Corporate Transformations: Mergers, Divisions, Transfers, and Legal Changes

What changes can a company undergo?

Mergers (merger by acquisition or merger by formation of a new company)

• the combination of two or more companies into one. In a merger by acquisition, at least one of the participating companies ceases to exist and its assets and liabilities are transferred to another, already existing successor company. In a merger by formation of a new company, all original companies cease to exist and a completely new successor company is established.
• Mergers are often used after acquisitions to consolidate businesses or simplify a holding structure. In other words, this can involve, for example, merging two sister companies into a single, stronger company that is better equipped to face competition.

Division of a company

• the division of one company into multiple companies. It can take place by split-up, where the original company ceases to exist and its assets and liabilities are divided among multiple successor companies (either newly established or existing – in which case we speak of a split-up by acquisition). The second form is a spin-off, where the original company does not cease to exist and only a part of its assets and liabilities is carved out into another new or existing company.
• A new feature since July 2024 is the third variant of division called a carve-out (vyčlenění), in which the company also does not cease to exist, but the carved-out part of its assets and liabilities is transferred to another company in exchange for a business share – either to a new company (the divided company becomes its sole shareholder) or to an existing company (the divided company acquires a share in the successor company).
• Thanks to the carve-out, the parent company retains 100% ownership of the newly established subsidiary into which it has placed part of its business. Generally, entrepreneurs use divisions, for example, to separate a certain division into an independent company (e.g., by spinning off a secondary activity that has its own customer base).

Transfer of assets to a shareholder

• a special form of transformation in which one company ceases to exist and all of its assets and debts are assumed by one principal (acquiring) shareholder. Typically, this is a situation where the parent company owns practically the entire subsidiary and decides to fully absorb it into its structure. Under Czech legislation, this is permitted only with a high level of participation: in the case of an s.r.o. (LLC), the acquiring shareholder must hold a contribution of at least 90% of the registered capital and at least 90% of the voting rights; in the case of an a.s. (joint-stock company), they must hold shares whose nominal value exceeds 90% of the registered capital and at least 90% of the voting rights. The goal is usually to simplify the group – eliminating the need to maintain a separate subsidiary.
• Minority shareholders of the dissolving company must be provided with fair compensation for their shares. The transfer of assets is therefore suitable, for example, if you want to eliminate a complex structure and streamline management by buying out minority shares and integrating the company into a single legal entity.

Change of legal form

• A transformation in which the company continues without interruption, only its legal form changes. For example, a limited liability company (s.r.o.) can change into a joint-stock company (a.s.), etc. Ownership relationships and company assets do not change, only the legal framework of the business.
• This option comes into consideration when the existing form no longer meets the needs of the business – e.g., a growing startup transforms from an s.r.o. into an a.s. to more easily attract investors or go public. Conversely, a company that wants to simplify its administration may consider changing from an a.s. to an s.r.o. Changing the form thus allows the company's legal structure to be adapted to current business requirements without having to dissolve the company and start anew.

(Note: The Act on Transformations also includes the cross-border transfer of registered office, where a company changes its domicile from one EU state to another. However, this is a specific case intended mainly for companies operating on the international market.)

Why do businesses undergo transformations?

Carrying out a merger or other transformations is not easy – why do companies do it at all? There are several reasons, and they are usually strategic intentions to strengthen and streamline the business. The main motivations include:

Consolidation and growth:

• By merging businesses, the strengths of two companies can be combined to gain a larger market share and exploit synergies – for example, eliminating duplicate costs, sharing technology or facilities, and thereby saving money. A stronger, consolidated company can better withstand competition and accelerate its growth, or expand into new markets. Every year, a number of mergers take place in the Czech Republic for these very reasons (often within a single holding, where sister companies merge to create a more efficient entity).
  

Simplifying structure and focus:

• Transformations serve to reorganize a business. Division in the form of a spin-off or carve-out allows certain activities or assets to be separated into a new company – for example, separating a secondary activity from the core business or dividing the company according to different business sectors or risks.
• This creates clearer entities, each with its own management focused on its specialization. A simpler structure increases the efficiency and value of the company. A change of legal form is also often related to the need for a different governance model – for example, transitioning to a joint-stock company allows for two-tier governance (board of directors/supervisory board) and easier transferability of shares, which can attract investors or capable managers.

Tax optimization and financial benefits:

• A properly planned transformation can also bring certain tax savings to a company. Under Czech legislation, subject to certain conditions, tax-neutral transformations are possible – the transfer of assets within a merger or division is not taxed immediately if statutory rules are met. For example, when merging a profitable company with a company in tax loss, the transfer of tax losses can be applied under certain circumstances.
• A division of a business can, in turn, separate profitable parts from less profitable ones for better tax optimization. Note: the tax aspects of transformations are complex and there are anti-abuse rules – any transformation motivated primarily by tax reasons must have a defensible business purpose, otherwise there is a risk of tax reassessment and penalties.

Strategic reasons (acquisition, sale, investor):

• Mergers and divisions are often part of M&A transactions. For example, an investor buys a company and subsequently merges it with their existing company to simplify the structure (a so-called upstream merger – the acquired company ceases to exist and its assets and liabilities are transferred to the buyer).
• If the buyer is not interested in all parts of the business, certain activities may be spun off before the merger, which the original owner retains. Similarly, when selling part of a larger business, the division being sold is often first separated into a new company (to make the sale clearer). The entry of a major investor may, in turn, require a change of legal form – e.g., a successful startup changes from an s.r.o. to a joint-stock company to be able to offer shares to more investors or go public.

In summary, a well-executed transformation can bring a number of benefits to a company: higher efficiency, cost savings (by consolidating duplicate activities), a clearer ownership structure, a better position for growth or the sale of part of the business, and sometimes tax relief. However, every case is different – it is always necessary to consider the economic impacts and feasibility of the plan. Professional assessment and thorough planning are key to ensuring that the resulting transformation truly meets the expectations of the company's management.

What to watch out for: risks and pitfalls of transformations

Although transformations offer attractive opportunities, they also carry significant risks and complications, which must be watched out for. Do not underestimate these pitfalls – even a minor mistake can mean a delay or invalidity of the entire transformation, or even fines and other sanctions. Here are the main risk areas that need attention:

Complex process and bureaucracy:

• Transformation is a complex process full of statutory requirements. The law sets out a number of mandatory steps and deadlines – it is necessary to draft a transformation project, obtain expert opinions (e.g., for asset valuation or share exchange ratio), inform creditors and employees, obtain the consent of the general meetings of all participating companies, etc.
• The entire process usually takes several months, as certain deadlines cannot be rushed. In addition, during this time, the company operates in a "transition period" – until the transformation is registered in the commercial register, it must not freely dispose of assets or distribute profits to shareholders, otherwise penalties may apply. If a company underestimates the formalities, the validity of the transformation may be challenged in court, or the entire process may be irreversibly delayed.
• Recommendation: Do not take such a major step without the assistance of an experienced lawyer who will monitor the schedule and ensure correct fulfillment of all obligations.

Financial and accounting impacts:

• Every transformation significantly affects the accounting and finances of the business. For example, in a merger or spin-off, assets are often revalued to fair value, which can lead to the creation of goodwill or valuation differences in the accounts. This can have unexpected effects – e.g., the creation of a so-called cash trap, where the company's equity increases on paper (e.g., due to asset revaluation), but subsequent depreciation of this higher valuation in the following years reduces profits, so in reality there will be no funds from which to pay profit shares.
• In other words, the owner "becomes rich on paper", but it is not enough for dividends. Furthermore, the planned synergies from the merger may not materialize – consolidating operations may run into unexpected problems, differing corporate cultures, etc. In the case of a division, there is also a risk that the separated part of the business will be incorrectly valued or unclearly defined, which can lead to disputes – under the law, whatever is not explicitly stated in the division project remains with the original company.
• Recommendation: Involve financial experts or auditors in the process to assess the impact of the transformation on accounting, help correctly set asset valuations, and monitor compliance with conditions for potential tax relief.

Legal risks and protection of minority owners:

• In transformations involving the settlement of shareholders (e.g., mergers with unequal shares or transfer of assets to a shareholder), there is a risk of disputes with minority shareholders. They may challenge the share exchange ratio or the amount of consideration for their shares if they consider it unfair. The law provides minorities with certain protection tools (right to settlement, option to petition the court to review the value of the consideration, etc.).
• Creditors may also request sufficient security for their outstanding receivables during a transformation if their recoverability deteriorates as a result of the transformation. They must assert this right in court within 3 months from the date of publication of the transformation project, otherwise it expires. The period therefore starts running from the publication of the project, not from the registration of the transformation, and filing a petition for registration of the transformation in the commercial register does not prevent it. This only applies to receivables arising before the publication of the project; creditors who have a right to preferential satisfaction in insolvency proceedings or are considered secured for its purposes do not have this right. Employees of the company automatically "transfer" to the successor company in a merger or division (their employment contracts continue without change at the new company), and therefore they must be informed of the situation; conversely, in a change of legal form, no transfer takes place.
• Recommendation: Conduct a thorough legal analysis of all impacts of the planned transformation in advance. Communicate openly with minority owners, creditors, and employees to prevent conflicts – for example, offer minority shareholders a fair buyout and obtain their consent to the transaction in advance.

Legislation, regulation, and sanctions:

• Every transformation must take place in full compliance with the law – otherwise, there is a risk of additional tax reassessment or direct sanctions from the authorities. For example, tax offices examine whether the transformation was carried out solely for tax avoidance; if so, they can retroactively deny tax benefits and assess penalties.
• From 2024, furthermore, a notary must refuse to issue a certificate on a cross-border transformation if they assess that the planned operation is abusive or fraudulent (e.g., a fictitious transfer of registered office just for show). In addition, in certain sectors (banks, insurance companies, investment companies, etc.), it is necessary to obtain the regulator's consent in advance for a merger or division – omitting such a condition would mean the invalidity of the transformation.
• Recommendation: Always verify all legislative requirements currently applicable to your case and consult your plan with lawyers and tax advisors. The Act on Transformations was most recently amended by Amendment No. 162/2024 Coll., effective from 19 July 2024, which, among other things, introduced carve-outs (see above) – it is essential to follow its wording. Ignorance or underestimation of the new rules can lead to serious problems.

How to successfully manage a transformation?

A company transformation is a major step – careful preparation and professional guidance are therefore essential. If you are considering any major change in your company – whether a merger, division of business, change of legal form, or other structured operation – do not hesitate to consult experts in a timely manner. An experienced Prague-based law firm can assess your plan from a legal and tax perspective, propose the optimal procedure, and handle all formalities. 

This minimizes risks and gives you certainty that the transformation process will run smoothly and in compliance with current laws. With the support of legal experts, the transformation of your company can become not a threat, but a successful milestone on the path of your business development. Act in advance and with information – your reward will be a stronger, more efficient company prepared for future challenges.