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Issues With Respect to Spin-Offs

Section 355 — Interpretations to 355 and 368 may differ. It is therefore prudent for the private company to obtain a ruling from the IRS prior to proceeding with the distribution.

Management and Governance —A spin-off might result in a new and inexperienced management team. The differences in managing the parent and the subsidiary require a thoughtful transition. The initial board of directors will be mostly compromised of the board of directors of the parent company as they vet management and overseeing the complete divestiture of the two private companies.

Separation of Assets — There may be significant issues in deconsolidating the assets of the parent private company and the subsidiary especially if they use the same inventory, office space or resources.

Capitalization — As the date of the distribution approaches, there may be debate over how much debt the parent private company and the subsidiary take on. It is important to understand that in large enterprises, funding and financing is allocated and obtained on the corporate level and is not always delaminated per subsidiary and operating unit. As a result, the spun-off subsidiary sometimes pays a dividend to the parent private company prior to the distribution in order to de-lever the parent and lever up the subsidiary.

Contingent and Other Liabilities — Certain liabilities of both private companies may have been intermingled in order to take advantage of economies of scale such as 401(k) plans and health benefits. Each of the items will have to be evaluated individually so as each private company accounts for their liabilities based on underlying resources. All contingent liabilities must be resolved prior to the spin-off in order to retain the maximum benefits from the transaction.

Relations with Customers, Supplies, and Shareholders —Often after a spin-off many investors sell out of their holdings since the new spin-off or the parent company no longer fit their investment criteria. With similar applications to customers and suppliers, many customers and suppliers have done business with the parent or the subsidiary as a result of the other. It is important to maintain good relations throughout and post the spin-off process to retain all customers and suppliers.

Subsequent Events — The IRS mandates that for the spin-off transaction to remain tax-free, neither the parent nor the spun-off subsidiary can be acquired within a set amount of time (usually two years). This is to ensure that shareholders for the company remain the same both before and after the spin-off transaction.

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