Separation of businesses: a strategic option for listed companies
By Dr. Robert Weber 

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Both nationally and internationally, the separation of businesses has developed into a growing trend. The most recent and most prominent German examples include the split-off of E.ON’s conventional energy generation business into Uniper and the spin-off of Bayer’s plastics business to Covestro, including the latter’s subsequent IPO. Prior to this, Siemens had already split off its lighting business into Osram; and a few years ago, Bayer had split off its chemicals and polymers activities into Lanxess. The separation of businesses is also a strategic option being exercised internationally. Examples include separation of the payment service PayPal from eBay as demanded by the activist investor Carl Icahn, separation of the Ferrari business from the Fiat Chrysler Group and separation of the Philips lighting business from Philips.

Background

Frequently, the reason for the separation of a business is the perception that full entrepreneurial potential can only be achieved by focusing on the company’s core business segments. The idea behind this is that two separate companies are able to act more dynamically and in a more focused way in a changed market environment. This also means improved diversification in terms of customers, technologies and risks. Different risk profiles attract different investors who can then target these business activities directly. The separated company has its own financial reporting and investor relations. In addition, the separated company will be less dependent on certain criteria for intragroup allocation of financing (such as strategic importance or synergy potentials for the entire group of companies). Remuneration for the staff of both companies can be better tied to the actual success of each business on the basis of tailored compensation plans, which makes it easier to find and retain qualified personnel.

On the other hand, separation of a business does (at least in the short term) have some drawbacks. There will be one-off costs for establishing two separate partial groups and, moreover, debt financing may have to be repaid at less favorable terms.

Alternatives

In Germany, there are, in principle, two alternatives available for such a separation: a split-off (Abspaltung) and a spin-off (Ausgliederung) with a subsequent IPO. These two alternatives differ as follows:

In the case of a split-off, the shareholders of the existing listed company receive certain shares on a pro rata basis in the new listed company holding the separated business, with these shares booked in the shareholders’ custody accounts. The advantages are obvious: The split-off can be implemented irrespective of the capital market environment, the remaining shares to be held by the shareholders of the existing or “old” company can be determined in detail and the typical transaction risks of a “classic” IPO or sale of a company can be avoided. On the other hand, the old company will not be provided with new liquidity.

This is different in the case of a spin-off with subsequent IPO. After the business division has been spun off into a subsidiary, the listed parent company will initially hold all shares in the subsidiary. In the subsequent IPO, new shares in such a subsidiary can be placed with new investors, providing the subsidiary with liquidity that can, for example, be used to pay debts it owes to the parent company. The listed parent company will remain a shareholder of the listed (subsidiary) company at least for a certain period of time. It can further reduce its equity interest in the subsidiary by selling shares in the subsidiary in connection with the IPO or later on the stock exchange, which will provide it with additional liquidity. In the case of an IPO with a sale of shares, new investors will, however, have to be found for the subsidiary and this involves a placement risk that cannot be fully assessed in the current capital market environment.

Implementation and pitfalls

Implementing such a separation of companies requires time and much experience. The initial considerations and plans will be made by board members or will in any case be limited to a small group of persons. As soon as the plans become more specific, however, a larger project team will have to be set up. The members of the project team usually include persons currently holding functions at the existing company and persons who will hold specific functions at the new company to be established in connection with the separation in order to ensure that the latter’s interests will be appropriately safeguarded in the process. From a legal perspective, it is not only important to prepare the technical side of the split-off or spin-off with a subsequent IPO, but also to identify and address at the start of the project all major pitfalls that could cause the project to fail (such as joint venture agreements containing change of control clauses). In addition, uniform provisions governing liability and taxes will have to be developed irrespective of the national law applicable to each of the companies. Future cooperation between the companies will have to be defined and agreed in legally binding terms. The effects of the corporate restructuring will have to be considered not only for the period up to the date of the separation, but for the foreseeable future thereafter. Otherwise, unpleasant surprises may occur when corporate law measures are implemented at a later point, for instance with respect to taxes.

It is the project team’s task to establish the company group to be separated from the old company and to prepare the split-off or spin-off with subsequent IPO. Both processes flow seamlessly into each other. Under aspects of corporate law, this means preparatory measures under the Reorganization Act, contributions with noncash capital increases, individual transfers and, if necessary, retransfers of certain assets that are required before the actual split-off or spin-off and IPO can be implemented. The time for resolutions of the shareholders’ meetings of the companies involved and for drafting the contract documents and their review must be considered in a step-by-step plan that includes the approval procedure for the securities prospectus to be issued for the new shares. Debts need to be discharged and new collateral and sureties must be negotiated and issued. The company to be separated will leave the cash pool of the old company and a new cash pool has to be set up. Any existing control and profit-and-loss transfer agreements must be terminated and a completely new contract-based group relationship will have to be established within the company to be separated. And in a final step, the separation will also have to be negotiated and regulated with respect to the following, usually centrally managed, areas: IT, HR and accounting, insurance, pension plans, pension commitments, permissions, patents and trademarks, and the like. In addition, numerous special legal problems often arise and need to be addressed.

Conclusion

The separation of a business is a complex transaction requiring coherent project planning and project steering. A variety of factual matters and circumstances involving partially complex and difficult legal questions have to be resolved in a pragmatic and legally sound manner. It is absolutely necessary that, apart from having the required technical legal expertise, the legal advisers entrusted with steering the project also understand business issues. The further development of the business and the risks involved will have to be anticipated in order to maintain an optimal scope for taking action in the face of both legal and tax issues for both companies following the separation.

rweber@whitecase.com

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