When performing a spin-off, a company shifts products or services, current team members, and other assets over to a brand-new entity. There are plenty of reasons to consider a spin-off, along with some potential pitfalls, that should be discussed with a skilled team of lawyers who can guide you through the process.
Why to Spin-Off a New Subsidiary From the Parent Company
Separating one area of a company from the whole can be an attractive proposition for many reasons. For instance, the new entity can acquire debt and attract new investors, which could be less of an option for the parent company. Some of the other top reasons to form a spin-off include:
- Alternative to a sell off – In some cases, a company may want to be rid of a specific division but can't find a buyer. In these situations, spinning off offers a secondary solution.
- Managerial concerns – The goals of an existing division may start to diverge from the parent company and require different strategies to be successful. Spinning off a separate entity can solve these problems with management and allow the spun-off division to go in its own direction.
- Market factors – Sometimes value for shareholders remains static with a reliable company. Creating a separate entity with its own stock is a way to increase value. The spin-off trades separately, and shares of the new company are distributed to existing shareholders. Sometimes a company may decide to forgo a spin-off and perform a split-off instead. In a split-off, existing shareholders are required to surrender their current stock to exchange for shares of the new subsidiary company.
- Regulatory hindrances – Depending on the type of business being run, oppressive legal regulations that interfere with operations or reduce earning potential may not apply to the spun-off entity.
- Profitability – A new entity could potentially produce more profit and create more shareholder value as its own separate company than as a division of the existing parent company.
- Spreading risk – If one particular department has the potential to cause losses for the company as a whole, it may make more sense to spin it off as a separate entity.
- Strategic problems – Due to changes in the local and national economy, basic structural changes to the company may be needed to survive and continue to thrive. A spin-off can help make those structural shifts in specific divisions.
- Tax issues – In some circumstances, there is no tax incentive to keep a division within the parent company. It may make more sense from a tax standpoint to spin-off into a separate entity.
Issues to Consider Before Spinning Off a New Company
Spinning off a new company is an involved process that requires making a public announcement, contacting the IRS about the spin-off's taxability, filing with the Securities Exchange Commision, and in some cases, even acquiring shareholder approval. An experienced legal team with a track record of success in business litigation and helping startups is critical in navigating that process.
An attorney can also carefully go over potential complications you may not have considered ahead of time that will require legal assistance. For instance, existing contracts for the parent company will likely need to be updated with vendors or lending institutions to include the spin-off as well.
Although it can be extremely beneficial under specific circumstances, there are situations when forming a spin-off can actually be detrimental. Existing employees may be opposed to starting over in a new work environment, while two companies mean dealing with twice the costs in terms of:
- Building upkeep
- Insurance policies
- Property taxes
Talk to an Attorney If You Are Considering a Spin-Off
The bottom line is that you need to ensure you have considered all the pros and cons before proceeding with a spin-off to mitigate any potential negative impacts and maximize your ability to earn profits. Your company's situation is unique and should be fully examined with an attorney's help before making any decisions. Call the Scott Vicknair law firm today to set up a consultation.