Mitigating Human Capital Risks And Unlocking Value From Spin-Offs

Spin-offs — corporate transactions in which business units separate from their parent company to become independent entities — are increasingly popular as companies reexamine their business strategies and search for additional ways to boost shareholder returns. Two Willis Towers Watson experts look at the unique human capital challenges associated with spin-offs and the steps organizations can take to minimize the risks and maximize the chances of success for these types of transactions.

What’s the difference between a spin-off, a separation and a sale?

Kelly Karger (Senior Consultant, M&A Consulting): A spin-off, a separation and a sale of a business are all similar in that they are ways for a firm to divest an asset or a business. They each enable the seller to reduce the size and scope of its operations and to focus on increasing shareholder return.

A spin-off creates a new, independent organization with its own structure, leadership and board. Spin-offs are currently tax-free transactions. A spin-off results in the parent corporation (ParentCo) issuing stock in the new organization (SpinCo) to existing ParentCo shareholders. Designated employees make the transition from employment with ParentCo to employment with SpinCo and to SpinCo’s HR programs.

A separation creates two or more independent, publicly traded companies from an existing organization through a tax-free transaction. The new entities (NewCos) are typically very different organizations than the ParentCo with different customers, growth profiles and products. Existing stock in ParentCo is converted into shares of both ParentCo and NewCos at the time of the separation. Employees make the transition from employment with ParentCo to employment with the independent NewCos and to NewCos’ respective HR programs.

A divestiture is the sale of a business to another buyer via a stock or asset purchase. The parent corporation receives payment for the entity and the assets transfer to NewCo. The buyer is responsible for onboarding the employees and moving them from ParentCo’s HR programs to NewCo’s programs.

What circumstances drive an organization to consider a spin-off?

Karger: Business leaders are taking a hard look at how their businesses are structured, and how and where they deploy their capital and other resources. They’re searching for new ways to respond to shareholder demands. When they have business units that aren’t closely aligned with the company’s core business or the organization’s strategy, or have lower growth rates, they may choose to spin them off.

Sometimes, a spin-off is focused on a more mature market or has a different growth rate than the parent company. Sometimes, it’s a business that’s no longer in sync with the company’s strategy or product/service mix. Shareholder activism and a perception that the business is undervalued can drive these transactions.

Spin-offs are often the result of a determination that various businesses can achieve their full potential more efficiently as stand-alone, independent companies. Creating smaller, more focused organizations can increase the value for shareholders and other investors. ParentCo can refocus its attention and resources, and SpinCo can benefit from new strategies and initiatives that might not have been previously supported.

What are the most urgent people-related issues?

Nell Stanton (Senior Consultant, M&A Consulting): Use the pre-close period to develop and pressure test your action plan for SpinCo Day One people priorities. It’s critical to define approaches to talent retention, talent selection and executive compensation early. How will leaders and staff be selected for SpinCo, and how should they be incented to maximize retention and engagement through the transition period and beyond? Filings such as SEC Form 10 and the preparation of the Employee Matters Agreement (EMA) require significant lead time; getting an early start on completing that language enables a smooth close. Don’t neglect building a communication and change management plan or establishing a PMO to prepare for the spin-off’s HR activity management. Other imperatives include defining an appropriate Total Rewards approach for SpinCo and, if your transaction is global, planning for the employees in legal entities that won’t transfer to SpinCo.

How do companies retain leaders and key talent during and after a spin-off?

Stanton: Our research shows that retaining leaders during and after a corporate transaction such as a spin-off is about more than money. Using a combination of financial retention and high-touch strategies to capture the “hearts and minds” of leaders results in more successful retention programs. No-cost tactics for retention include clearly defining the role that the leader will have in SpinCo, providing an executive mentor and making it possible for the leader to have an active role in shaping the future of SpinCo.

It may be necessary to realign the roles at ParentCo to allow the leaders to focus on their new roles at SpinCo. Financial retention strategies should aim to retain leaders not only to successfully complete the spin-off but also to achieve initial business goals for SpinCo.

The most commonly cited reasons for leaders and key talent leaving after a transaction are discomfort with the culture of the new organization, aggressive pursuit by competitors, and dissatisfaction with their new role or with the strategic direction of the new company. Involving key talent in shaping the culture of SpinCo, setting clear expectations and enabling employees to focus on their new roles as well as ensuring they understand how their roles contribute to the organization’s strategic direction are all tactics that can address these issues from the start. If leaders and other key talent are engaged, they will be less likely to entertain offers from competitors.

What are the key steps in the talent selection process?

Stanton: Defining an effective selection process, securing the requisite legal reviews of selection criteria/approach and communicating the planned SpinCo selection process to employees should be pre-close priorities. The parent company executives decide whether to implement a “freeze” on employee movement between ParentCo and SpinCo businesses between announcement and close. In addition, they establish a governance protocol for exception management/approvals for internal hiring and movement.

Organization charts clarify the structure of the SpinCo’s business and specify the number of employees (how many boxes), and the types of roles required and where those roles will be located. The next step is to define the selection process to fill those roles. Early clarification of a talent sourcing strategy is key: Understanding from where to source external candidates in order to complement internal talent, and identifying the right third-party recruitment firms to assist in the proactive development of those external talent pipelines is very important. Getting position descriptions and reward packages ready in advance helps make the talent selection process more agile.

What should companies do to prepare employees for changes resulting from a spin-off?

Stanton: Because preparation timelines are often lengthy, it can be challenging to determine how and when in the pre-close period to focus on communications and change management for stakeholders. Our perspective is this: When you have defined the key parameters of the SpinCo business’s scope, as well as completed 80% or more of organization design, and the Total Rewards approach and selection process — in essence when you know with some degree of certainty what’s changing — you need a plan for communicating that information to key stakeholders. These include both the employees who will be staying with ParentCo and those who will be moving to SpinCo. Equip leaders and line managers across the business with talking points to help them consistently, clearly and easily articulate the business rationale for SpinCo and what’s changing for employees. In particular, focus on the “what’s in it for me” information: reporting relationships, pay and benefit-related changes.

What other insights can you share from your spin-off experience?

Karger: Our experience tells us that companies that establish a Project Management Office (PMO) to prepare, coordinate and align plans and resources are most successful in this effort. An HR PMO ensures that HR activities are globally aligned and coordinated with the timelines and plans established by the Separation Office for the overall separation of the business. Key HR PMO activities include developing employee communications, designing the SpinCo employee onboarding experience, documenting key decisions and outcomes, addressing and resolving open issues and tracking progress against plans. In addition, the HR PMO establishes the project scope and decision-making governance protocols. It also identifies areas of spin-off execution risk and develops mitigation strategies for those risks.

How do you ensure that you are ready to transfer employees on Day One?

Karger: The key to transferring employees on Day One is preparation. This starts very early in the pre-close period with a simulation activity to identify cross-functional dependencies (i.e., where an activity in one function depends on an activity in another) and provide for seamless employment transition and minimal business disruption. The objective of this simulation is to have all functional areas identify the critical processes, systems and programs that are needed to function on Day One and then move backward to determine all of the steps needed to put those elements in place by Day One. For example, it’s one thing to say that we need to be able to pay employees on Day One, and it’s quite another to step back from there to understand all of the activities that make paying employees possible.

Human Resources needs to rely on all of the other functional areas to complete certain activities that will make it possible to transfer employees on Day One. Legal, IT, Finance and Facilities (for example) will all have their parts to play. By determining cross-functional dependencies very early in the process, we are more likely to be able to work with lead times that these other functional areas require and ensure resources are available to perform the activities.

How should leaders develop a Total Rewards approach for SpinCo? How should they address existing Total Rewards programs?

Karger: Business leaders must develop an approach to Total Rewards for SpinCo that aligns with the spin-off’s business rationale and value proposition. The approach may be similar to that of ParentCo, but often the business rationale will require a different approach reflecting the talent attraction and retention needs of SpinCo and a different set of comparator companies. For example, a business rationale that includes streamlining the organization to account for narrow margins will likely lead to a different Total Rewards approach than a business rationale that includes aggressive pursuit of talent with specialty expertise.

It’s also critical to address the impact of the spin-off on the existing Total Rewards program. In some cases, it will be appropriate to spin off portions of retirement plans or establish new plans that mirror the existing programs. But this should only be done with a good understanding of how those programs align with and support SpinCo’s Total Rewards program. By articulating the Total Rewards viewpoint of the leaders in the pre-close period, you can then ensure that the language in the Employee Matters Agreement regarding compensation and benefits reflects the business needs of SpinCo. In addition, it’s important to define the Total Rewards strategy, which will provide valuable information for change management and communication efforts focused on rewards.

Who makes decisions about SpinCo’s HR programs?

Karger: Prior to closing, ParentCo will need to define the decision-making process for SpinCo’s programs, including who at ParentCo has the authority to make final decisions with regard to the programs and the adoption of the new legal plans. The ParentCo will become a fiduciary of any programs or plans created prior to closing and until those plans are assigned to SpinCo at closing. Once SpinCo is a separate legal entity and assumes the sponsorship of the plans or programs, it also bears the responsibility for decisions with regard to those plans. For this reason, it’s important to establish the fiduciary committee at SpinCo and ensure it’s in place on Day One with appropriate bonding and liability coverage.

Ideally the senior leadership of SpinCo (to the extent they have been named) will be included in the decision-making process for SpinCo programs pre-close, even if they do not have voting rights or decision-making authority at ParentCo.

How do employees balance preparing for spin-off with focusing on day-to-day activities?

Stanton: It’s important to encourage employees to focus on “business as usual” in the pre-close period, with the objective of minimizing disruption to customers and to the business. Individuals on the spin-off preparation core team often struggle with balancing “day jobs” and expectations with participation in time-intensive spin planning activities. One of the key functions of the Human Resources Project Management Office (HR PMO) is to clarify team member roles and what percent of their time can be dedicated to spin preparation activities; 80% dedication for core team members is a realistic expectation.

How do spin-offs differ from mergers and acquisitions in terms of human capital needs?

Stanton: Spin-offs are not acquisitions in reverse. While spin-offs, and mergers and acquisitions all require effective employee communication and strategies for retaining key talent in an environment of change and uncertainty, spin-offs present their own unique HR challenges.

With the creation of a new legal and independent entity, SpinCo, the HR organization must be fully ready to operate on a stand-alone basis on Day One. Plans must be prepared to ensure compliance with regulatory and reporting requirements (SEC, IRS, DOL, for example) that ParentCo might have handled prior to the spin-off. Meeting these requirements might involve adding employees, developing and documenting new processes, and training employees on new processes and systems. In addition, talent acquisition may become more challenging for SpinCo as applicants may perceive there to be more unknowns and fewer opportunities than in the past. SpinCo’s employee value proposition may be very different from ParentCo’s, and SpinCo may also have a very different culture.

Setting up the HR organization in a spin-off is a challenging process. In many ways, a spin-off provides a unique opportunity to envision the structure of the HR organization with fresh eyes — without the constraints of a preexisting organization — and to unlock greater value.