How Much Is That Spin-Off Business Worth?

When companies sell part of their operations as a separate business, calculating the new company’s value can be more complicated than you might think. Its value may need to be adjusted to account for changes in the relationship with its former parent company.

Standing alone

For companies that were independent before the sale, valuation issues are usually 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 being a standalone company
• The impact of the transaction on the divested business unit’s earnings and risk profile for valuation purposes
• How to project future earnings and cash flow if no historical records are available

For example, control issues related to management, intellectual property and transfer pricing may all require adjustments to the valuation.

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 increases charges for management services, the company’s earnings must be adjusted accordingly.

If the divested business unit will transition to full independence, the valuator should evaluate the capabilities of its own management team. Any shortcomings should be reflected in the valuation, either by adjusting projected earnings or treating the shortcomings 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 may not 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, which may necessitate earnings adjustments.

Every business is unique

Divestitures and spinoffs create many challenges — these are just a few examples. If you have questions about a potential plan, Weaver can help evaluate control-related issues and provide a clear picture of the divested company’s value. Visit our Transaction Advisory Services webpage or contact us for more information.

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