Spin-off

What is a spin-off?

Spin-off (German: Abspaltung or Ausgründung, literally an offshoot) refers to the separation of a business unit into a legally independent company whose shares belong to the shareholders of the existing company. The shareholders then hold two investments instead of one, without a purchase price changing hands. Under German law, this corresponds above all to the split-off (Abspaltung) under the German Transformation Act (Umwandlungsgesetz, UmwG).

Spin-offs serve to run, finance or sell business areas with different profiles separately, to prepare a succession or to meet merger control conditions. In listed groups, the shareholders receive shares in the company that has been split off, which is then traded independently on the stock exchange. In the start-up scene the term also covers the spin-out from a university, a research institution or a corporation, in which a team transfers a technology into a new company. The basis, depending on the route, is a demerger agreement or demerger plan under the UmwG or purchase, licence and transfer agreements, supplemented by an agreement on transitional services. In film and television, by contrast, spin-off refers to a derivative series with characters from an existing work.

Legal routes under the Transformation Act

The UmwG recognises three types of demerger (Section 123 UmwG):

• Split-up (Aufspaltung): The transferring company divides its entire assets among at least two other legal entities and ceases to exist. Its shareholders receive shares in the receiving entities.
• Split-off (Abspaltung): The transferring company transfers part of its assets and continues to exist. The shares in the receiving or newly formed company go to its shareholders. This is the spin-off in the narrower sense.
• Hive-down (Ausgliederung): The transferring company transfers part of its assets but itself receives the shares in the receiving or new company. A subsidiary arises whose shares can be sold later.

The demerger effects a partial universal succession: the designated parts of the assets pass as a package in one step. The items, contracts and liabilities designated in the demerger agreement or, in the case of a new formation, in the demerger plan pass as a whole upon registration, without each contracting party having to consent. A prerequisite is a precise designation of the assets that pass. The agreement and resolutions must be notarially certified, and the resolution requires a majority of three quarters of the votes cast. The draft agreement must be forwarded to the works council at the latest one month before the resolution is passed. Employment relationships pass under Section 613a of the German Civil Code (BGB) with the part of the business to which they are assigned.

Liability for existing liabilities

For liabilities that were established before the demerger takes effect, all participating companies are jointly and severally liable (Section 133 UmwG), that is, the creditor can turn to any of them. The company to which a liability was not allocated in the demerger agreement is, however, liable only to a limited extent. The liability must fall due within five years and be asserted against it in the manner provided by law, for example by judgment or enforcement. As to amount, this joint liability has been limited since the 2023 reform of transformation law to the value of the net assets (assets less debts) that were allocated to the company in the demerger. For pension obligations under the German Company Pensions Act (Betriebsrentengesetz), the period is ten years. In the internal relationship, the demerger agreement regulates who bears the liability economically.

Carve-out as an individual transfer

Not every separation runs through the UmwG. In a carve-out, the unit is transferred by way of individual transfer to a new company or sold directly to an acquirer, that is, legally as an asset deal. Contracts then need the consent of the counterparties, and the employment relationships likewise pass under Section 613a BGB. Often the two routes are combined: the unit is first hived down or contributed into a subsidiary, and its shares are then sold as a share deal. The choice depends on the number of contracts, the consent requirements, the joint and several liability under the UmwG and the tax consequences.

Separation and transitional services

The most laborious part of a spin-off is the separation (disentanglement). The following are usually shared:

• IT systems and licences, often a shared accounting and merchandise management environment
• Administrative functions such as finance, HR, legal and purchasing
• Contracts with suppliers and customers that affect both units
• Trademarks, patents and software used in both units
• Locations, insurance policies and financing arrangements

What is not separated by completion continues to be provided for a limited period. The existing company provides the separated unit for a transitional period with, for example, IT operations, accounting and payroll against payment. This is regulated in a transition services agreement (TSA), whose term depends on how long it takes to build its own systems. Shared intellectual property rights are allocated to one side and licensed to the other; continuing business relationships are regulated by supply or cooperation agreements.

Spin-outs from universities and research institutions

In spin-outs from academia, the central question is how the rights to the technology reach the new company. Possible are a transfer (IP assignment), an exclusive licence or a grant in return for a stake for the institution. In due diligence, investors examine whether the rights lie with the company completely, permanently and without reversion clauses, because the company value rests on them.

Tax treatment of a spin-off

Split-offs and split-ups of corporations can take place at book values under Section 15 of the German Reorganisation Tax Act (Umwandlungssteuergesetz, UmwStG), that is, without hidden reserves (the difference between book value and actual value) being taxed. A prerequisite is that a business unit (Teilbetrieb) is transferred, a part of an enterprise that is viable in its own right with its essential foundations. In a split-off, a business unit must also remain with the transferring company (double business unit requirement). Tax neutrality lapses, among other things, if the demerger prepares a sale to outside persons. The law assumes this if, within five years after the demerger, shares are sold that make up more than 20% of the shares existing before the demerger.

The hive-down of a business or business unit in return for new shares is a contribution under Section 20 UmwStG and can likewise take place at book values on application. If the shares received are sold within seven years, the contribution is retroactively taxed pro rata, the taxable part falling by one seventh with each year that has elapsed. Real estate in the transferred unit triggers real estate transfer tax unless a relief for group restructurings applies. Because these conditions are narrow, the tax review often decides the route of separation.

Worked example: value of a software unit before and after the spin-off

A company is considering splitting off a software unit that shows EBITDA (earnings before interest, taxes, depreciation and amortisation) of EUR 3.0 million within the group. Allocations of EUR 0.4 million a year, with which headquarters charges its services to the unit, have already been deducted. As an independent company, the unit needs its own administration for finance, HR, IT and legal, which costs EUR 1.1 million a year. The one-off separation costs are estimated at EUR 0.8 million. Comparable independent software companies are valued at nine times EBITDA, the unit within the group at only six times, because investors often apply a discount to mixed groups of businesses. All values are enterprise values before deduction of debt (enterprise value).

• EBITDA as an independent company: 3.0 plus 0.4 minus 1.1 = EUR 2.3 million
• Value within the group: 6 × 3.0 = EUR 18.0 million
• Value as an independent company: 9 × 2.3 = EUR 20.7 million
• Increase in value after separation costs: 20.7 minus 18.0 minus 0.8 = EUR 1.9 million
• Without taking the costs of independence into account: 9 × 3.0 = EUR 27.0 million, that is EUR 6.3 million too high

The higher valuation benchmark alone does not justify a spin-off. It must exceed the ongoing costs of its own administration and the one-off costs of the separation. For prospective buyers or investors of a split-off unit, stand-alone financial information (carve-out financial statements) is therefore prepared that discloses these costs.

Distinctions: spin-off, merger, MBO and business split

• Merger: The merger brings assets together, the demerger divides them.
• Management buy-out: A separated unit is sold to its own management team, often following a hive-down.
• Business split (Betriebsaufspaltung): Tax term for the making available of essential business assets by a holding company (Besitzunternehmen) to an operating company (Betriebsunternehmen) where there is personal entanglement. Despite the similar name, it has little in common with a spin-off.

Common mistakes

• Costs of independence underestimated. Anyone who plans earnings with group allocations instead of complete own administrative costs values the unit too high.
• Transitional services too tightly measured. A TSA with too short a term or a vague service description leads to interruptions in ongoing operations.
• Tax conditions overlooked. If a business unit is missing or shares are sold within the lock-up periods, hidden reserves are retroactively taxed.
• Unclear allocation. Contracts, employees and intellectual property rights that are not clearly allocated in the demerger agreement lead to disputes between the companies.
• Subsequent liability not priced in. The joint and several liability for existing liabilities continues for five years and belongs in the valuation of both sides.
• Key people not retained. During the separation, high performers often decide afresh, especially when their future role is open.

Frequently asked questions

What is the difference between a spin-off and a carve-out?

In a spin-off, the existing shareholders receive the shares in the new company, and no purchase price flows. In a carve-out, the unit is separated and as a rule sold to a third party.

What happens to the shares in a spin-off?

Shareholders keep their shares and additionally receive shares in the company split off, in proportion to their previous holding, without paying for them. Arithmetically, the value of the old shares falls by the value of the unit given up. For private investors, the transaction can be tax-neutral; the acquisition costs are then allocated between old and new shares.

Is a split-off possible on a tax-neutral basis?

Yes, if the conditions of Section 15 UmwStG are met, in particular the double business unit requirement, and no harmful sales of shares follow within five years.

Who is liable for old liabilities after a split-off?

All participating companies jointly, but for liabilities not allocated to them limited in time and in amount. Economically, they are borne by the company to which they are allocated in the demerger agreement.

How long does a spin-off take?

The legal steps often take several months, the separation of IT and administration often considerably longer. The timetable is usually determined by the separation of systems, not by the registration.

The Roemer Capital view

If a split-off is under discussion, we first calculate the earnings position of the unit as an independent company, with complete own administration and without group allocations. Only if the unit is worth more on this basis than within the group is the effort of separation worthwhile.

If the unit is subsequently to be sold or financed separately, we prepare with the client a financial model over at least three years with a base case, a cautious case and an optimistic case. It includes the costs of the TSA and the build-up of own functions. The legal and tax route of separation is determined by the law firm and tax advisers.