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Spinoffs Become More Popular but Require Careful Planning

Company spinoffs were all the rage last year with even more expected in 2012. From toy and technology companies to food distribution and agriculture companies, 2011 was a record year for businesses wanting to break up into smaller, perhaps more profitable entities.

The market has been busy for several reasons. Since the market has been weak, companies are being more creative to build value for their investors. Some “activist investors” even push company management to separate the high-growth part of the business from the rest of the company. The uptick in spinoffs may also be a result of a slow IPO market.

Spinoffs should be attempted only after considering the complicated legal issues that are likely to arise with a qualified corporate and securities lawyer. The board needs to take into consideration what is in the best interest of the shareholders while still being fair to the stakeholders. Management will have to carefully split up assets, liabilities and workers so that neither of the two companies created by the spinoff are left weak and potentially unable to survive.

Management will also need to revisit compensation terms and non-compete agreements since the structure of the new company may put one of the new businesses (and its executives) at higher risk. Thorough disclosure to shareholders is also required in a spinoff transaction.

U.S. tax codes dictate that both companies in the spinoff need to have been performing the same function for at least five years to qualify as a tax-free transaction. This means a company cannot start a new business and immediately spin it off into a new public company. It would need to incubate for five years.

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