While it may not be suitable in all cases, the spin-off of a subsidiary or a division into a stand-alone public company should be considered among these strategic options.
In a typical spin-off transaction, the parent company (Parent) “spins off” its subsidiary by distributing all of that subsidiary’s stock to Parent’s stockholders. After the transaction, both Parent and the spun-off entity (SpinCo) have separate and independent existences with the stockholders of Parent owning the stock of Parent and, initially, the stock of SpinCo.
As used in this article, the term “spin-off” does not include a:
„ Split-off, which involves Parent offering stock in a subsidiary in exchange for a specified number of Parent’s shares held by Parent’s stockholders.
„ Subsidiary offering, which occurs when Parent makes a public offering of its subsidiary’s stock.
„ Split-up, which involves Parent distributing stock in its subsidiary to its stockholders after which Parent dissolves.
REASONS FOR A SPIN-OFF
Some of the key reasons why companies decide to engage in spin-offs are to:
„ Enable management to focus its attention on its core business, while allowing non-core businesses the resources and management attention to develop and realize full stockholder value.
„ Incentivize officers and employees of disparate business lines by allowing management of those lines to implement appropriate employee compensation packages without the friction and administrative burden created by having differing employee compensation metrics within the same organization.
„ Separate a subsidiary from Parent in preparation for that subsidiary’s sale to a third party.
„ Maximize stockholder value in highgrowth business lines that may be undervalued due to their performance being obscured by their attachment to slower-growth businesses.
„ Shed businesses that are no longer wanted and no longer fit within Parent’s business plan but that either are illiquid or do not have a current market valuation that Parent believes to be fair.
„ Allow Parent and SpinCo to raise capital and seek financing separately which may allow either entity (or both) to do so more effectively and efficiently.
„ Establish a takeover defense. Spinningoff a subsidiary may make Parent less attractive as a takeover target without destroying value for existing stockholders (as those stockholders get the stock of the subsidiary).
„ Avoid regulations. Following a spinoff, Parent and/or SpinCo may not be subject to the same regulatory regime post-transaction as they were pre-transaction and, depending on the cost and administrative burden of the regulations, may unlock stockholder value that would otherwise be suppressed.
„ Reduce costs. Although spin-offs may in certain circumstances have the potential to increase costs through loss of synergies, in certain scenarios costs may be reduced. For example, before the spin-off, the subsidiary may have been subjected to extraordinary costs by virtue of its affiliation with a particular Parent business.
„ Eliminate conflicts between Parent and SpinCo business lines.
TIMING AND PROCESS
A typical spin-off transaction can be completed in about six months: two months of preannouncement preparation followed by four months primarily focused on the SEC and distribution process. For a general list of the key process tasks that should be taken when conducting a spinoff, see Box, Conducting a Spin-off and for a detailed sample timeline of the principal steps involved in a spin-off, see Box, Spin-off Transaction Timetable.
PRIMARY DOCUMENTATION
The distribution agreement (also referred to as the separation agreement) sets forth the basic terms and conditions of the spin-off, including:
„ The assets and liabilities to be allocated to SpinCo.
„ Cross-indemnifications of historical liabilities.
„ Representations and warranties regarding the assets and liabilities to be transferred.
„ Tax-related covenants and indemnifications.
„ The mechanics of the distribution.
Other agreements typically necessary to document the allocation of assets and liabilities and employees between Parent and SpinCo, post-spin-off services and other operational relationships between Parent and SpinCo or other aspects of a spin-off include: „ Tax allocation agreement. „ Employment and benefits agreement. „ Intellectual property agreements. „ Insurance agreement. „ Environmental agreement. „ Legal proceedings agreements. „ Transitional services agreement. „ Leases. „ Supply agreements. „ Management services agreement.
ASSET AND LIABILITY ALLOCATION
In any spin-off, Parent must transfer the relevant assets and liabilities to SpinCo unless the assets and liabilities already reside in SpinCo. Many of the considerations and issues involved in this transfer are similar to the issues and considerations involved in any sale of a business or division to a third party.
GENERAL CONSIDERATIONS
The allocation of assets and liabilities between Parent and SpinCo generally tracks the underlying businesses being retained by Parent and those being spunoff with SpinCo. Therefore, assets related to, or liabilities arising from, businesses that are being spun-off generally would be transferred to SpinCo. This allocation becomes difficult when various assets, services or personnel are used before the transaction by both Parent and the business to be spun-off. In addition, if both Parent’s business and that of SpinCo are operated in an overlapping manner, it can be difficult to trace certain known or contingent liabilities (such as environmental or litigation liabilities). In such cases, it is important to pay careful attention to identifying those assets and liabilities that are staying with Parent and those that are being transferred to SpinCo in the distribution agreement (for example, through use of qualifiers such as “primarily related to” or schedules of specifically enumerated assets and liabilities).
PRE-EXISTING SPINCO
For a spin-off involving a pre-existing SpinCo, conduct due diligence early to determine which assets and liabilities to be spun-off already reside in SpinCo and which ones must be transferred to SpinCo.
ASSIGNMENT AND CHANGE OF CONTROL ISSUES
Review all contracts to which SpinCo is a party (or is intended to be a party following the transfer from Parent) in the context of the contemplated transaction (including the assignments, transfers, contributions, dividend and other corporate actions planned to effectuate the spin-off) to identify anti-assignment and change of control provisions that may necessitate obtaining third-party consents.
SOLVENCY AND FRAUDULENT TRANSFER
Ensure that no transfer of assets or liabilities between Parent and SpinCo in connection with a spin-off subsequently may be voidable as a fraudulent conveyance. Similar to the ultimate spin-off dividend of the shares of SpinCo, such asset and liability transfers generally are not made in return for “reasonably equivalent value.” Therefore, the transfers may constitute fraudulent conveyances if, at the time of or following the transfers, the transferring and transferee entities do not meet applicable solvency and capital requirements. See below Fraudulent Conveyance and Solvency Issues.
LIABILITIES TO THIRD PARTIES AND INDEMNITIES
The assignment of a liability in a spinoff transaction generally does not absolve the assigning party of its obligations to a third party with respect to such liability absent the consent of the third party. Consequently, distribution agreements generally contain cross-indemnities between Parent and SpinCo for the liabilities intended to be assumed by each party.
ADDITIONAL CONSIDERATIONS In addition to the general asset and liability allocation considerations highlighted above, intellectual property (IP) assets, employee benefits and executive compensation assets and liabilities, and environmental liabilities need to be considered.
Intellectual Property A spin-off may pose particular concern for a company’s IP assets. To a much greater degree than real or tangible property, IP rights may be owned by one entity and used by others, and shared throughout the corporate organization by affiliates, with those rights often not being fully understood. Carefully identifying and allocating rights to any shared IP is therefore a critical element of a spin-off.
Employee Benefits and Executive Compensation If the spin-off involves the transfer or spin-off of employees, the parties must consider what that means to former Parent’s employee benefit and executive compensation plans. For example, potential issues may involve: „ Continuation of benefits. „ Separation of plan assets and liabilities. „ Consequences of termination or change in control events. „ Requirements under collective bargaining agreements. „ Equity-based compensation.
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