The mechanics of a spin-off are relatively simple: in a spin-off, a parent company distributes shares of a subsidiary on a pro rata basis to the parent company’s shareholders. As a result, the subsidiary becomes a separate company. The question, however, is how to conduct the spin-off in a manner that falls in step with SEC requirements, and does not require a full-blown registration statement. Luckily, the SEC has offered solid guidance on the requirements for a spin off. Understand, of course, that we’ll have to utilize some generalizations for the purposes of this discussion
The Big Issues
First, the greatest concern in conducting a spin-off is to avoid a “sale” when shares of the subsidiary are distributed to shareholders–recall that a “sale” triggers registration under the ’33 Act. Second, if a fully reporting company under the ’34 Act spins off a non-reporting company, the spin-off may yield a company with an active trading market but no adequate public information.
The Five Requirements for a (Relatively) Simple Spin-Off
Ideally, a company would obviously desire to effect a spin-off without the need for a full-blown ’33 Act registration statement. Luckily, a spin-off can be effected without a registration statement if the following requirements are met (and we’ll cover each requirement in detail below):
The parent shareholders must not give payment or consideration for the spun-off shares (payment triggers a “sale”).
The spin-off must be pro-rata to the parent shareholders.
The parent must have a valid business purpose for the spin-off.
The parent must provide adequate information about the spin-off to its shareholders and to the trading markets.
If the parent spins-off restricted securities, it must have held those securities for at least two years.
The Parent Shareholders Cannot Give Value
The parent shareholders cannot give any payment or other consideration in order to receive the spun-off shares. If shareholders give value for their shares, that means the spin-off is a sale of securities, which triggers a registration statement.
The Spin-Off Must Be Pro-Rata
The shares granted to shareholders in the spin-off must be pro-rata to the shareholders in the parent company. This way, the shareholders in the spin-off will own the same proportionate interest that they own in the parent (as of the record date for the spin-off). If the spin-off were not pro-rata, the shareholders’ relative interests change and some shareholders give up value for the spun-off shares. This triggers a sale, which triggers a registration statement. Note that the number of shares spun-off need not be the same number of shares outstanding in the parent, only that the interests be proportionate among all shareholders.
A Valid Business Purpose
The parent must have a valid business purpose for the spin-off. The SEC has recognized the following as examples of valid business purposes for a spin-off:
allowing management of each business to focus solely on that business;
providing employees of each business stock-based incentives linked solely to his or her employer;
enhancing access to financing by allowing the financial community to focus separately on each business; or
enabling the companies to do business with each other’s competitors.
The SEC has specifically recognized that there is not a valid business purpose for a spin-off when the purpose is:
the creation of a public market in the shares of a company that has minimal operations or assets; or
the creation of a public market in the shares of a company that is a development stage company that has no specific business plan or whose business plan is to engage in a merger or acquisition with an unidentified company.
Adequate Public Information
Another requirement for a spin-off without triggering a registration statement is that the parent must provide adequate information regarding the spin-off and the subsidiary to its shareholders and the trading markets. What constitutes adequate public information depends on whether the parent is a fully reporting company. Parent companies who are not fully reporting can accomplish spin-offs, but the shares spun- off are subject to significant limitations on resale.