By Mike Thorne
When a company separates from its parent company, the move can be exciting, with fast timelines, massive challenges, and huge opportunities. But the complexities and risks of planning and executing such a “corporate spin-off” (a method of corporate reorganization in which a parent company divests itself of a business unit) can be tremendous, and no one wants to destroy value in the process.
Not surprisingly, in a separation, the overwhelming focus of the management team is on execution and achieving readiness from day one. While execution is certainly key, “don’t destroy value” is very different from “create value.”
One way CFOs can create more value for their businesses during a separation is to intentionally work with tax and finance leaders to design Day Two from the ground up.
More than the sum of its parts
There can be massive tax implications of a separation, not only in the way the new company (NewCo) is structured, but also in the way it will operate. New service agreements, supplier contracts, facilities, and business models have tax impacts. Even for a separation as simple as splitting a company in two, the tax implications are significant.
Breaking up a company very often changes the realities of the business. An organization may find that the allocation of its taxable profits changes as a result of changes in the centers of activity or where NewCo decision makers sit. (They are typically not hired until just before the transaction closes.) Taxable earnings can also change depending on where NewCo’s assets are located, where its employees work or where capital is invested.
The same goes for the remaining part of the company (RemainCo). If your tax calculations were based on certain research and development (R&D) incentives and you are now building your R&D division, your tax assumptions will clearly change. Or maybe you’re breaking up your contract manufacturing division to focus on core services; that will also have a significant impact on RemainCo’s tax status as it removes physical assets from the books and turns toward service revenue.
Tax and finance leaders must have a good understanding of the implications of exclusion for operations and business models to develop the most effective business structure. They cannot assume that previous models will stick. From the very beginning of the execution process, they need to understand what day two will be like.
The benefits of a day two approach
Post-separation business planning allows tax leaders to better advise the CFO on how future businesses should be structured. And that can improve both financial value and business flexibility.
In part, planning for day two is about aligning the business structure and earnings profile to ensure NewCo maximizes its potential tax benefit. Virtually every market offers a variety of tax incentives or rebates for anything from R&D investment to environmental impact. But taking advantage of those tax opportunities depends on making a profit in the same market. Maximizing tax value requires foreclosure teams to plan for the future.
Planning for day two is also about creating more flexibility for both NewCo and RemainCo. The business environment will continue to change after the separation. NewCo will grow into new markets and segments; supply chains and investment flows will evolve; profit centers and employee locations may change. By focusing too much on day-one preparation, companies can miss the opportunity to create the right environment for the success of both organizations.
Tomorrow’s opportunities today
There are many reasons why CFOs and tax leaders shouldn’t hold off on day two. Perhaps the most important is that the planning for day two directly influences the funding that the deal can attract. Private equity investors often look for debt structures that provide tax relief by matching interest costs with earnings, thereby lowering the cost of capital. Funding sources will have a direct effect on how the deal is funded.
At the same time, CFOs need their tax leaders to consider the broader matrix of opportunities. They may set up a large structure to claim relief from interest costs in a market, but once in place, they may find that it changes where their organization’s profits are located, which changes the overall effective tax rate and the cost of capital.
A moment of modernization
Thinking about day two also means thinking about your tax operating models, as they will have to change. The exceptions can provide a clean sheet on which to design the optimal tax operating model for NewCo. The fresh start allows planners to think holistically about their strategy and the type of skills and capabilities they need. New tools, outsourcing, co-contracting and operating models offer an unprecedented opportunity to start NewCo with a streamlined and efficient tax function. The same can be applied to RemainCo.
Smart outsourcing is key to improving your tax operating model. Considering all the options available to NewCo and RemainCo can reduce transformation disruption, help you manage costs, and create a more tax-effective and flexible operating model.
Tax professionals are often the first to admit that preparing a company to carve-out is hard work. But in most foreclosure situations, tax and finance leaders may be missing opportunities not only to protect value but also to create it.
Deloitte is a recognized global leader in mergers and acquisitions, with an established network of experienced professionals around the world. To learn more about how Deloitte M&A can help your organization, visit deloitte.com.
Mike Thorne is a partner at Deloitte UK.