A spin-off company can be understood as a new, independent company resulting from either a separation or a solution from a larger parent company. The action of ‘spinning-off’ a company may be achieved by distributing or separating the shares (including its assets, employees, and intellectual property) from the parent company as special dividends on a pro-rata basis.
There are number of reasons why parent companies create spin-offs. One common motive is to allow the parent company to focus on core operations and on the management of its resources and divisions while using a spin-off to expand into a wider market. While this can potentially have higher costs, it can also potentially scale up profitability. Another common scenario is when a company with no potential to grow or experiencing little growth creates a spin-off, so it can direct efforts to a product or service with higher growth prospects.
A company may also separate a business unit into its own entity if the company has been unsuccessful in finding a buyer to acquire the unit. For example, the offers to purchase the unit may be unattractive, and the parent company might realize that it can provide more value to its shareholders by spinning-off the business sector.
Creating a spin-off of the company also provides a stronger operational transparency for the company that has multiple lenders and/or investors who have disparate images and information. With more focus on the field of work and shorter bureaucracy in the company, transparency tends to be supervised easier, which undoubtedly adds to validity to the company’s true value.
However, there is another side of this issue that should be examined. There are distinct disadvantages of forming a spin-off. One obvious drawback is that changes in the company’s cost structure might have negative impacts. If a company has spread its fixed costs including rent, maintenance, personnel allocation, and administrative support over two or more business units, the remaining business units must now absorb those costs. This also may affect partnership agreements, support agreements, and such. These contracts must either go with the spinoff company or undergo further modification.
Now that we have considered some benefits and weaknesses of spin-offs, what about their structure? The form of spin-offs itself may vary depending on the purpose and benefits of the spin-off. Some of the possible structures are as follows:
- Pure Play
A Pure Play Spin-off compels shareholders to distribute shares of the subsidiary as a special dividend, but the companies have a common shareholder base. This method can be easily distinguished from an initial public offering (IPO), whereas the parent company actually offloads some or all of its ownership in a division rather than just divesting it without any consideration to the company’s cash.
- Equity Carve-out
In this method, the parent company sells an interest of less than 20% (twenty percent) of the new subsidiary to the public in a registered public offering for cash proceeds instead of just existing shareholders.
- Tracking Stocks
As opposed to a spin-off where a division becomes separate from the parent company and establishes itself as a financially and managerial autonomous company, Tracking Stocks Spin-offs represent shares that are still very much a part of the parent (i.e no legal split of the assets or liabilities). The parent company and tracking stock spin-off have a common management team and board of directors. However, this spin-off represents a separate financial reporting and analysis from their parent company.
- Partial Spin-off (Stubs)
When a company distributes shares in a subsidiary to the public while retaining ownership to some extent, it is known as a Partial Spin-off. Once the spun-off unit or the subsidiary becomes publicly traded, we can determine the market value of the investment by the parent company in the subsidiary.
While it’s clear there are a variety of factors involved with and types of spin-offs, thoughtful and informed decision making is critical. Having the right legal counsel to advise on these matters can both allow growth directives to be met and prevent future complications from occuring. Please inquire at Schinder Law Firm for assistance.
Jakarta, 31 July 2018
Written by Juliani Hanly, SH and assisted by Geoffrey Auryn, SH