What is Demutualization?

Malcolm Tatum
Malcolm Tatum

Demutualization is the process of converted a mutually-owned company into a shareholder-owned company. This type of conversion usually takes place when a company has grown to the point that it wishes to issue shares of stock as a means of expanding the company in some manner. Going through the procedure of demutualization often helps to set the stage for making an initial public offering (IPO).

Businessman giving a thumbs-up
Businessman giving a thumbs-up

Mutual Companies and Stockholder-Owned Companies

A mutual company, sometimes called a cooperative, is one that is owned by its customers; this structure is most common for organizations like credit unions and insurance companies. As the customers are the owners, the idea is that the company operates with the good of its clients as its top priority. Many of the day-to-day operations of a mutual organization are the same any other company, as it provides financial services, insurance policies, or whatever products are specific to the company to its clients. A mutual company does not issue publicly traded stocks.

A stockholder-owned public company is one that issues shares of stock that are available through one or more stock market exchanges. Shareholders purchase the shares of stock and, in so doing, become part owners in the company. This is a highly desirable status for many companies, as it can help generate significant amounts of capital that make it possible for the company to grow in ways that would not be possible if the corporation remained privately held.

Why a Company Would Demutualize

To operate, any company must have capital; mutual companies raise this capital from their members, through insurance premium payments, credit union deposits, or other methods. If its members will not or cannot provide enough capital for the organization to operate or expand, the mutual company may choose to go through the demutualization process in order to raise capital in other ways, primarily through selling shares to the public. Mutual companies are ideally run for the benefit of their customers, not with the primary goal of making money; by demutualizing, the company may become more efficient and more able to generate needed funds.

Depending on the circumstances, the process of demutualization may take place in a short period of time or occur over several years. Generally, any company that is considering this type of conversion will take time to thoroughly weigh the advantages of converting against the potential liabilities that may occur. Once the company has determined that the benefits outweigh the possible disadvantages of the conversion, an escalation strategy is established to ensure that every legal and operational aspect of the demutualization process is handled in a timely and efficient manner. Approval from a government agency is often required before a company can demutualize.

Types of Demutualization

There are three main types of demutualization:

In a full demutualization, the mutual company becomes a stockholder owned company. The customers — often called members — typically get stock in this new company or are given some other or additional compensation as the owners of the company. Ownership in the company is now severed from being a client, and any new customers do not become owners; stockholders can continue to own the company even if they are not clients.

A mutual holding company is a variation on full demutualization. In this structure, members still own part of the company, but another part becomes public. The mutual part of the company may own some or all of the stock in the public part, or that section of the company may be publicly traded. This structure is not permitted in all jurisdictions.

Sponsored demutualization involves a third party company which funds the demutualization, and which takes a controlling interest in the converted company. The third party buys most or all of the stock in the mutual company, essentially buying it out, and members receive compensation in the form of stock or cash from that purchasing company.

How Demutualization Affects Customers

From a strictly customer perspective, demutualization should not affect the company's regular business. If a financial institution is demutualized, customer checking and savings accounts will still exist as they did before, as will any loans, mortgages, and other products. Someone who has a policy with a mutual insurance company that goes public will still be covered. This is not to say that rules or options for customers won't change; fees could be added or new financial products could be offered by the converted company.

For its members, the conversion to a public company could bring immediate short-term benefits. All members receive some sort of compensation, including stock in the converted company, a cash payout, or some combination of the two. Should the member become a shareholder, he or she may continue to benefit from the conversion if the value of the stock rises.

In the longer term, however, there is the possibility that customers will experience a decrease in customer service from the converted company. Fees may rise or policies be put into place that benefit the company rather than the client. As the focus of a publicly traded company is generally on generating profits for stockholders rather than providing the most benefit to its members, customers may find that the company is not as responsive to their needs.

Malcolm Tatum
Malcolm Tatum

After many years in the teleconferencing industry, Michael decided to embrace his passion for trivia, research, and writing by becoming a full-time freelance writer. Since then, he has contributed articles to a variety of print and online publications, including wiseGEEK, and his work has also appeared in poetry collections, devotional anthologies, and several newspapers. Malcolm’s other interests include collecting vinyl records, minor league baseball, and cycling.

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