What is Spin-off | Working, Types, Advantages and Disadvantages

A variety of corporate actions like acquisitions, mergers, buybacks, bonus shares and the like tend to influence the market operations by bringing in drastic changes in the market shares.

Therefore, market participants and investors need to be alert and well-aware of the meaning and outcomes of these corporate actions to avoid encountering any market risks.

One of such corporate actions that tend to affect market operations significantly is a corporate spin-off.
A spin-off is a form of operational manoeuvring that entails the dissolution of an existing subsidiary of a parent company and the establishment of a new independent company.

The resultant company is termed as the Company Spun-off and is created with an eagerness for generating more value than the parent company. As such, a spin-off can also be considered a form of divestiture.

How does Spin-off work?

First of all, it is crucial to note that a spin-off is a form of mandatory corporate action. It follows that a decision to venture for a spin-off can be taken only by the board members. The shareholders have no right to vote in this context.

When a parent company ventures for a spin-off, it dispenses a hundred per cent of its holding interest in the company spun-off in the form of a stock dividend to the extant shareholders in proportion to their ownership in the parent company.

The parent company can also give its extant shareholders discount offers to swap their shares in the parent corporation for a holding in the spin-off. For example, the parent company can offer its shareholders to barter their $100 of the parent corporation’s stock for $200 of the company spun-off stock.

Generally, it takes six months to more than two years for a spin-off to take off. Once the decision to establish a spin-off has been taken, the following significant steps are likely to follow.

  1. Identification and selection of a team of competent leaders for the spin-off company.
  2. Generating a suitable operating model.
  3. Chalking out an appropriate financial plan.
  4. Informing and explaining the terms and conditions of the spin-off to the extant shareholders.
  5. Completing all the required legal procedures.
  6. Taking other vital steps to enable the spin-off company to create a distinct identity of its own unless the company spun-off finally takes off.

Generally, the company spun-off assumes a new name and a separate management structure. However, it inherits its intellectual properties, assets, human and other resources from the parent company.

Besides that, in the majority of cases, the company spun-off may continue to receive technological and financial support from the parent corporation.

Types of Spin-offs

Based on the proportion of holdings retained by the parent company, a spin-off can be classified into two types.

  1. No ownership: The parent company does not retain any shares in the company spun-off. All the shares are dispensed among the extant shareholders. Consequently, the company spun-off becomes autonomous on taking off.
  2. Partial ownership: The parent company can acquire up to 20 per cent in the company spun-off, leaving the rest to be distributed among the extant shareholders. In this case, the parent company retains the power to regulate the operations of the company spun-off and have some say in the decision-making process.

Advantages of Spin-off

A corporation may choose to go for a spin-off for a variety of reasons. Among them, the following are the most significant reasons to venture for a spin-off.

  1. For better focus: Certain subsidiaries of a parent company may have different yet promising business goals and strategic priorities. To unravel the full potential of these divisions and streamline its management and financial operations, the parent company may choose to turn these subsidiaries into independent companies.
  2. Lack of success in selling off a subsidiary: Spin-off is the last option chosen by a parent company to separate itself from its sick subsidiary.
  3. To lessen the agency costs: To diversify its business interests, a company may sometimes acquire or establish divisions that are in stark contrast to its core capabilities. Consequently, the investors may either show zero interest or may oppose those new subsidiaries. To lessen the agency costs incurred from resolving these disputes, the parent company may choose to get separated from the new divisions by turning them into independent companies.
  4.  To get rid of risks and debts: A company may opt for creating a spin-off if it finds that one of its subsidiaries has a long-term potential but is currently going through losses and is turning into a burden for the parent company. The company spun off may or may not inherit its debts based on the parent company’s decision.
  5. To lessen overhead: A company can get rid of the overhead of its subsidiary by turning it into an independent company.

Disadvantages of Spin-off

Although a company ventures for a spin-off in the hope of lucrative returns, the process is not without its share of disadvantages. 

  1. Volatile share price: The share price of spin-offs tends to be extremely unstable. It may dip in the short term despite having long term potential.
  2. Dependent on market trends: The turbulent market trends tend to influence spin-offs a lot. If the market is strong, the spin-offs can outperform. Conversely, if the market is weak, the spin-offs can underperform.
  3. Costly process: The cost of venturing into a spin-off is quite extortionate as there are too many legal and other institutional matters involved.
  4. Shareholders’ discomfort: The shareholders of the parent corporation may not want the shares of the company spun-off because of its incompatibility with their investment standards.
  5. Employees’ distress: The employees of the subsidiary may become uncomfortable with the idea of a spin-off as they may have joined that division due to its connection with the parent corporation. Besides that, they may become distressed on the face of spin-off related uncertainties.

References

  1. https://www.sciencedirect.com/science/article/pii/S0304405X99000173
  2. https://journals.sagepub.com/doi/abs/10.2307/4131471