Whether it’s to improve investment prospects or protect assets, demerging – dividing a business into separate entities – can be a wise move.
It can make it easier to attract capital, manage risk and planning for succession might become easier.
However, demerging is not without its difficulties. For accountants, managing diverse accounting systems, coordinating cash flow and consolidated financial reporting can prove challenging.
Here, we delve into the ins and outs of demerging with Nailia Alimova, Accountant, and Founder and Chief Financial Officer, Xsource Control.
What are the steps required to demerge?
Demerging requires careful planning to ensure a smooth transition and legal compliance, says Alimova.
Businesses should begin by defining their goals, conducting audits, consulting tax professionals and determining the best possible new structure, before preparing legal documentation.
After that, effective communication with stakeholders, proper registration and obtaining licenses are essential.
“The transfer of assets and personnel ensures operational continuity, [and should be] followed by establishing new financial and reporting systems,” says Alimova.
“This methodical approach aligns the split with business goals and legal requirements.”
When is demerging a good idea?
Splitting a business into separate entities can be a strategic move where risk management, asset protection and attracting capital are priorities.
Further, demerging may be beneficial if compliance is complex and costly, such as when a business launches a new product line, expands into foreign markets or operates in a regulation-heavy environment.
“Other considerations include estate planning, enhancing talent acquisition through employee share schemes and achieving operational efficiencies,” says Alimova.
What are the benefits of demerging?
One of the primary advantages of demerging is better protection.
“Each entity provides a liability shield, [which protects] assets, such as intellectual property or real estate, from creditors or lawsuits against other parts of the business, ensuring that difficulties in one entity do not affect others, and reducing overall risk,” says Alimova.
It can also make attracting capital easier.
“Investors may prefer to invest in specific segments, potentially leading to future divestiture or sale of individual entities, and better outcomes for owners,” says Alimova.
Further, demerging may promote accountability, as each entity must produce its own financial statements and performance metrics. This can mean more streamlined reporting and more straightforward succession planning, given that demerging makes the transfer of ownership easier.
Accountants should also look out for opportunities for tax optimisation.
“Separate entities [may] enable [more] strategic allocation of profits and losses, [attract] tax incentives or credits specific to certain industries or activities,” says Alimova.
“[It] may [also] enable flexibility in structuring transactions and investments to maximise tax efficiency, including options for income deferral or capital gains treatment.”
When is it appropriate to create simple business units for the purposes of internal reporting and profit and loss statements?
This approach is often best for large or diverse companies.
“Establishing distinct business units allows for better insight into the performance of each division or region, especially in companies with a variety of goods, services, or locations,” says Alimova.
It may achieve this in three ways. First, the revenue, expenses and profitability of each unit can be measured more precisely. Businesses can then make better decisions about the allocation of resources – from cost-cutting strategies and pricing of products to upgrading, expanding or creating spin-offs.
Second, the financial performance of each manager, team or product line may be assessed more easily. The information gathered can be used to identify strengths and weaknesses, create development plans and enhance accountability, in order to foster motivation.
“[Third], for compliance, some industries or regulatory environments may require specific reporting based on [particular] activities or product lines,” says Alimova.
For accountants and finance teams, what are the challenges of working with businesses composed of separate entities?
While demerging can simplify compliance on an entity-by-entity basis, it may nonetheless create some challenges for accountants and finance teams.
Potential hurdles include managing diverse cash flow cycles, dealing with contrasting accounting systems, and meeting extra reporting requirements, as well as managing risk management and internal controls.
In addition, consolidated financial reporting may become more complex.
“[Accountants] must consolidate all entities’ financial statements to provide a comprehensive view of performance,” says Vilamova.
“This task is compounded by inter-entity transactions, different accounting policies, and varying fiscal year-ends.”
To respond to such challenges efficiently, Alimova recommends utter consistency in policies, procedures and controls.
“Lastly, managing workload and resource allocation, particularly during peak periods, like year-end reporting or tax compliance deadlines, requires careful planning and coordination,” she says.
Ultimately, Alimova concludes, the decision to demerge can be beneficial in two main ways.
“Overall, having separate entities offers a range of benefits that simplify work for accountants and finance teams, while potentially providing tax advantages tailored to the business’s needs and objectives.”
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