The financial and economic crisis will continue to feed the spinoff market as distressed companies and oversized conglomerates seek to sell non-core assets and thereby enhance their balance sheets.
A spinoff transaction requires that a parent carve out a currently integrated business as a stand-alone. The issues involved in a carve-out include how to split assets and liabilities, how much debt the spun-out entity will take on and how much debt will remain with the parent, and what type of working relationships should be put in place between the parent and the spun-out entity. These issues are more difficult to resolve when, as is often the case in the current crisis, the transaction is born of necessity and little groundwork has been laid to prepare the spun-out entity to operate on a stand-alone basis.
As an example, the parent and the spun-out entity will usually need to enter into agreements that provide for the sharing of intellectual property. In the case of trademarks that are associated with the parent, the parent will usually want to limit use to a short transitional period. In the case of other intellectual property, a co-ownership arrangement or perpetual licence is often appropriate. The parent may seek to limit the business or geographic scope of these rights to help preserve the value of its similar businesses in other jurisdictions. The limitations can cause issues for the spun-out entity later if the business evolves beyond the permitted scope and the restricted intellectual property is not easily excised from operations (as is often the case with, for example, custom software).
In addition, the parent will often be required to provide transitional services until the spun-out entity assembles its own information technology and other support systems and services; the parent may then need to participate in the migration of these services to the spun-out entity. These arrangements can be difficult to negotiate, not only because the spun-out entity often requires a wide range of services over an extended period of time but also because of the inherent tension in the arrangement: the spun-out entity seeks an outsourcing operation with the highest standards of performance for mission-critical functions, whereas the parent is not in the outsourcing business and is therefore ill-equipped to provide the service. A long-term relationship may also be desirable in some operational areas – for example, supply and distribution functions.
These dynamics complicate not only the terms of the transaction itself but also the sale process. In the case of an auction, it is unlikely that all bidders would have the same transitional needs and expectations for ongoing relationships. This makes the job of comparing bids difficult and can require the simultaneous negotiation of these arrangements with multiple bidders before the preferred bid can be determined. The current auction process involving assets of Nortel Networks highlights many of the complicating elements that splitting off an integrated business can create.
If the spinoff is achieved by way of an IPO, the underwriters would be subject to additional pressure to ensure that the spun-out entity has the tools that it needs to succeed.