Demergers – UK & International Insights
Key Contact: Simon Wilson
Breaking up can be (relatively) easy…
At a time of much business upheaval and turmoil it is useful to revisit initiatives that could help with business continuity, survival and prosperity. The use of a demerger is one such initiative that might assist businesses to emerge from the current COVID-19 crisis in better shape and ready to capitalise on new growth areas.
Many businesses operate different activities and lines within the same company or group. However, for numerous reasons, it can be advantageous to separate these different activities. Here are some examples:
- Ring-fencing loss-making business lines/assets
A good example would be a retail business that is struggling with its physical store trade, but which has seen growth in its online sales since lockdown was initiated. Such businesses might benefit from separating out the loss-making/less profitable store trade so that it does not impinge on the remainder of the business or the more successful online activities.
- Increasing value of successful business lines
Using the same example above, the online trade may benefit from being in its own separate entity; by demerging it is often possible to achieve the full value potential of a successful business. A successful trade in its own ‘clean’ entity is also often a more attractive prospect to potential investors (facilitating growth) and to buyers, should a future sale or exit be in contemplation.
- Allowing different activities to focus without unnecessary regulatory constraint
As a result of the current COVID-19 crisis, some businesses have branched out into new more profitable areas; and indeed, this may have been the case even before the crisis. For example, where one business line must abide by regulatory or financial constraints, this may place unnecessary burden on those parts of the business that would benefit from the freedom of being within their own entity or mini group. Businesses subject to financial regulation and strict capital requirements such as those within the insurance and banking industries, are obvious examples.
- Separating a jointly owned business
Demergers are often an efficient way of enabling business partners to go their separate ways should they reach this stage in their journey. This may also facilitate succession plans and inheritance planning. A demerger can provide a neat method of separating business lines and/or assets between owners.
- Separating valuable investments and property
Many successful businesses have invested in property over the years. Given increased values, it might be that property assets have significant value, relative to the business itself. In such scenarios it can be very efficient (including from a tax perspective) to separate any property from the original trade. This may also open opportunities to separately develop property investments.
There are a variety of interesting legal methods that can be adopted to achieve a UK demerger depending on the particular circumstances of the business and desired structure; the end result is usually the same in that it should be possible to separate business lines or assets between two or more companies, or mini groups, that are either owned by all the same shareholders or divided between the original shareholders.
Methods such as direct dividend/transfer demergers; indirect/three cornered capital reduction or indirect dividend demergers; solvent liquidations under section 110 Insolvency Act 1986; or schemes of arrangement under Companies Act 2006, can all be used.
Outside of the UK, many jurisdictions including Brazil, Argentina, Mexico, Germany, France, Austria, Russia, Poland, Netherlands, Switzerland, Spain, Italy, Belgium, Egypt, China, and Japan benefit from some form of local statutory demerger procedure. This means it is possible for certain assets and liabilities within a company to be transferred ‘automatically’ by operation of law, provided the necessary local procedures are followed.
The transfer process can accordingly be simplified as matters like counterparty consents to the transfer of a contract from one entity to another, may not be required. Therefore, this separation method can be a useful tool for international businesses with foreign operations and foreign group entities too.
The success of a demerger often comes down to good planning, efficient project management and having the right legal and tax expertise on board from an early stage. If this can be achieved, then the opportunities are often extremely attractive.
Businesses are having to think on their feet and be flexible, even more so now than ever before; demergers should be considered as a tool to assist with staying afloat, getting ahead and potentially thriving.