Demutualization

A process that represents a company's transition from a mutually-owned company to a shareholder-owned company.

Author: Himanshu Singh
Himanshu Singh
Himanshu Singh
Investment Banking | Private Equity

Prior to joining UBS as an Investment Banker, Himanshu worked as an Investment Associate for Exin Capital Partners Limited, participating in all aspects of the investment process, including identifying new investment opportunities, detailed due diligence, financial modeling & LBO valuation and presenting investment recommendations internally.

Himanshu holds an MBA in Finance from the Indian Institute of Management and a Bachelor of Engineering from Netaji Subhas Institute of Technology.

Reviewed By: Austin Anderson
Austin Anderson
Austin Anderson
Consulting | Data Analysis

Austin has been working with Ernst & Young for over four years, starting as a senior consultant before being promoted to a manager. At EY, he focuses on strategy, process and operations improvement, and business transformation consulting services focused on health provider, payer, and public health organizations. Austin specializes in the health industry but supports clients across multiple industries.

Austin has a Bachelor of Science in Engineering and a Masters of Business Administration in Strategy, Management and Organization, both from the University of Michigan.

Last Updated:November 1, 2023

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 the services of the company are limited only to its owners, who are also their customers. 

The distribution of profits is usually made in the form of dividends and can depend on the amount of business each customer conducts with the company (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.

Key Takeaways

  • Demutualization occurs when a mutual company changes its structure to a stock company that can publicly sell its shares. Its owners and customers are legally separated through this process.
  • There are three types: complete, sponsored, and hybrid. The type of procedure determines whether the current owners get automatic shares in the company once the structure is finalized or if they will have to purchase them with personal capital. 
  • It is advantageous for companies to go through this change because it will allow them to raise more capital on public stock markets. As well as the ability to expand their business globally.
  • However, the disadvantages include decreased customer service due to conflicting interests between shareholders and customers and shareholders having the power to drain the profits from the owners. 
  • 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. Hence it might be a beneficial move. It makes it possible for 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 to it. 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. 

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, there is a possibility 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

The process starts with a mutual company electing to change its corporate structure to a publicly traded company by its board of directors. It is extremely rare for its members to propose demutualization. 

This decision can stem from the benefits of demutualizing being greater compared to continuing operations as a mutual company. Companies can face problems with decision-making and raising capital, which could be minimized by changing their structure. 

A mutual corporation derives its capital from a mutual liability ownership structure. As a result, among many other capital funding sources, a mutual firm raises capital mainly from its customers. 

However, changing its structure gives it access to other low-cost forms of raising capital, such as issuing publicly traded equity. 

Additionally, this decision can stem from changes in the legal and political environment and the desire to make the business similar to the dominant businesses in a particular industry. 

For instance, if the mutual company is lagging behind its competitors with a demutualized structure, it can consider changing its structure to meet industry standards. 

The type will determine whether the members will automatically get ownership conversion rights in the form of equity in the company or if they will have to invest their capital to buy the newly issued shares. 

“Sponsored Demutualization” is more favored due to members' receiving automatic shares in the company or compensation for loss of membership. Therefore, the members are rewarded for voting for the transfer and will be more inclined to do so. 

This process takes approximately 12 to 24 months to be completed and for the company to be able 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:

1. Mastercard 

2. TMX Group

3. New York Stock Exchange (NYSE)

4. Visa 

5. Sun Life Assurance Company

6. Prudential Insurance Company 

Examples of existing mutual companies in the US include:

1. American Family Insurance 

2. Auto-Owners Insurance 

3. Ameritas

4. Altana Federal Credit Union

5. America First Credit Union

6. Bayport Credit Union 

Demutualization FAQs

Researched and authored by Anja Corbolokovic | Linkedin 

Reviewed and edited by Tanay Gehi | Linkedin

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