Unlocking fresh business value through well-designed carve-outs and spin-offs

New ways to conduct carve-outs

Historically, in Poland and Europe in general, there were in fact only two efficient ways to conduct a carve-out from the legal perspective, i.e. a direct sale of assets or a demerger of an entity carried out in a formal proceeding. Both ways are highly regulated processes which entail  relatively specific restrictions and steps.

In the first case, a carve-out of a business does not involve universal succession to rights and obligations and to this extent, in general, it requires the other parties’ consents to the transfer of particular contracts. 

Until now, it has not been possible to demerge a company by carving out part of its business to move it to a direct subsidiary. Shares in the carved-out company had to be subscribed for by its shareholder(s) and not the company itself. This will change with the implementation of the new EU Directive 2019/2121, which permits the so-called “demerger by separation”. This new type of demerger will allow the companies to carve out part of their business to transfer it directly to a subsidiary and subsequently to dispose of the subsidiary’s shares. As a result, the M&A transaction involving a carve-out will be carried out by the parent company (and not its shareholders) and the funds thus raised may be directly transferred to the company and potentially allocated to finance future investments.

Thorough preparation for the transaction with clear information about the structure/split

Carve outs and spins-offs are highly complex and companies need to invest their time and energy into the preparation process before implementing the change. Once the perimeter of the target has been identified, special consideration should be given to determining if the business that is being sold is a standalone business or whether it is dependent on centralised functions such as tax, IT, finance, supply chain, physical office location(s), etc. If there is such dependence, one will need to consider how to “carve out” the business, allocate the functions and personnel so that the organisation is properly prepared for sale. The key dimensions to take into account are not just around the systems, but also processes, assets, contracts and employees. Getting on a granular level around allocating relevant assets and liabilities whilst minimizing business disruption will ensure a smooth process. Such considerations should take place, depending on the complexity, between 6-18 months prior to the contemplated disposal so that stand alone financial records and reports are prepared for diligence by potential buyers.

Special purpose carve out accounts

Regardless of the form of a transaction, entities need financial statements reflecting the operations to be divested to comply with regulatory requirements, to enable the seller and the buyer to evaluate the potential transaction and provide a basis for calculating the purchase price, or to seek and obtain financing. Carve-out financial statements reflect the separate financial results and the financial position of a portion of a larger entity, which can take the form of a subsidiary, an operating unit, a product line, or a brand.

The financial statements presented may or may not be of a legal entity, which can generate a number of complexities and a high degree of management judgement about the basis of preparation of the carve-out accounts. Those complexities subsequently put more burden on the buyer to thoroughly assess and evaluate the basis of preparation and to obtain reasonable comfort that there is no financial information relating to the business or the company which has been omitted or under- or over-valued. The assets and liabilities actually sold need to mirror the financials produced, which is not so simple when significant assets, liabilities, and operations are shared with other parts of the business.

Ultimately, the buyer will need to assess whether they have gained reasonable comfort from diligence with respect to the quality of the information based on which the price for the shares is to be calculated. The price the seller will ask and the warranties they will give to the buyer will largely depend on the quality of the financial information for the target. Special purpose accounts, if subject to audit and vendor due diligence, provide the buyer with more comfort and maximise the value of the deal. Otherwise, carve-out accounts that have been insufficiently defined may lead prospective purchasers to question credibility of the segregated assets, and thus raise significant doubts. Such concerns could diminish the worth of the assets in the eyes of potential buyers, diverting their attention from the possible synergies and financial benefits associated with them.

Significant tax implications – effect of the Polish Deal (“Polski Ład”)

Under Polish CIT law, a demerger may be recognized as a transaction that is either tax neutral or taxable, so it should be taken into account that carrying out a demerger through a spin-off requires a complex tax analysis.  

Until 2022, the demerger through a spin-off remained, albeit under specific conditions, neutral for CIT purposes. In other words, there was usually no liability to CIT for the demerged entity or its shareholders as long as the property affected by the transfer, and the property remaining in the demerged entity qualified as an organized parts of the enterprise (OPE) and the demerger had commercial justifications. As a result of the implementation of the Polish Deal (Polish: “Polski Ład”), new conditions were added for the neutrality of a demerger through a spin off. From January 1st, 2022 onward, a demerger will not generate any income for a shareholder if the shares in the demerged entity were not acquired or taken up as a result of an exchange of shares or allocated as a result of another merger or demerger of entities. In addition, the receiving entity is required to continue the tax valuation of the assets of the demerged entity acquired as a result of the demerger.  

As the foregoing shows, the new wording of the law governing company demergers may, as in the case of other reorganization operations, present multiple serious interpretation problems for taxpayers, so a comprehensive tax analysis from the perspective of particular entities is required for the proper assessment of the implications on the planned transaction structuring.

Summary

Although a divestiture is indeed a big step to take with a series of hurdles that must be overcome along the way, there is no doubt that separations can unlock fresh enterprise value in the current challenging market environment.  With careful pre-sale preparations, realistic planning and proper assessment of the key carve-out considerations prior to the execution of the transaction, you will surely end up on a less bumpy ride, with the value of your deal maximized as a result of the process being run and managed more efficiently.