Demergers offer a strategic restructuring manoeuvre for companies seeking to focus their operations on their core business activities, increase shareholder value and streamline operations.
Whilst a company demerger may appear to be a straightforward reorganisation process on the surface, there are a multitude of legal complexities and potential pitfalls that companies must consider prior to embarking on one.
Our Corporate Law team has extensive experience advising on and carrying out demergers and can assist your business through the entire process, from preliminary planning to post-demerger compliance.
What is a demerger?
A demerger is a reorganisation process whereby different business activities carried on by a company or a group are separated into distinct companies or groups of companies.
These companies or groups of companies will either operate on their own or be sold or liquidated.
Common reasons to demerge a company:
The most common reason for a demerger is to increase shareholder value, particularly when there is excess cash in the business and shareholder funds.
Often, a successful business can be undervalued by its association with a struggling part of the business.
Therefore, a company may perform better as two separate legal entities than one, and the aggregate value of the shares of the two separate companies can often be more valuable than the value of the original single company’s shares.
However, the decision to demerge a company can be influenced by a variety of different reasons, including:
- Dividing a company or group between shareholders in dispute or who have agreed to go their separate ways;
- Separating businesses between different business sectors to focus on specific markets;
- Freeing one business from the regulatory or financial requirements imposed by another business;
- As an alternative to a sale, i.e. where the company or its shareholders are struggling to sell the business/part of it;
- Dividing a jointly owned group;
- To facilitate the sale of part of a business to a third party;
- Ringfencing liabilities;
- Separating business assets to either ringfence or make them attractive to a potential buyer, i.e. separating substantial property assets from a trading business; and
- Extracting a subsidiary business from a group so that individual shareholders can benefit from tax reliefs (such as Business Asset Taper Relief).
What are the different types of demergers in the UK?
There are different methods of affecting a demerger in the UK, each with its own advantages and disadvantages.
The method chosen is often influenced by tax considerations, the value of the company being demerged and the availability of distributable profits in the company.
Direct dividend
This is the most straightforward type of demerger. The process involves the parent company declaring a dividend in specie (i.e. a distribution of assets rather than cash) of the shares of the subsidiary to be demerged to its shareholders. This transfers ownership from the parent company to its shareholders.
However, in order to effect this kind of demerger, the parent must have distributable reserves at least equal to the book value of the assets being demerged.
In addition, it is not often a tax efficient structure as there will likely be tax consequences for the recipients of the distribution in specie.
Indirect dividend or three-cornered dividend
This type of demerger involves the parent company declaring a dividend in specie of the shares of the subsidiary (or of the assets of a business) to be demerged to a new company set up (or existing third-party company). The newco then subsequently issues shares to the parent company’s shareholders.
An indirect dividend can qualify as a scheme of reconstruction and can offer substantial tax relief advantages over a direct dividend structure if structured correctly.
Capital reduction
Where a company lacks sufficient distributable reserves to declare a dividend in specie or does not want to significantly reduce its distributable reserves then a capital reduction demerger may be the most attractive option.
The parent company will reduce its share capital and then transfer the assets to be demerged to either the parent’s shareholders or a newco which then issues shares to the parent’s shareholders.
Capital reduction demergers are usually quite complex and therefore tax and accountancy advice is essential in order to ensure that the demerger is unlawful and reduce the risk of triggering any adverse tax consequences.
Scheme of arrangement
A court approved procedure under Part 26 of the Companies Act 2006 which is carried out with shareholder consent and (frequently) creditor approval to make a compromise or arrangement with the members or creditors of the parent company.
This method is often used in combination with the direct dividend, three-cornered dividend, three-cornered reduction of capital and/or a liquidation scheme.
Liquidation scheme
This type of demerger often involves the solvent liquidation of the parent company under section 110 of the Insolvency Act 1986 and its assets are transferred to two (or more) new companies. The liquidator accepts the shares in the new companies as consideration for the transfer of the assets to the newcos and then distributes the shares to the parent’s shareholders pursuant to the parent’s winding-up.
Although the parent company will not require distributable reserves for this type of demerger, it can be an unattractive structure for a demerger as holders and directors of the company will not want to be associated with a company in liquidation.
What are the tax implications of a Demerger?
If a demerger is not planned carefully unintended tax consequences may result from the transaction including stamp duty, capital gains tax payable by the original distributing company and shareholder chargeable gains and income charges payable by the shareholders on the distribution receive.
Careful tax planning is therefore vital to save substantial costs.
You will need to consider possible stamp duty implications, particularly for share transfers and property transfers.
It is essential that prior tax advice is obtained before embarking on a demerger to ensure that the demerger is structured appropriately from a tax perspective and to obtain any available tax clearance.
There may also be ongoing tax implications post-demerger which will need to be considered when considering the structure.
What are the potential risks of a demerger?
Tax
There is a risk of unintended tax consequences if not structured appropriately, as referred to above.
Consents
Stakeholder resistance could be a potential challenge to a proposed demerger, as well as delays and hurdles caused by lenders or the time taken to obtain tax clearance.
Our advice is to apply for clearance and enter into discussions with lenders as soon as possible to ensure that any necessary security arrangements for the new entities is dealt with in sufficient time.
Formalities
There are a vast amount of documents and formalities required for a demerger to take effect.
Careful co-ordination of shareholders, directors and lenders is important.
Leveraging online signatures and powers of attorney can streamline the execution process.
HR problems, customer views and supplier views
You will also need to consider other factors, namely the views of your customers, suppliers and employees.
When you demerge your company, your existing employees may move to the new entity, and compliance with employment law will be necessary.
Contact Our Corporate Team
Our experienced corporate solicitors have dealt with a wide variety of demergers.
We understand that every company’s circumstances are different, and we work closely with our clients to understand their unique situation and can find the best solution for you.
01619414000
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Kiera Goodwin
Solicitor
Kiera is a Solicitor in the Corporate team at Myerson and a member of the Financial Services and Manufacturing teams. Kiera has experience in a variety of corporate matters, including employee ownership trusts, share sales, share buybacks, employee share option schemes, company reorganisations, and other general corporate matters.
About Kiera Goodwin