Valuing divestitures and spinoffs
From the May/June 2018 issue of BCC Advisers Litigation & Valuation Report
It’s not uncommon for companies to sell or “spin off” part of the business. However, valuation adjustments may be needed to reflect changes in the newly independent company’s relationship with its former parent.
A question of dependency
If the new company is essentially a standalone company, before and after the transaction, the valuation issues will be minimal. But if the company was dependent on its former parent, a valuator must determine:
- Whether the divested business unit will continue to receive support from the parent or whether it will eventually transition to a standalone company,
- The impact of the transaction on the divested business unit’s earnings and risk profile for valuation purposes, and
- How to project future earnings and cash flow if no historical records are available.
Examples of control-related issues that may require valuation adjustments to report transactions on an arm’s-length basis include:
Management. If the former parent provided the divested business unit with management services, it’s important to evaluate the terms of the parties’ relationship, including how much the parent charged and how long the management services will continue. Often the details are spelled out in the sales agreement or a separate written contract. If the new arrangement calls for additional charges for management services, the valuation expert should adjust the company’s earnings accordingly.
If the divested business unit plans to transition to a standalone business, the valuator should evaluate the capabilities of its management team. Any shortcomings should be reflected in the valuation, either by adjusting projected earnings or treating it as a risk factor.
Intellectual property. If the divested unit relies on patents, trademarks, copyrights or other intellectual property (IP) owned by the parent, the valuation expert must determine whether the company will be able to license the IP going forward and review the terms of any license agreements. If the scope of the license is narrow, it may create additional risk or inhibit the company’s growth potential. If the divested business unit will pay the parent a license fee, the expert needs to assess whether the fee is reasonable based on comparable royalty rates and adjust earnings to reflect these fees.
Transfer pricing. Market prices don’t necessarily apply to intercompany sales. But if the divested business unit and its parent continue to do business after the deal closes, the parties will need to negotiate a market pricing structure. And the valuation expert may need to adjust earnings accordingly.
Divestitures and spinoffs give rise to many challenges — these examples are just the tip of the iceberg. A valuation professional can help deal with control-related issues and provide a clear picture of the value of what’s being transferred.