporate spin-offs is growing, with CEOs now targeting ambitious and transformational separations, beyond just shedding underperforming divisions. Additionally, corporate boards and executive leadership are pursuing large-scale breakups before activist investors pressure them into it.
The Treasury Department and the IRS have suggested new rules about tax-free spin-offs, split-offs, and similar corporate transactions. If these rules are finalized, they will change how spin-offs work, including how companies handle debt and certain reorganizations and incorporation events. These proposals follow two important announcements from the Treasury and IRS made last year. The new rules also come with detailed and possibly burdensome documentation and reporting requirements, which could make compliance difficult for the affected companies.
No two spin-offs are the same
The success of a corporate spin-off depends on many factors.
Spin-off transactions have surprisingly strict and short timelines. During this period, deal teams must identify how the new entity will be separated from the parent and meet legal and compliance requirements for the parent company and the spun-off entity. In addition, deal teams must determine governance issues such as the composition of the spin-off’s board of directors, potential conflicts of interest, and more.
Regulatory, tax, and reporting requirements can vary significantly depending on the exit structure, method, and jurisdiction, and usually involve different timetables and locations.
Failure to address these and other issues can be damaging for both parties.
To address these requirements, below is a checklist outlining the critical steps, considerations, and trigger events for any spin-off.
Phase 1: Strategic planning for corporate spin-offs
For a successful spin-off, the parent company must have a clear understanding of transaction priorities and ensure all levels of the company are aligned behind them.
Below are key steps to follow during this phase:
- Assemble a team comprising key individuals from both the parent company and, if necessary, the spin-off entity. This team will review and resolve key issues associated with the transaction.
- Develop a detailed spin-off strategy, encompassing various critical aspects such as:
- Business objectives.
- Identification of assets to be spun-off, including contracts and intellectual property.
- Capital structure considerations.
- Tax implications.
- Configuration of the operating model, organizational structure, and governance framework.
- Evaluation of senior management and staffing requirements.
- Director and board composition.
- Compensation, regulatory compliance, and other pertinent matters.
- Define the relationship between the parent company and the spin-off. The separation of entities can vary from day one depending on the interoperability of systems, abbreviated spin-off timeline, etc.
Phase 2: Comprehensive preparation for corporate spin-offs
Unforeseen regulatory constraints or demands have the potential to disrupt the spin-off process and lead to unwarranted delays. It is crucial to assess these implications across all jurisdictions, particularly when establishing new legal entities. Early planning is essential, as the groundwork for post-spin filings must coincide with the spin-off company's SEC registration process.
This phase explains the tasks required to carry out the separation, with certain steps overlapping with those in phase one:
- Engage a team of multidisciplinary third-party consultants to advise on regulatory issues.
- Establish a timeline with key dates and tasks (such as soft- and final spin-off dates).
- Develop a communication plan and strategy, including which stakeholders will have knowledge of the spin-off before it is made public (employees, partners, vendors, regulators, etc.)
- Form the subsidiary entity (select and reserve a name, choose a registered agent, draft and file articles of incorporation, etc.)
- Establish a spin-off company board. Elect directors and officers and adopt bylaws (including takeover defense provisions) and adopt and implement corporate governance policies.
- Draft separation documents, including a separation and distribution agreement, transition services agreements, commercial agreements, and tax matters agreement.
- Address and resolve any regulatory compliance issues and secure regulatory approvals, where necessary.
- Prepare the requisite SEC filings and registrations for both the parent and spin-off companies.
- Identify systems and processes that require replication or replacement in the spin-off, assessing the need for any redundant services.
- Conduct a comprehensive review to determine which records and data should be phased out (sunset) and which should be retained after the spin-off.
- Conclude the process by finalizing financial statements.