You would think that a startup spun off by a mature parent company would have a considerable survival advantage over the lowly startup. Yet spin-offs often fail in the real world. I was part of one myself a few years ago and felt the pain, so the phenomenon has intrigued me ever since.
Spin-offs are like struggling adolescents with over-protective parents. When companies spin off a division (sometimes called a demerger or deconsolidation), they naturally want it to grow and succeed on its own merits, just as they have. But like protective parents everywhere, they tend to shelter it in ways that stunt its growth in the long run.
Before we look at my specifics, I should mention some of the reasons companies make the spin-off decision in the first place. Contrary to popular belief, according to a report by Kearney, these go well beyond an organization getting rid of its “problem children:”
- Deconsolidate—shed non-core functions to focus on core competencies. An example would be Time Warner spinning off AOL—to end a disastrous, dot.com-era marriage.
- Mingle and learn from the startup culture and new technology – without losing control. Foreign companies in the US like to use spin-offs to find expansion opportunities.
- Unlock shareholder value, which the spin-off can do as an independent entity. They may not be so constrained by monopoly fears and Sarbanes-Oxley controls.
- Grow faster, which a spin-off can do outside the parent company. Airlines, for example, have difficulty scaling up through mergers and acquisitions (M&As), but they can spin off their maintenance businesses and let the spin-off do the M&A in its own field.
- Grow in new dimensions from the parent company. Service operations such as call centers can grow far beyond their parent companies, especially if their services are more generic.
In retrospect, as in the situation I experienced, I believe there were several areas in which the parent company consistently fails in their discipline:
- Rewarding without earning. The parent company guaranteed the spin-off a revenue stream and provided incentive bonuses based on artificial objectives, rather than competitive or market-driven targets. The guaranteed revenue and incentives were only loosely tied—at best—to the spin-off’s performance.
- Fostering dictatorial leadership. Effective management skills in a startup are actually quite different from those in a large enterprise. The dictatorial leaders who survived and prospered in the enterprise parent were ill-suited for the collaborative and highly adaptive spin-off and startup requirements. Yet they had “earned” the right to run an autonomous unit, and were not easily dislocated.
- Supporting them for an undefined period. Parent companies provide services or infrastructure to the spin-off at below-market prices or for an excessively long period of time. In the reverse direction, this “support” carried the high overhead that is standard in the enterprise, but not financially sustainable in the spin-off.
In my view, fostering successful spin-offs, like raising adolescents, often requires tough love, embodied in the tough financial objectives and a firm timeline that startup investors impose on their charges. No free passes, and no bailouts.
In most other ways, the success of a spin-off depends on the same factors that are critical to a startup, but sometimes get forgotten or taken for granted as a corporation matures. These include a clearly articulated vision and business strategy, communicated from leaders in a way that heightens motivation and lessens team anxiety of the unknown.
For entrepreneurs, this analysis should be a positive message, but it should also be a wake-up call to the overriding value of leadership and effective communication. For all of you who all too quickly tie your business success or failure to funding (or the lack of it), think again. Sometimes it helps to be “hungry” in that respect.