Corporate Carve-Out

Corporate Carve-Out vs. Spin-Off: Understanding the Key Differences

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Corporate restructuring is a huge undertaking for any entity. Business leaders must figure out how to increase shareholder value by improving cash flow, paying off debts, and increasing the company’s focus in one area of the sector. 

Divestiture is often the strategy of choice for achieving these goals, with corporate carve-outs and spin-offs leading the way in terms of specific divestment methods. While some may refer to them interchangeably, these terms are not the same. Each has distinct implications for stakeholders, tax structures, and operational frameworks. 

In this article, you’ll learn the key differences between corporate carve-outs and spin-offs; from the impact on the parent company to the level of independence granted to the new entity. 

By understanding the nuances in these differences; executives and investors can make much more informed decisions on which path is best for their company; and the stakeholders who invest in it.

Four Essential Differences Between Carve-Outs and Spin-Offs

Corporate carve-outs and spin-offs are two forms of what is known as corporate divestiture, a term referring to what happens when a company disposes of assets or relinquishes ownership of at least part of its business. 

Divestitures are initiated for many reasons and have key differences in terms of cash flow; tax implications, and even the way shares are dealt with. 

Knowing these differences helps you understand which one is right for you. If you’re considering a divestiture move, here’s a rundown of how carve-outs and spin-offs may affect your business.

1. Dealing With Shares

Both a carve-out and a spin-off result in the creation of a new entity. However, these two strategies differ in how they distribute the shares of that new company. In a corporate carve-out, shares of the new company are distributed to the public in the form of an IPO, which establishes a new set of shareholders for the new company. 

In a spin-off, a parent company distributes shares of the new company to the shareholders. The parent entity can spin off 100% or distribute 80% and keep no more than 20% interest in the new company. This allows them to maintain their shareholder base during the divestiture process.

2. Tax Implications

A carve-out can have tax benefits, especially if the company is looking to do a corporate spin-off in the future (which many opt to do). However, to take advantage of those tax benefits; the parent company can only put 20% of its shares up for sale in an IPO, which can be severely limiting.

A spin-off, however, is generally tax-free for both the shareholders and the company. To get these tax benefits, both entities must meet the specific conditions of Internal Revenue Code 355. This includes the fact that the parent company must relinquish control of at least 80% of their interest in the company.

3. Cash and Assets

When initiating a corporate carve-out, the parent company does receive cash inflow in the process. As a result, reasons for choosing a carve-out may sometimes be money-driven; such as raising capital, reducing debt, or disposing of non-performing assets. 

Some firms, like Cyrus Nikou’s Atar Capital, specialize in acquiring complex corporate carve-outs and underperforming businesses. Firms like these partner with each entity to help them achieve their desired growth. 

In this way, a carve-out can also help resolve funding issues; as the debt freedom and new sense of independence achieved with carve-outs can help source funding. 

Spin-offs can also be money-driven, but it’s important to recognize that the parent company does not receive any cash or assets in the deal.

4. Level of Independence

With a corporate carve-out, a parent company can only offer 20% of its shares in the IPO. That means they don’t give up complete control of the company and still hold much of the interest, giving them greater power to make decisions.

Spin-off companies are generally more independent, as they are distinct entities with their own management and governance teams. 

A parent company can spin off 100% of the shares, but even if they don’t, they’ll only maintain a maximum of 20% interest. This effectively removes the parent company from any rights to decision-making in the company.

Divestiture: Not a One-Size-Fits-All Approach

Whether you choose to go the spin-off route or decide on a corporate carve-out, you should know that both forms of divestiture have many of the same advantages. 

They both promote the creation of pure-play entities that increase a company’s focus on just one sector, allow for better capital allocation in businesses where subsidiaries have different capital needs, and can often resolve antitrust issues by breaking up a conglomerate.

Still, spin-offs and carve-outs have distinct differences and achieve slightly different objectives. The one your company chooses will depend heavily on your needs and goals and the preferences of your stakeholders. 

Consult a corporate advisor, determine your ultimate objective, and consider how the right divestiture move can help you achieve the growth you desire.

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