Separation Agreement
(Equity Carve-Out)

Summary

This template separation agreement for an equity carve-out (or subsidiary initial public offering (IPO)) sets forth the principal transactions and arrangements that are required to effect a separation of the business of a subsidiary from its parent company prior to an IPO of the subsidiary's shares. This template includes practical guidance and drafting notes. The separation agreement identifies assets to be transferred, liabilities to be assumed, and contracts to be assigned to each of the carve-out subsidiary and the parent in implementing their separation. It sets forth when and how the transfers, assumptions, and assignments will occur, and provides for arrangements governing the relationship between the parties after their separation. In these respects, the separation agreement in an equity carve-out is similar to a separation agreement entered into prior to a spin-off. While equity carve-outs are capital-raising transactions and spin-offs are distributions of parent company value to its shareholders, the mechanics of these transactions prior to the sale or distribution of the subsidiary's shares are quite similar. This template assumes that the subsidiary issuer has operated principally as a separate subsidiary, with certain additional parent assets and liabilities that need to be transferred to it prior to the IPO. A separation agreement provides for the parent company to transfer to the carve-out subsidiary any assets it owns and liabilities it has assumed that are principally related to the subsidiary's business. The agreement typically defines transferred assets, assumed liabilities, excluded assets, and retained liabilities through a combination of categorical descriptions and specific schedules of the relevant assets and liabilities. The parties will have to determine whether it is better to list the relevant assets and liabilities in schedules to the agreement or whether the descriptions of the categories are clear enough that the burden of preparing extensive schedules would outweigh the benefit of specificity. Often, a combination of descriptive categories and schedules are used. In some cases, working capital or other balance sheet adjustment mechanisms, similar to those that are included in private asset sales and divestitures, may be included. This template does not include such mechanisms. Note that a parent company may follow an equity carve-out of a portion of the subsidiary's shares with a spin-off of the remaining shares. Given the similarities between the separation agreements in an equity carve-out and a spin-off, the protections typically built into a spin-off separation and distribution agreement should already be in place in the separation agreement for the equity carve-out. In order for a spin-off to qualify as a tax-free transaction, the parent company must distribute at least 80% of the voting equity of the subsidiary. Therefore, if the parent wants to spin off the subsidiary after an equity carve-out, it must limit the percentage of subsidiary shares sold in the carve-out to no more than 20%. If the parent wishes to raise more than 20% of the value of the subsidiary in the equity carve-out while maintaining the ability to undertake a tax-free spin-off later, it might consider a dual-class capital structure for the subsidiary, in which one class has one vote per share and another class has multiple votes per share. The subsidiary (or the parent, in a secondary offering) could sell low-vote stock to the public while the parent retains high-vote stock. It should be noted that the IRS no longer provides private letter rulings on the tax status of low-vote/high-vote arrangements. See Basic Tax Considerations in Divestiture Transactions. As with any IPO, an equity carve-out involves filings with the Securities and Exchange Commission (SEC) and the listing of the offered stock on a securities exchange. Accordingly, each party's obligations with respect to applicable disclosure requirements are provided for in this agreement. For further discussion of the agreements required in an equity carve-out transaction, see Operative Agreements in Divestiture Transactions, and Ancillary Agreements in Divestiture Transactions. For examples of recent spin-off transactions, see Spin-Off and Divestiture Tracker. For a broad collection of content related to divestiture transactions, see Divestitures of Divisions and Subsidiaries Resource Kit.