Demutualization

What Is Demutualization?

Demutualization is a process that represents a company’s transition from a mutually-owned company to a shareholder-owned company. A mutual company possesses a structure where its customers are also its members. Therefore, the company focuses solely on creating value for its customers.

On the contrary, stock companies' primary focus is creating value for their shareholders. Therefore, the change could benefit companies because companies can generate more funds by issuing stocks.

However, it is disadvantageous because a conflict of interest could arise between shareholders and customers, jeopardizing the business's long-term growth.

Demutualization is when a company changes its structure to legally transform from a mutual company (member-owned) to a publicly traded company (shareholder-owned).

The main characteristic of a mutual company is that it is a private firm owned by its customers, who are also its owners. In turn, they are entitled to receive a share of their profits.

The company’s mutual liability is evenly shared, and its services are limited only to its owners, who are also its customers.

Profits are usually distributed as dividends and can depend on the amount of business each customer conducts with the company (on a pro-rata basis). On the other hand, some companies choose to use their profits to reduce customer premiums.

Mutual companies can be referred to as cooperatives, and some examples of companies that use this structure can be found in insurance companies and credit unions.

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Demutualization occurs when a mutual company changes its structure to a stock company that can publicly sell its shares.
Demutualization is advantageous for companies to go through this change because it will allow them to raise more capital on public stock markets.
The process originated in 17th century England due to the need for insurance companies that covered house fire damage.
Mutual companies have fallen out of favor in the recent decade due to regulation changes and stock markets’ ability to provide larger capital.

Understanding Demutualization

Demutualization is the process of changing a company's financing structure from one that is driven by shareholders to one that is mutual.

Mutual firms, which should not be confused with mutual funds, are businesses that were started by individual investors who are also either members or consumers of these enterprises.

Mutual companies are frequently constituted as insurance companies, savings and loan groups, banking trusts, and credit unions.

Demutualization gives a mutual firm access to alternative, less expensive sources of capital investment, so it might be beneficial. It also allows the recently established legal body to obtain outside funding.

Additionally, the business has the capacity to grow and attract more clients. Lenders might be more inclined to lend more money in such a situation.

Generally, there are three types of demutualization companies follow:

Full
Sponsored
Hybrid

The first occurs when a company launches an initial public offering (IPO), which entitles the company to be traded in public stock markets. However, this option does not grant shares automatically to its former mutual company members.

Additionally, this method requires each former member to invest separately, likely from personal capital.

However, in the second option, the company’s former members automatically receive shares under the company’s new structure. Likewise, former members typically receive greater compensation as an award for their previous membership.

They are also allowed to buy additional shares if they choose to form their private capital.

The transaction's prices and terms are some things members can expect to change after the company goes through this process. However, they may continue to utilize its products and services as they did before.

After this process, the company will achieve a distinct separation of legal liability between the owners and its new non-owner customers.

There is also the “mutual holding company, " a hybrid structure of both a stock and mutual company.

A significant company segment (over 50%) is still considered “mutual” and holds its core members. The rest of the company can be publicly traded as a stock company.

Advantages and Disadvantages of Demutualization

It has both positive and negative aspects. Therefore, management must evaluate these factors before deciding to demutualize. The disadvantages and advantages include:

Advantages

1. Ability to raise more capital on stock exchanges

The mutual company typically raises capital from its customers/members to provide them with good service. Additionally, it redistributes some of its profits to its members.

However, a traditional stock company raises funds from its shareholders (and debt holders) to raise capital to provide goods and services to its customers.

Stock exchanges provide a more accessible method of raising funds for companies. The capital earned is usually larger and faster obtained compared to raising capital from customers/members.

2. Ability to reach foreign investors and expand the business globally

Mutual companies have been falling more out of favor due to the ability of companies to raise more capital on stock exchanges and reach more global investors.

Note

Since the business is listed publicly, it is more accessible to foreign investors, giving the business a better chance at foreign expansion and a broader range of willing investors.

3. Broader capital base due to having customers and owners legally separate

Likewise, in mutual companies, the roles of members and customers are legally joined. Hence, mutual companies have fewer options for raising funds than stock companies.

That can pose a problem because if funds provided by their customers are insufficient, it can lead to bankruptcy.

Disadvantages:

1. Possible decreased customer service due to customer and shareholder conflicting interests.

In stock companies, there is a possibility that the interests of customers and shareholders conflict. This disadvantage can lead to a decline in customer service.

2. Prioritizing shareholders can drain the capital from the company’s members.

The structure of a demutualized business is altered to serve its shareholders. Hence, it is possible that the shareholders will drain the capital from the company’s members.

3. Conflicting shareholder and customer interests can also hinder the company’s long-term growth.

Mutual companies focus on serving their community and the customers for which they operate instead of raising capital from likely only profit-driven investors who are not concerned with the company’s long-term growth.

The Demutualization Process

Demutualization is a significant transformation for a mutual company, shifting its structure from a member-owned entity to a publicly traded corporation.

Here is a step-by-step overview of the demutualization process:

1. Initiation by the Board of Directors

The process begins with the mutual company's board of directors deciding to change the corporate structure to a publicly traded company. It is extremely rare for members to propose demutualization.

2. Decision Rationale

The decision to demutualize is often driven by the advantages of a public structure, such as improved decision-making and capital-raising capabilities, outweighing those of remaining a mutual company.

Note

Mutual companies primarily raise capital from their customers due to their mutual liability ownership structure.

3. Access to New Capital Sources

Transitioning to a publicly traded company allows access to additional, lower-cost capital-raising methods, such as issuing publicly traded equity.

4. Influence of Legal and Industry Standards

Changes in the legal and political environment, as well as the desire to align with dominant industry practices, can influence the decision to demutualize.

Note

A mutual company may seek to adopt a demutualized structure if it lags behind its competitors.

5. Ownership Conversion Rights

The type of demutualization will determine whether members receive automatic ownership conversion rights in the form of equity or if they need to invest capital to purchase newly issued shares.

6. Sponsored Demutualization

Sponsored demutualization is preferred as it grants members automatic shares in the company or compensation for the loss of membership, incentivizing them to vote for the transition.

7. Timeframe

The demutualization process typically takes between 12 to 24 months to complete, culminating in the company's ability to issue its initial public offering (IPO).

History of Mutual Companies

The Philadelphia Contributionship was the first American mutual insurance company founded in 1752 by Benjamin Franklyn. Its purpose was to aid families who lost their houses to fire.

Mutual insurance companies originated in 17th century England when individuals sought coverage for their property loss due to fires.

However, early examples can be found in the late 18th century when the insurance company called the Union Insurance Society of Canton underwent a structural change from 1873 to 1882.

This was initiated by its secretary, N.J Ede, and it led to its re-registration as a limited company as opposed to a mutual company, which was how it was first established in 1835.

In recent decades, mutual companies have fallen out of favor with most business owners due to the deregulation of the savings and loan industry throughout the United States that occurred in the 1980s.

Likewise, the perceived benefits of demutualization outweigh the risks. Thus making traditional corporate structures more favorable to business owners.

In the early 2000s, noteworthy demutualizations occurred of a few insurance companies, such as Prudential Insurance Company, Sun Life Assurance Company, and Phoenix Home Life Mutual Insurance Company.

This could have prompted other insurance companies to do the same and alter their structure as well.

A list of companies in the US that underwent demutualization includes:

Mastercard
TMX Group
New York Stock Exchange (NYSE)
Visa
Sun Life Assurance Company
Prudential Insurance Company

Examples of existing mutual companies in the US include:

American Family Insurance
Auto-Owners Insurance
Ameritas
Altana Federal Credit Union
America First Credit Union
Bayport Credit Union

Demutualization FAQs

What is mutualization?

Mutualization is the opposite of demutualization, where a company’s structure changes from a joint stock company to a mutual company.

Following this process, the owners of a company are still active clients that receive benefits from doing business with the company, as before the process took place.

However, the members now have decision-making power and can appoint senior management and, sometimes, board members.

They are now eligible to receive cash distributions directly proportionate to the company's revenue from each member.

At the end of the calendar year, the members receive distributions from the total annual profit earned by the company.

Three types of businesses chiefly favor Mutualization:

1. Savings banks

2. Savings and loan companies

3. Insurance companies

Which one is a better company structure, mutual or publicly traded?

Both structures can be beneficial to companies depending on their objectives. For example, companies whose primary goal is to raise a large quantity of capital for their operations might prefer to be a stock company instead of a mutual company.

However, there are benefits to being a mutual company as well. The company’s primary goal is to benefit its members can attract newcomers. Likewise, it allows for strategic focus within the company since its customers are not separate from its members as with stock companies.

The main difference can be that stock companies favor quick or quarterly results, whereas mutual companies formulate their strategy to yield long-term results.

Why do mutual companies exist?

Mutual companies exist because their structure is needed. Companies with a mutual structure usually include insurance companies and credit unions.

Those kinds of companies require a mutual structure because their function is compatible with it. Insurance companies and credit unions require members, and those members benefit by doing business with the company.

Why did mutual companies fall out of favor?

A mixture of changes in regulation and the ability to raise more capital in stock markets (which can prepare a company for periods of economic downturn) all contributed to the falling favor of mutual companies.

For instance, in 2016, a new rule called 12b-1 introduced a mandatory mutual fund fee. This legislation resulted in fund investors paying an additional 800 million in 2021 compared to the year prior.