Business Demergers for Owner-Managed Companies: A Practical UK Guide

A business demerger can help an owner-managed company separate distinct trading activities, assets or business divisions into different companies. It can be an effective way to resolve diverging shareholder objectives, prepare for succession, isolate risk, separate commercial property from a trading business, or prepare part of a group for investment or sale.

For an owner-managed business, a demerger is rarely a simple asset transfer. It can involve company law, tax, accounting, valuation, finance, employees, commercial contracts, intellectual property, property and shareholder arrangements. The legal structure should reflect the commercial outcome the owners wish to achieve.

Early advice can help establish whether a demerger is viable, identify tax and consent issues, and assess whether another route would better meet the shareholders’ objectives.

This guide is the starting point for owner-managed businesses considering a demerger or wider business separation. Our related articles consider specific circumstances, including shareholder disputes, shareholder buyouts, management buyouts, family-business separations, commercial property, company structure reviews and the role of accountants and solicitors in implementing a demerger.

What is a business demerger?

A business demerger is a corporate restructuring that separates businesses, assets or trading activities so they are carried on through different companies or owned by different shareholder groups.

For example, a company may operate both a manufacturing business and a property investment business. The same shareholders may own the company, but one shareholder may wish to develop the trading business while another wishes to retain the property interests. A demerger may enable the activities to be separated into different companies, with ownership arranged around the agreed commercial outcome.

The precise structure depends on the existing group, the assets and liabilities involved, the shareholders’ objectives and the tax position. A demerger may involve:

• Transferring a trade or business division to a newly incorporated company
• Distributing shares in an existing subsidiary to shareholders
• Reorganising shareholdings or share rights
• Reducing share capital
• Separating property, investments or intellectual property from a trading company
• Using a solvent liquidation reconstruction in appropriate circumstances

The desired end position should be agreed before the legal mechanism is selected.

Is a business demerger right for your company?

A demerger may be worth considering where a company has developed beyond its original structure or shareholder interests have changed over time.

• Distinct business divisions: The company may operate two or more established activities that could function independently. Separate ownership can make it easier for each business to pursue its own strategy, funding requirements and management arrangements. 
• Different shareholder objectives: Shareholders may wish to remain in business but focus on different activities. A demerger can provide a framework for separating those interests while allowing each party to retain an agreed business interest.
• Family succession: Family members may have different long-term interests or involvement in the business. Separating activities can form part of a wider succession plan, subject to careful consideration of tax, value and governance arrangements.
• Investment, refinancing or sale: An investor or buyer may be interested in one division only. Separating that activity may make a future transaction easier to structure. A proposed sale or investment should be considered when the demerger is first planned because it may affect the available tax treatment. 
• Property or investment assets: The company may own commercial property, investments or other assets that the owners wish to separate from the trading business. The legal and tax position will depend on what is being transferred and the proposed structure.
• Different risk or funding profiles: Different divisions may have materially different commercial, operational or regulatory risks. Separate companies may provide greater flexibility in managing those risks and securing appropriate funding.

Demerger or Shareholder Buyout?

A demerger may be suitable where shareholders want to retain and develop separate businesses or assets. Where one shareholder instead wishes to leave and another wants to continue with the existing company, a shareholder buyout may be the more direct route. The appropriate option will depend on the business, the shareholders’ objectives, the allocation of value, available funding, tax treatment and whether the relevant activities can operate independently.

Main types of business demerger

There is no single demerger structure that works for every company. The appropriate route depends on the group structure, the activities and assets involved, the intended ownership position and the tax consequences.

1. Direct demerger

In a direct demerger, a parent company distributes shares in a subsidiary to its shareholders. The shareholders then hold the subsidiary directly alongside their shares in the original parent company.

This route may be available where the relevant statutory conditions are met. Those conditions are detailed and require specialist tax advice. They can include requirements relating to the subsidiary’s ownership, the trading activities and the proposed arrangements.

2. Indirect or three-cornered demerger

An indirect demerger, sometimes called a three-cornered demerger, can involve transferring a trade or subsidiary to another company. That company then issues shares to the shareholders of the original company.

This can be useful where the business to be separated is operated within the same company as another trade. It can also require detailed analysis of the consideration, value allocation, company law steps and tax treatment.

3. Capital reduction demerger

A capital reduction demerger can involve a reduction of share capital combined with the transfer of shares or assets to a new company or another group company.

A private company may use a solvency statement procedure where the statutory requirements are satisfied. This can require directors to make a solvency statement, shareholders to pass a special resolution and prescribed documents to be registered at Companies House. The capital reduction takes effect on registration.

4. Liquidation reconstruction

A solvent company may in certain circumstances be placed into members’ voluntary liquidation. The liquidator can distribute shares in newly established companies to shareholders as part of a reconstruction.

This route is more involved and will generally be considered only where the commercial and tax outcomes justify the additional process and cost.

What are the legal steps in a business demerger?

Every demerger has its own requirements, but the following stages should usually be addressed before implementation.

1. Agree the intended end position. Identify which businesses, assets, liabilities and contracts will sit with each company after the separation. The intended ownership structure should be clear before the legal route is chosen.
2. Agree the allocation of value. Consider what each shareholder or shareholder group will receive. This may involve the allocation of cash, debt, retained profits, property, intellectual property, working capital, guarantees and contingent liabilities. Where the proposed demerger is being considered because the relationship between shareholders has broken down, our guide to Business Divorce: When Shareholders No Longer Want to Work Together explains the wider legal and commercial issues that may need to be addressed.
3. Review the existing structure. Review the articles of association, shareholder agreement, share rights, group structure and restrictions on a reorganisation. These arrangements can affect approvals, voting rights and the available options.
4. Obtain tax, accounting and valuation advice. The legal steps should be tested against the intended tax treatment and the commercial allocation of value. Tax advisers, accountants and valuers may need to be involved before the transaction documents are prepared.

Consents, Documents and Completion

1. Identify consents and dependencies. Finance documents, leases, licences, key customer and supplier contracts, insurance arrangements and regulatory permissions may restrict transfers or reorganisations.
2. Prepare the transaction documents. Depending on the structure, these may include business transfer agreements, share transfer documents, board minutes, shareholder resolutions, new articles, shareholder agreements and transitional services agreements.
3. Complete and implement the separation. Completion may involve Companies House filings, updates to statutory registers, asset and contract transfers, new banking and insurance arrangements, employee communications and notices to relevant third parties.

Early due diligence is important. Resolving lender consent, lease assignment and key contract issues before the structure is fixed can reduce delays and avoid the need to redesign the transaction.

What happens to employees in a business demerger?

Employees are often central to the success of a business separation.

Where a business or part of a business transfers from one employer to another, the Transfer of Undertakings (Protection of Employment) Regulations 2006, commonly known as TUPE, may apply. Where it does, employees assigned to the transferring business will usually move automatically to the new employer with their existing employment rights and continuity of employment preserved.

The relevant employers must provide prescribed information to appropriate representatives of affected employees long enough before the transfer. Consultation will be required where either employer envisages measures connected with the transfer that may affect employees.

The outgoing employer will also normally need to provide employee liability information to the incoming employer at least 28 days before the transfer. The assessment is not limited to job titles or an organisational chart. It may be necessary to consider whether each employee is genuinely assigned to the relevant business or activity.

Tax implications of a business demerger

Tax is often central to the choice of structure.

A transfer of a trade, assets, property or shares between companies can create Corporation Tax, Capital Gains Tax, VAT, Stamp Duty Land Tax or stamp tax consequences. There may also be tax consequences for shareholders receiving shares or other value.

Qualifying statutory demergers and company reconstructions may receive specific tax treatment where the relevant conditions are met. The tax treatment of the companies, the distribution and the shareholders will depend on the statutory route and the facts of the transaction. The Capital Gains Tax treatment for shareholders, including the allocation of base cost between shareholdings, will depend on the particular structure and facts.

A demerger should not be assumed to be tax-free. The tax consequences for the company, its shareholders and any recipient companies should be considered as a whole. Specialist tax advice should be obtained before implementation.

HMRC clearance

Advance clearance from HMRC can be important where a statutory demerger is proposed. A company can apply for confirmation that a proposed distribution will be treated as an exempt distribution.

Clearance can provide useful comfort before implementation, but it does not replace the need to satisfy the statutory conditions or take advice on all other taxes arising from the transaction. It should normally be sought before the relevant distribution is made and should explain the proposed transactions and commercial rationale clearly.

Recent anti-avoidance changes affecting certain share exchanges and company reconstructions may also need to be considered where relevant to the proposed structure. Historic advice and precedent structures should be reviewed against the current rules.

VAT, SDLT and other taxes

Corporation Tax and Capital Gains Tax are only part of the tax analysis.

VAT and transfers of a going concern

Where a business or part of a business is transferred, the transaction may qualify as a transfer of a business as a going concern, often called a TOGC. If the relevant conditions are satisfied, no supply takes place for VAT purposes.

Where part of a business is transferred, that part must be capable of separate operation. Other conditions must also be considered, including the intended use of the transferred business by the receiving company.

Property and SDLT

A transfer of commercial property can introduce additional issues, including landlord consent, lender consent, VAT, Capital Gains Tax and Stamp Duty Land Tax.

Reconstruction relief or group relief may be available in some circumstances, but the conditions are strict and relief can be withdrawn following later events. Property should be considered at the outset rather than treated as a final implementation issue.

For more information, see our article on Separating Commercial Property from Your Trading Business.

Stamp taxes on shares and business transfers

Stamp taxes may arise where shares, assets or undertakings are transferred. Relief may be available for qualifying reconstructions, but the conditions can include requirements relating to the consideration, shareholder continuity and commercial purpose of the transaction.

Valuation, funding and accounting

A demerger must be commercially fair as well as legally effective.

The businesses, assets and liabilities being separated may need to be valued, particularly where shareholders will receive different interests after the demerger. The analysis may include:

• Profitability and growth prospects of each business
• Cash, debt and working capital allocated to each company
• Commercial property and investment assets
• Intellectual property, software and brand value
• Guarantees, security and contingent liabilities
• Funding needs after the separation

The company’s accountants should be involved from the outset. Accounting treatment can affect the balance sheet, distributable reserves, financial reporting and the viability of the proposed transaction.

Contracts, finance and shared services

A successful demerger should leave each business able to operate effectively after completion.

1. Banking and finance arrangements

Borrowing agreements may restrict asset transfers, reorganisations, changes of control or the release of security and guarantees. The resulting companies may need new or amended funding arrangements.

2. Commercial contracts

Customer, supplier and service agreements may require consent before transfer or contain change-of-control provisions. Key contracts should be reviewed before the structure is finalised.

3. Intellectual property and technology

Trade marks, domain names, software licences, databases, source code and know-how should be allocated clearly. Ownership should be confirmed rather than assumed.

4. Property and premises

Leases, licences to occupy and property ownership require review alongside tax and funding implications. A property transfer can affect the wider demerger structure.

5. Data protection

Personal data may need to be transferred or shared as part of the separation. Appropriate privacy information, data-sharing arrangements and data processing terms may be required.

6. Shared services

Finance, HR, payroll, IT, management, premises and administrative support may need to continue temporarily under a transitional services agreement. The agreement should identify responsibilities, charging arrangements, service standards and an appropriate end date.

How long does a business demerger take?

There is no standard timetable.

A relatively straightforward restructuring with a limited number of companies, no property and few third-party consents may be completed within weeks. A complex demerger can take several months, particularly where it involves commercial property, employees, external finance, significant contracts, valuations, shareholder negotiations or HMRC clearance.

The timetable may be affected by:

• The complexity of the legal and tax structure
• Tax advice and any HMRC clearance process
• Valuation and accounting work
• Lender, landlord, customer, supplier or regulatory consents
• TUPE information and consultation requirements
• Negotiations on ownership, funding and value allocation
• Companies House procedures and corporate approvals

How much does a business demerger cost?

The cost depends on the structure and work required.

A relatively simple restructuring may involve a small number of companies, limited assets and no external finance. A more complex transaction may involve several trading companies, commercial property, employees, intellectual property, lender consent, tax clearance, valuations and detailed transitional arrangements.

Professional fees may include legal, tax, accounting, valuation, employment and property advice, together with Companies House fees, lender fees and other transaction costs.

An initial scope of work is usually more useful than a generic estimate. Once the intended ownership structure and the relevant businesses, assets, liabilities and contracts are understood, advisers can identify the necessary workstreams and provide a meaningful estimate.

How JLN can help with a business demerger

A business demerger can involve corporate restructuring, shareholder arrangements, tax planning, business transfers, commercial contracts, property, employment and TUPE issues.

JLN can help owner-managed companies assess whether a demerger is likely to achieve the intended commercial outcome before significant implementation work is undertaken. We can develop the legal structure and manage the transaction, working with accountants, tax advisers, valuers and other professional advisers where specialist input is required.

Our work can include:

• Reviewing the existing company and group structure
• Assessing the practical legal options for separating business interests
• Preparing corporate approvals, Companies House filings and transaction documents
• Advising on shareholder arrangements and the post-demerger ownership structure
• Reviewing finance arrangements, commercial contracts, property, intellectual property and employee issues
• Coordinating the legal implementation with tax advisers, accountants and valuers
• Preparing transitional services arrangements and other post-demerger documents

Taking advice before shareholders commit to a structure can identify tax, funding, employee and consent issues at an early stage. It can also help ensure that the legal structure reflects the owners’ intended commercial outcome.

Frequently Asked Questions: Business Demerger

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This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited.