Corporate Carve Outs

Over the past few years, divestitures have accounted for a rapidly increasing percentage of total M&A activity. Organizations generally complete more acquisitions than divestitures, in particular during times of growth. However, firms looking at buying divested businesses will face the challenges of how to integrate certain divested assets from separate entities into a corporate whole. This is one of the most challenging, but exciting, M&A scenarios.

But…what is a carve-out?

The generally accepted definition for the term “carve-out” is the operational and organizational activities necessary to complete the transfer of a business during a divestiture transaction. Although both buyer and seller have joint responsibilities during the carve-out process, the majority of the burden generally is on the shoulders of the buyer. This is intuitive, as they need to manage a host of differing, and highly complicated, issues in order to maintain and maximize the deal value during the carve-out process. If they mess up the integration, you have placed at risk the initial value creation ability.

Why are carve-outs so complex?

If a firm wants to attain both the desired operating efficiencies and business functionality, the company will need to operate based on highly integrated processes and systems, largely relying on estimated data, to support their entire corporation throughout the integration. Corporates are like an ecosystem, each feeding on each other. When a part of this ecosystem is removed (divested) from its corporate parent, its highly integrated processes, systems, applications and data must be disintegrated.

Below we list a variety of factors that normally make carve-outs more complex and riskier than expected:

• Assets: The assets involved in a carve-out are generally non-core. This translates to assets that have been historically neglected, including lack of investment, maintenance or management. Take the extra time to understand the assets and why they no longer meet the strategic imperatives of the parent company.

• Costs: Calculating accurate costs is nearly impossible. It is difficult to understand and forecast the carve-out and stand-up costs for both parties, so assume there will be a margin of error.
• Financial statements: The divestiture is generally not comprised of a fully intact entity. For this reason, there are often no financial statements for the asset, unit or product line, and these will have to be created. These estimated financial statements are generally incorrect in hindsight as the synergies are never as expected.

• Transaction challenges: Every transaction during any M&A deal is different and has difficulties. The buyer and seller will still need to undergo due diligence, valuation, legal, tax, and financial advisory review.
• Talent: Sellers often “cherry pick” talent, and include these into their However, individuals can still decline an offer and you may even lose the key person within the division if you do not sell the move to them.
• Employee psychology: Employees often feel rejected and betrayed if you leave them out of the loop. If you sell their division, that means they were dispensable. More so, if this division was a cog in a larger wheel, you may have just limited their planned career progression.

Six steps for help ensure success

Below we provide 6 steps we think will help guide you through the carve-out process.

1. Determine the key elements of the deal.

Like with all deals, the first thing you need to do during the carve-out process is to determine and define exactly what’s included in the deal. Communication is critical here.. Make sure you clarify what is and what is not included in the deal. Where possible, try and determine the operating model necessary to run the business involved in the carve-out. Due diligence is key, and use this time to find possible hidden costs and hidden contracts.

2. Try and complete the TSA yourself!

A Transitional Service Agreement (TSA) is made between a buyer and seller and contemplates having the seller provide infrastructure support such as accounting, IT, and HR after the transaction closes. Instead of relying solely on the seller to lead the TSA process, the buyer should complete their own independent needs analysis; which includes costing analysis and benchmarking. Timelessness is key, and make sure you build in reasonable deadlines that allow you as the buyer to build, test, migrate and operate new systems independently at TSA exit.

          3.  Define your definition of “operations”

You need to define a comprehensive concept of operations. This is a fundamental part of the carve-out integration strategy and allows you to take control of what you will or will not be taking over / buying. To define the operations, begin with the overall strategic context for the purchase; the specific target company or business unit and your deal logic.

For each integration decision to be determined, work out timelines, short vs. long so you can start to piece together how long the integration will take in its entirety. Secondly classify each according to the overall approach to integration that will help you most effectively preserve, capture and maximize deal value.

5. Know your leadership

It’s important to gain sufficient insight into the leadership on both the buyer’s and seller’s side:

The buyer’s leadership will be responsible for setting the vision, communicating the strategy, and inspiring staff who may feel rejected or betrayed.

Regarding the seller and the leadership to be divested, consider the historical and current relationship between the seller’s parent entity/leadership team and the to-be-divested entity/leadership team.

6. Apply best practice integration

Though a carve-out affords a unique set of challenges and considerations, it has a lot in common with other M&A deals, in particular, other types of integrations. Don’t neglect best practices from these other, arguably less complex, transactions. For example, you should still enforce a strict integration framework, and you must prioritize your initiatives and objectives from day one. Carve-outs require cautious change management and culture alignment by mitigating potential flashpoints and resetting expectations for high performance.

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