Homework: Private Equity & Corporate Restructuring Assignment
Carolyn DeClusin
Liberty University
BUSI 536 Mergers and Acquisitions
Dr. Jeffrey Woo
April 28, 2024
1. Spin-offs, Equity Carve-outs and Divestitures
Companies are always growing, shifting, and changing. This can be done in many
different ways. A divestiture is simply when a part or division of a company is sold usually to
another firm and is no longer part of the parent company. “Companies pursue other forms of sell-
offs, such as a spinoff or an equity carve-out, to achieve other objectives in addition to getting rid
of a particular division.” (Gaughan, 2018) In a spin-off, a division of a company splits from the
parent company and the current shareholders are given shares in the new company based on their
ownership in the parent company. For example, if Sam owned 2% of company X and a spin-off
took place, he would now own 2% of both company X and the new company Y. “Existing
shareholders benefit by now holding shares of two separate companies after the spin-off instead
of one.” (Picardo, 2021) In an Equity Carve-out, a division of the company would split off
essentially making its own little company under the wing of the parent and would create equity
in itself by doing a public offering. This lets the company test the waters to see if there is a
market for the product or service and if it is not promising they can cancel the sale. (Gaughan,
2018)
There are three main differences between a Carve-out and a spin-off. The first difference
is in the shareholders. A carve-out will end up with totally new shareholders from the parent
company, in a spin-off however, all of the shareholders will be the same. The second difference
is cash flow in a carve-out because there is a public offering there will be immediate cash flow to
the entity, in a spin-off there will not have immediate cash flows. Third, there are greater out-of-
pocket costs for the parent company in a Carve-out and also more Strick reporting and disclosure
requirements to the SEC than there would be in the case of a spin-off. (Michaely & Shaw, 1995)
From a business perspective to me it makes the most sense to use a Carve-out over a
spin-off simply because one would have immediate cash flow. However, the advantage of having
the same shareholders and not new ones and not having to submit as much paperwork to the SEC
is also alluring. One also has to look at the different tax implications of each move. Both work
and serve their purpose and I think that it would depend on the situation which one would be best
to use.
2. Increase in divestitures in the 1970’s
In the 1960’s companies were expanding and growing rapidly Mergers and acquisitions
were the main vehicle of growth used at the time. However, moving into the 1970’s this began to
change as the United States moved into a recession in 1974-1975. “The recession was preceded
by a phase of slower growth, starting in March 1973.” (Zarnowitz & Moore, 1977) This
recession caused many companies to have a need for cash flows and thus turned to divestitures to
meet that need. Competition from international companies pressured some to sell acquisitions
that were not able to compete in the market. “This reversal of the acquisition trend was visible as
early as 197.” (Gaughan, 2018) The percentage of companies divesting hit a high in 1975 at 54%
of all transactions. It continued to stay very high throughout the 1980s though not quite as high
as in 1975 staying between 35%-40%.
Many things were happening in the 1970s that contributed to the rise in divestitures. The
economic recession caused high levels of inflation and there were high rates of unemployment.
War in the Middle East caused oil prices to almost triple. “This included a ban on oil exports to
the US and a series of production cuts intended to increase competition for oil and fragment the
unity of Western nations.” (Paisner, 2022)GLife became more expensive not only for the
everyday American but also for businesses.
3. Two reasons for Voluntary Divestitures
There are several different reasons that a company may choose to voluntarily divest part
of itself two that we will look at today are reverse synergy and poor performance. In a synergistic
Merger or Acquisition, two companies combining will benefit both of them and cause them to do
better than they would otherwise be able to do on their own. Reverse synergy is the opposite,
looking at the different parts of a business a company might decide that if they were to separate
from a particular department or division both would now operate better. Thus, instead of being
more profitable together, they are more profitable if they are separate. The second reason for a
voluntary divestiture is poor performance. “Companies may want to divest divisions simply
because they are not sufficiently profitable.” (Gaughan, 2018) If a division of a company is not
meeting the earning goal of the company or only earning enough to not be underwater, a
company may look at divesting just that division. The division may still be making money just
not at a high enough rate for the company to think it is worth keeping it.
Everyone at some point in their life has experienced buyer’s remorse. Maybe the shoes
that looked so cool online hurt your feet or just didn’t live up to your expectations. The same
thing can happen in Mergers and Acquisitions, unfortunately, there is not a return policy on
businesses. Rather if a company or a division of that company does not live up to everything that
it was supposed to a company may decide to divest it due to its poor performance. (Feldman,
2022) That division might do better if owned by a smaller company that could potentially
restructure it. Another reason that an acquisition might fail is that an idea for why the merger
took place was theoretical and when the boots hit the ground the theory did not pan out.
This idea of Mergers and Acquisitions not panning out reminds me of Luke 14:28-29
“For which of you, desiring to build a tower, does notGfirst sit down and count the cost, whether
he has enough to complete it?G29 Otherwise, when he has laid a foundation and is not able to
finish, all who see it begin to mock him,”. Getting wise counsel and looking at all aspects of
what it looks like to be successful in a field is key. Now even with research done sometimes
things simply do not go as planned and a divestiture is necessary but counting the cost
beforehand and doing due diligence before making a deal, especially of that magnitude would be
stewarding things well.
4. Recent Corporate Divestiture
In 2015 Verizon bought AOL spending $4.4 billion and began acquiring other media
companies such as Huff Post, and in 2017 bought Yahoo for $4.5 billion. They created a
subsidiary that contained over 50 technology and media brands called Oath. “Oath, a diverse
house of more than 50 media and technology brands that engages more than a billion people
around the world.” (Campbell, 2017) The goal was to be the best company where consumers
could access media. However, it did not turn out the way that Verizon had hoped that it would.
Verizon was having trouble keeping up with its competitors Google and Facebook. They were
trying to put their finger in too many pies. Oath was unable to spend as much on digital
advertising as its competitors. “Forcing Verizon to write down Oath’s value by $4.5 billion (half
of the total price Verizon originally paid to acquire AOL and Yahoo!).” (Feldman, 2022)
Verizon decided it was best for their company to divest Oath thus, getting rid of AOL and
Yahoo. This is an example of divesting a problematic section of a company. This was not a good
fit for Verizon, while they wanted to venture into different avenues of the tech and media
industry it became apparent based on what they spent their money on that it was not the right fit
for their company. In 2021 Verizon sold its media division to Apollo Global Management Inc for
$5 billion taking a big loss on the company. In the future Verizon plans to spend its time and
talent on improving its 5G networks and internet. (Lahiri, 2021)
Again, I think it comes down to counting the cost and understanding the field that one is
walking into. It is hard to take companies such as AOL and Yahoo that are slowly becoming
obsolete and turn them around without having a lot of money and time and people who know
what they are doing pouring into the company. Verizon spread itself too thin and rather than do
one thing well ended up with several things at a mediocre level.
5. The six-step Divestiture and Spin-Off Process
Divesting a division of a company is not as easy as returning a shirt to the store or selling
a clock at a yard sale, it takes lots of time and effort. According to Gaughan, there are six general
steps a company will take to divest a piece of itself. The first step is to decide that a divestment
or a spin-off is the best move for the company. Once it has been decided that a divestment is the
best course of action the second step is to then make a plan for how the company is going to
restructure itself. This step is crucial in the case of a spin-off as there will still be a relationship
with the parent company.
The third step is to find a buyer for the business if the company is not doing a spin-off.
The company may hire an investment banker to facilitate this process. Finding buyers who are in
the market and have the means to buy. Step four is to get approval from the shareholders. “The
extent to which approval of the plan is necessary depends on the significance of the transaction
and the relevant state laws.” (Gaughan, 2018) Once it has been approved then Step 5 is the
register any new shares with the SEC and Step six is to complete the deal.
These six steps can be put into five stages of a divestiture. Strategy, Planning,
Preparation, Execution, and Closing. Step one would be part of the Strategy phase. Steps two and
three would fall under the planning and preparation steps four and five would fall into the
execution phase then step six would be the Closing phase. (Gole, 2008) So, what phase or step
would take the most amount of time? The preparation phase or step two would take the most
time. Restructuring and negotiating takes time and lots of paperwork.
6. Wealth Effects
Shareholders have chosen to buy a share in a company in the hope that the company
makes money and that they then receive a dividend. How a divestment or a sell-off affects a
company is a big deal for a shareholder. “Overall, price reaction to the announcement of
takeovers is negative for the firm initiating the takeover (the ‘bidder’ firm) and positive for the
firm being taken over (the ‘target’ firm).” (Marquette, 2007) This reaction makes sense from a
shareholder’s point of view, the firm being taken over is usually underperforming or just not
doing what the parent company wants from it. The Target firm that is being taken over is going
to get a new makeover and hopefully, some new life that will make it more profitable. From the
standpoint of a shareholder of the firm that is doing the takeover things may not look quite so
bright. Your firm is acquiring a business that either has not been doing well or did not meet the
needs of its prior company.
The wealth effect says that if someone a stockholder for example feels like their
investment in the market is doing well, they are more likely to spend money in other areas of life.
(Liberto, 2021) Looking at different studies none have shown a direct correlation of an
announcement of a divestiture to shareholder wealth. “There is no consistent evidence that these
takeovers either benefit shareholders or destroy wealth. (Marquette, 2007) Prices fluctuate with
every different situation and because every situation is different it is very hard to pin down things
like correlations in an announcement. It will depend greatly on the companies involved and the
shareholders themselves and how risk-averse they tend to be.
7. Tax Consequences of a Spin-Off
Spin-offs are unique in that under the right circumstances they can be done tax-free. This
can be a major deciding factor in a company deciding whether it should do an outright
divestment or a spin-off. Divestitures do not have the same tax-free savings that a spin-off could
potentially have. There are, however, many different requirements that the company must
comply with in order to be eligible for the spin-off to be tax-free. A couple mentioned by
Gaughan (2018) are the company must own a minimum of 80% of the shares of the division that
is to be spun off. Another is that the company must not have acquired this division in the past
five years. Tax regulations regarding this process can be found in the Internal Revenue Code
section 355. If a spin-off is done in such a way as to not follow the guidelines for tax-free
movement, there will be a capital gains tax. Since companies are supposed to look out for the
interests of their shareholders many make sure to meet the guidelines set up in IRC section 355.
The spin-off can also not be used as a way to distribute funds to shareholders without
taxation. “The distribution must not be principally used as a “device” to distribute the
corporation’s earnings and profits to its shareholders.” (Seago, 2021)GThe move must also be a
good strategic move for the overall company. Not as a way to not pay taxes. Ethics is the name
of the game. Everything in the deal needs to be above board and done in an ethical manner not
doing it because it is a tax write-off or because it benefits certain people but not the company and
shareholders. (Investopedia, 2023)
In Proverbs 11:1 it says, “A false balance is an abomination to theGLORD,Gbut a just weight
is his delight.” (ESV, 2016) I find it sad that so many rules have to be in place for people,
companies, and businesses to not try and do things in an unethical manner. In a spin-off, there
are amazing tax benefits if all the rules and steps are followed and there are ones in place to
make sure that it is not being done as a way of getting out of taxes. No one likes taxes so paying
the least amount possible while still fulfilling our duty to pay them is acceptable. In Mark 12:17
it says, “Jesus said to them,G‘Render to Caesar the things that are Caesar's, and to God the things
that are God's.’” (ESV, 2018) Jesus commands us to pay what is owed to the government, it is
not wrong to look for a tax break as long as one is doing it ethically and not trying to skirt what
the law says.
8. Liquidation versus Reorganization
When a company decides that it is not doing well financially and that it would be best if it
ceased to operate and goes out of business, it will liquidate all of the assets. Everything that can
be sold will be to pay as much of its debt as possible. This is usually done using a Chapter 7
bankruptcy and only after it has been determined that a restructuring will not work. “Liquidation
is a distressed firm’s most drastic alternative, and it is usually pursued only when voluntary
agreement and reorganization cannot be successfully implemented.” (Gaughan, 2018) Most
times a trustee will be appointed to oversee the liquidation process and the payment of the debts.
Absolute Priority comes into play when it comes to paying off the debts of the company being
liquidated. This rule simply put is that there is an order in which debts must be paid. Any secured
debt will be the first thing paid out of the proceeds, second will be any unsecured debt and lastly
will be the shareholders, preferred shareholders first, and common shareholders last. (Hayes,
2021)
Restructuring a business is a whole process and is usually done through a Chapter 11
bankruptcy. First, the management of the firm decides that what they are doing is not working
then they file for bankruptcy. This allows the company to still operate as it figures out how to
restructure itself to become profitable again. “A business rescue plan seeks to convince, by
appealing to reason, the notion that through its approval the creditors will remain better off than
in liquidation.” (Rosslyn-Smith, 2021) The Original management stays in charge of the company
during this time unless the creditors petition the court the appoint a trustee to manage the
company through this process.
Both of these processes are hard, but they get the job done. It is sad to me that a company
would let it go far enough to get to the point where either of these things would need to be done.
If this were a home or a personal business as a believer, I think this reflects badly on how well
we are managing what God has given to us. In a big corporation it’s a little different because one
person does not have the biggest say in how the overall company is run it might take getting to
this point for the fact that things are not being run as they should to be seen or realized or
become important enough to be acted upon.
9. Advantages and Disadvantages of Chapter 11 Bankruptcy
There are several advantages to doing a Chapter 11 bankruptcy for the indebted company.
One is that there is a stay put in place so that the creditors will have to stop asking for their
money giving the company time to reorganize without having to pay immediately. The biggest
one is that the business will continue to operate. “The opportunity to continue operating your
business while working through repaying your debts can provideGseveral more advantages,
including the ability to retain your workforce and potentially avoid layoffs.” (Weintraub &
Selth, 2019) This can be great for employees or the community which may struggle if the
business were to suddenly lay off hundreds of employees.
A disadvantage is that it is expensive, and not all companies survive the shift.
Larger companies seem to have a better time navigating this process and coming out on top than
smaller companies do. “The reason for the size differential in survival rates is that larger
companies are in a better position to handle the additional unique demands placed on a Chapter
11 debtor.” (Gaughan, 2018) A larger company will have the manpower to spare people to work
on the paperwork and logistical side of the restructuring and a smaller company might have to
add that responsibility to a manager who is in charge of everyday operations.
Whether or not the business chooses to restructure or liquidate the goal is to do what is
best for the shareholders to be a good steward of what they have entrusted to the company. A
restructuring is like a second chance for the company. Thank the Lord that we are given second
chances and third and fourth ones. Jesus came and died so that we could have life and receive a
second chance. While some companies need a restructuring or a second chance to succeed every
person also needs a second chance and a new life in Christ.
References
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diverse-house-50-brands-under-new-oath-subsidiary
Feldman, E. R. (2022). Divestitures : creating value through strategy, structure, and
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