In every organization’s life cycle, there comes a point where it needs to reevaluate its corporate structure. A wide range of factors or circumstances could set off this moment.
For example, the original company might have started out as a small entity with a single, clear vision, but over the years, it might have evolved into a multifaceted conglomerate. Unfortunately, this evolution, while commendable, can come with its own set of challenges, such as operational complexities, resource allocation issues, or even a diluted brand identity.
An organization that finds itself in such a situation might decide to initiate a demerger as a strategic move.
But a demerger is a monumental decision — one that requires thorough deliberation, an understanding of all the intricacies involved, and a careful weighing of the advantages and challenges.
In this comprehensive guide, we will explore seven key questions that you should ask to determine if a demerger is the type of corporate restructuring your organization needs.
What is a Demerger?
A demerger involves the splitting up of a corporate entity into two or more separate and independent entities. Essentially, it’s the opposite of a merger.
A spin-off demerger is when a parent company separates off one or more divisions of its existing business. The existing shareholders of the original company are then given the shares of the new entity on a pro-rata basis (that is, in proportion to how much they already own).
The new entity retains the same staff, assets, and intellectual property as it did under the parent company. The parent can also retain an interest in the spun-off demerged entity.
In this type of demerger, no cash transaction is involved, as only shares are transferred.
Here, the parent company is split into two or more separate companies, with the parent company ceasing to exist after the demerger. Basically, it results in the formation of two brand-new entities.
A carve-out demerger is sort of similar to a spin-off except that a portion of the shares in the subsidiary are sold to the public via an initial public offering (IPO). The parent company, however, retains control of the subsidiary by maintaining a majority stake in it.
How to Decide if a Demerger is Right For You
So when is the right time, and under what circumstances is a demerger a good move for your company? Here are seven key questions you should ask yourself to decide.
1. Will the Demerger Unlock Value For Shareholders?
Perhaps the most important question when considering a demerger is whether it will unlock any value for shareholders.
Ask yourself whether the total valuation of the standalone entities is higher than that of the combined entity. If the answer is yes, then a merger could be a good strategic move that creates extra value for shareholders.
Additionally, evaluate how the demerger might affect investor interest. Sometimes, breaking up might mean that each demerged entity becomes more appealing to a specific set of investors. Increased investor attention on each demerged company can result in higher share prices and, by extension, more shareholder value.
Under specific circumstances, demergers can also come with tax advantages. If there are any tax benefits to be gained from separating into a new company, this also presents another positive argument for a demerger.
Aside from the above financial metrics, consider whether the demerger aligns with the strategic objectives of the company and whether shareholders are likely to support the move. Both factors can serve as proxies for the demerged entities’ potential to create value in the long term.
2. Can Each Segment Operate Independently?
The success of a demerger hinges significantly on the ability of each segment or resulting company to function on its own.
Examine the skill set of the management team designated for each proposed independent entity or demerged company. Are they equipped or prepared to operate autonomously? Will they be able to make decisions that are tailored to the unique operational demands of the new entity?
Also, reflect on the available resources. Does each entity or resulting company have the required capital, technology, infrastructure, and workforce to succeed on its own? The goal is to make sure that after the separation, neither entity is deprived of essential resources, which would hinder its ability to compete effectively in the market.
Consider the operational constraints involved in physically and legally splitting the company. Will there be challenges in separating intertwined operations such as supply chains, shared technologies, or customer bases?
If resolving these constraints requires a significant investment of time and resources, you should weigh this against the anticipated benefits of the demerger. If the former outweighs the latter, a demerger might not be the best move.
3. Are Market Conditions Favorable?
Timing is a crucial factor when it comes to a demerger.
If the separate entities can better exploit or benefit from current market conditions, then a demerger may be the right move. For instance, if one of the segments serves a niche that’s witnessing a surge in demand or positive investor sentiment, splitting might allow it to capitalize on this trend more effectively.
Conversely, if the current market conditions are not favorable, it might be prudent to postpone or delay the demerger until a more opportune moment arises.
4. Is the Operational Complexity Manageable?
Demerging can introduce significant operational challenges, so gauging whether these are manageable upfront is vital. Is it possible to separate the IT systems, human resources, procurement, and other back-office functions without significant disruptions?
If two segments have been heavily integrated, the costs and complexities of splitting these services can be substantial. You need to determine if the operational benefits of an independent entity will outweigh these complexities.
Moreover, think about potential loss of synergies. Sometimes, combined operations can lead to cost savings or enhanced efficiency — like bulk purchasing power or shared research and development.
Post-demerger, these synergies might dissipate, possibly resulting in higher overall operational expenses for the newly formed entities. If these potential increases are significant, they might affect the ability of the two entities to create meaningful value for shareholders and succeed.
5. How Will the Demerger Affect Employees?
One often overlooked aspect of a demerger is its impact on the company’s workforce. The stability, morale, and motivation of employees can significantly influence the success of both entities post-demerger.
As you contemplate the split, think about the potential uncertainty and anxiety that could arise for your employees. Consider how they might react and how their work lives will be affected by the demerger. Is there a communication strategy in place to allay their fears?
Ensure that your employees not only understand the reasons behind the demerger but also its implications on roles, benefits, and career progression.
6. Have All Legal and Regulatory Implications Been Considered?
When considering a demerger, keep in mind that as much as it’s a strategic business decision, it’s also a legal process that needs to adhere to set rules and regulations.
Check to see whether there are any hurdles you might encounter in this regard. For example, are there any antitrust concerns? Can you work around them without jeopardizing your long-term objectives?
Don’t forget about contractual obligations. Your company might be bound by contracts that explicitly or implicitly rely on its combined form. Post-demerger, will these contracts remain valid, or will they need to be renegotiated or terminated? Are there any foreseeable legal challenges or liabilities that might arise from these contractual shifts?
Make sure that breaking any existing contracts doesn’t result in penalties that undermine or jeopardize the financial viability of the demerged entities.
7. Is There a Clear Roadmap For Execution?
Without a clear plan, even well-intentioned demergers can stumble and potentially fail. So before you decide to proceed with a demerger, ensure there’s an in-depth plan or roadmap at hand. A good plan should outline the key milestones, establish realistic timelines, and pinpoint the roles of various stakeholders.
Equally as important as a detailed roadmap is a contingency plan. Unexpected obstacles can arise, regardless of how well you plan. These can range from regulatory hiccups to unanticipated market changes or even technological challenges.
A contingency plan provides a safety net and ensures you can change course quickly without any major disruptions.
A demerger can be a strategic business move that helps a company hone in on its strengths, unlock value for shareholders, and open the door to new opportunities. But this is only possible if it’s executed correctly and for the right reasons.
Use the seven factors we’ve discussed here to decide if a demerger is the right move for your organization.
And if you indeed conclude that this corporate restructuring is the proper course of action, one vital tool to have in your arsenal during its execution is a virtual data room (VDR).
CapLinked offers sophisticated VDRs tailored for a wide range of business transactions, including demergers. With CapLinked, you can ensure that sensitive documents and critical data are accessed by the right stakeholders in a controlled, secure environment during your demerger.
Want to learn more? Sign up for a free trial today.
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Sean LaPointe is an expert freelance writer with experience in personal and business finance. He has written for several well-known brands and publications, including The Motley Fool and Angi/HomeAdvisor.