A term often heard in relation to Mergers and Acquisitions and other areas of corporate law is “demergers”. In this article, Christia Malaktou, Managing Associate in our Corporate Team, takes a closer look at demergers, how they work and key practical considerations.
What is a demerger?
Often also referred to as spin-offs, demergers are a type of restructuring whereby different business activities of a group are segregated. There are different reasons why a trade or subsidiary may be split off from a company or group, including the following:
- Separating businesses in different sectors – this may be necessary to allow businesses to focus on their particular markets and strategies in order to best meet their respective long-term goals, eliminate an under-performing division or maximise investment opportunities.
- Preparing for a sale – a prospective buyer may not want to acquire all of the business or the whole of the group. A demerger can help move out the parts of the business or subsidiaries the buyer does not want.
- Borrowing/ investing issues – similarly, a prospective lender or investor may be willing to lend to or invest in one part of the group but not the others. A demerger can help segregate the desired part for lending/ investment purposes.
- Relationships between shareholders have broken down – a demerger can help shareholders part ways without losing their interest in their business.
Types of demerger
There are five main ways of demerging a company or group of companies:
- Direct dividend demerger – this is the simplest demerger structure. A company declares a dividend in specie (i.e. of assets rather than cash) of shares in the subsidiary to be demerged or certain assets and those shares or assets are transferred directly to the shareholders.
- Three-cornered demerger – this is a variation of the direct dividend demerger but the shares or assets are transferred to a company owned by the shareholders rather than the shareholders directly. In consideration for the transfer, the company issues shares directly to the transferring company’s shareholders. Both this, and the direct dividend demerger, require the company to have sufficient distributable profits and, depending on the assets to be transferred, may not necessarily be the most tax efficient demerger methods.
- Capital reduction demerger – this is where a parent company reduces its share capital and at the same time transfers assets (normally shares in a subsidiary) to a newly formed company owned by the shareholders. The new company then issues shares in itself to the original parent’s shareholders. A capital reduction demerger is an option where the parent company does not have sufficient distributable reserves to declare a dividend in specie or does not want to reduce the amount of its distributable reserves significantly.
- Scheme of arrangement – primarily used by public companies, this is a statutory procedure whereby a company may make a compromise or arrangement with its members or creditors. Though it requires court approval and is therefore inherently more complex, time-consuming and costly than other types of demergers, it can be useful where procedural issues restrict other methods.
- S110 liquidation scheme – this involves the solvent liquidation of the parent company and the transfer of its assets to two or more newly formed companies owned by the shareholders. The commercial challenges involved in liquidating an active operating company will need to be taken into account with this method of demerger.
Key practical considerations
All of the above demerger methods have their advantages and disadvantages. Choosing the right demerger method will usually be driven by a variety of tax, legal and commercial considerations, including the following:
- The shareholders’ intentions and in particular, who is to own what in the end;
- Achieving the most advantageous tax treatment both for the companies involved and their respective shareholders – to this end, advance tax clearances may need to be obtained to ensure that the demerger will be carried out in a tax-efficient manner;
- How the company’s balance sheet is structured, and more specifically whether distributable reserves are available;
- Calculating the market and book values of the businesses being transferred; and
- Due diligence, shareholder and other third-party approvals, employee transfers, pensions and transitional arrangements.
Advance planning is key. Tax and legal advisers typically need to work together to create a plan that implements the demerger objectives. We have the legal expertise to advise on all legal aspects and to document and implement the demerger whilst working closely with tax advisers with the appropriate tax structuring expertise.
