Spinoff vs. IPO: An Overview

Both a spinoff and an IPO or an initial public offering result in a new, public company. However, a spinoff is the creation of a new public company out of a current public company, while an IPO is a private company going public for the first time.

Key Takeaways

  • A spinoff is the creation of a new, public company out of a current public company.
  • A spinoff can occur when the new company is expected to be more profitable alone than it would otherwise be under the parent company.
  • An IPO is a private company going public for the first time, which involves issuing stock to the public to raise capital or money.
  • Both spinoffs and IPOs achieve the same result of being a new, independent, public entity despite having different starting points.

Spinoff

A spinoff is when a public parent company organizes a subsidiary and distributes shares to current stockholders for the new business, thereby creating a new, publicly traded company. A spinoff is typically done when the new company is expected to be more profitable alone than it would otherwise be under the parent company.

Spinoffs are a type of corporate restructuring in order to improve the parent company's profitability. A spinoff can also help the parent company focus on its core competencies by ridding itself of an underperforming division. A company might want to streamline or consolidate its businesses. Spinoffs can help a company reorganize and re-establish itself into a more streamlined corporation.

The spinoff of a division or subsidiary into a new, independent company means that the new company takes with it all the assets and employees that it had under the parent company. These assets can include products, production lines, and technologies. In some cases, the spun-off entity must take on new debt to pay the parent company for all of those assets.

A spinoff can also occur when the division has become successful but falls outside the parent company's core product offerings. For example, a manufacturer might establish a division to develop software in-house to run its equipment. If the software is successful, other manufacturers might want to buy it. As a result, the parent company might spin off the software division as a separate company since it can develop its own client base and earn a profit.

Equity Distribution

The parent company issues its equity interest in the spinoff to its current shareholders. In other words, the parent company's shareholders receive stock dividends. Dividends are payments that are made to shareholders by a company, which can be in the form of cash or shares of stock.

The equity shares are distributed on a pro-rata basis, meaning the stock dividends are paid to its shareholders according to their holdings in the parent company. This is a tax-free distribution to shareholders of the spinoff’s stock. Shares in the new company are not taxed as capital gains to investors, which is a significant advantage.

The equity shares are usually distributed at a discount to the parent company's shares. For example, shareholders might be able to exchange $50 worth of existing shares of the parent company in exchange for $100 worth of shares in the new company. Typically, shareholders of the parent company don't need to forfeit their shares of the parent company in exchange for the new company's shares.

Benefits of Spinoffs

Many spinoffs occur at the demand of activist hedge funds since they create investment opportunities for capital gains from the company's stock that might not have occurred if the company remained under the parent company. Also, spinoffs are viewed favorably by market participants because they create individual companies with a distinct brand identity and are more focused on their core business objectives.

Large conglomerates with disparate businesses under management can be slow to respond to market changes. Spinoffs allow companies to seek out more opportunity for growth. Also, if a spinoff was profitable under the parent, it tends to perform well in the markets, making them even more attractive.

IPO

An initial public offering (IPO) occurs when a private company first sells stock to the public to raise capital or money. The money raised from the IPO could be used to pay down debt or invest in the long-term health of the company. The capital could be spent in a number of ways, including on research and development, expanding into new product lines, or purchase fixed assets, such as equipment and buildings.

IPO Process

Private companies work with investment banks to provide financial backing and guide them through the IPO process. The underwriters perform due diligence to determine how much money the IPO can potentially raise from investors. The underwriters also help the company file the necessary statements and meet the requirements of the U.S. Securities and Exchange Commission (SEC).

The investment bank's underwriters value the privately-held shares and purchase them from the company. In turn, the underwriter sells the shares to a network of investors at a higher price during the initial public offering. The underwriters earn the spread, called the gross spread, which is the difference between the purchase price and the sale price.

During the IPO process, the equity shares of the private investors convert into publicly-owned shares of the new entity. Typically, those early investors might cash in by selling the stock once the new company's shares have begun trading.

Benefits of an IPO

The chief benefit of an IPO is to help the company raise money. However, access to the capital markets, including debt or bond offerings also allows the company a greater ability to expand in the long-term. Companies also get a boost in credibility since the IPO process requires transparency of their financial statements. As a result, that transparency can help the company gain access to credit facilities from lenders and banks in the future.

An IPO helps a company gain liquidity by being listed on an exchange, meaning there would be access to plenty of buyers in the market for their shares. Once a company has gone public, they could issue additional shares in what's called a secondary offering to raise more capital. As a result, determining whether there's enough liquidity and buying interest for the company's stock is critical to the success of an IPO.

Spinoff vs. IPO: The Same Destination

An IPO is the process of a private company becoming a new, publicly-listed company, while a spinoff is part of an existing company that has gone public. However, both achieve the same result of being a new, public entity even if they have different starting points. Once a publicly-listed company, whether from an IPO or spinoff, each have their own management teams, independence, regulatory requirements, and ability to raise more capital in the future.