Spin-off transactions - Governance considerations

In the loop Jan 06, 2016

Spin-offs have seen a resurgence in recent years. Learn about the governance issues associated with these transactions.

What you need to know about spin-off transactions

  • Spin-off transactions continue to be popular because they can be financially rewarding for investors, and can improve the focus on individual businesses.
  • Shareholder activism has been a recent driver of spin-off transactions.
  • Advance planning to address issues such as the capital structure of the parent and spin-off entity and the composition of the spin-off company board are essential.
  • Having a clear understanding of the many governance issues associated with a spin-off and starting early will smooth the transaction process.

Spin-off transaction volume remains high

Spin-offs have seen a resurgence in recent years. Some management teams and corporate boards are finding that spinning a business into a stand-alone public entity can be a desirable move to capture shareholder value, as certain businesses may command higher valuations if owned and managed separately. Spin-offs are also top of mind for shareholders.

What may be causing this trend?

While there are a number of drivers of the increased volume of recent spin-off activity the past two years, shareholder activism is a predominant one. Spin-offs are often one of the actions activists will demand of companies in which they have taken a position.

From a more general perspective, a spin-off may provide a higher return than other opportunities in the current low-yield environment. Spin-offs can also be used to unlock value from non-core businesses by improving the focus on these operations. From the parent company’s perspective, a spin-off may be part of a larger strategic or capital structure change, such as a way to facilitate debt paydown.

To spin or not to spin?

Preparing for a spin-off can be a complex exercise, and a board will need to consider a number of financial, legal, tax, accounting, and governance issues. While there are many potential advantages to spin-offs, such as the ability to implement the most business-appropriate capital structure and creating distinct identities for each business (which may be attractive to investors focused on a particular industry), there are also potential drawbacks. These could include the loss of cost synergies and economies of scale, disruptions to the business, and significant separation costs. The board will need to weigh the potential advantages and disadvantages of spin-offs in determining whether to move forward with the transaction.

Preparing for a spin-off

In preparing for a spin-off, there are several key questions to consider:

  • Should outside advisors be hired to help the board evaluate the potential transaction?
  • What will the composition of the new entity’s board look like?
  • What will board leadership, including committee chairs, look like for the new entity?
  • If activists are involved, how will their potential demands for board representation be considered?
  • Will the new entity establish the same governance structure as the parent (e.g., director elections, exclusive forum provisions, voting standards)?
  • At what point should separate legal representation be established for the parent and spin-off entity?
  • What actions can be taken to mitigate the potential for shareholder lawsuits?

Once a board has decided to move forward with a spin-off, a key consideration will be to determine the desired capital structure for the entity. While there are different methods of effectuating the capital structure and the spin-off, the strategy will typically be driven by financing and tax considerations. There are alternatives under which a spin-off can be accomplished tax-free to the parent company and its shareholders.

Constructing the board of the new entity

Determining the composition of the new company’s board is another issue that should be given high priority. A question often arises as to whether individuals who serve on the parent company’s board can also serve on the spin-off entity’s board. Although generally not prohibited, due care must be exercised in making this decision. Matters to consider include:

Potential conflicts of interest – in the event of conflicts between the parent and the spin-off company, overlapping board members may need to recuse themselves from certain deliberations.

Parent and spin-off company becoming competitors – the Clayton Antitrust Act provisions prohibit companies engaged in competing businesses from having overlapping directors.

Independence rules - directors on both the parent and spin-off company boards may not be viewed as independent based on stock exchange listing rules.

Building a solid foundation for the long run

Spin-offs require an intensive planning effort, and the board and deal team should be prepared for the many governance issues that must be considered. Other key issues that should not be overlooked include understanding shareholder approval requirements and the duties of the parent-company board and evaluating the desirability of takeover defenses. Starting with a clear understanding of the governance issues to be addressed, beginning the work early, and closely monitoring transaction progress will help ensure an effectively executed transaction.

 

How PwC can help

To have a deeper discussion about spin-off transaction governance considerations, please contact:

Beth Paul

Strategic Thought Leader, US National Professional Services Group

Email

Paula Loop

Leader, Governance Insights Center, Florham Park

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Beth Paul
Strategic Thought Leader, US National Professional Services Group
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