"Carve-outs" are partial divestitures of a business unit in which a parent company sells a minority interest of a child company to outside investors. While they're among the most complex transactions that private equity (PE) firms today undertake, they're also often among the most profitable at exit.
PE firms have completed more than 460 such deals in the past decade, collectively representing more than $68 billion in value — of which Bain Capital's $17.9 billion carve-out of Toshiba Memory Corp. and Blackstone's $17 billion carve-out of Thomson Reuters' Financial & Risk (F&R) unit are noteworthy examples from the past year alone.
And there are good reasons to believe carve-outs might be on the rise in the year ahead. Namely:
- Private equity firms have unprecedented reserves of dry powder on tap right now. With all that capital just waiting to be deployed, the conditions are ripe for carve-outs and related transactions.
- The full impact of the 2017 Tax Cuts and Jobs Act, which brought the federal corporate tax rate to 21 percent — a reduction of nearly 40 percent — is still being felt. Rolling back the tax burden associated with large-asset sales obviously makes transactions like carve-outs much more appealing.
However, with so many moving pieces to consider — people, assets, services, contracts and more — carve-outs come with complexity built in. And for PE firms looking to capture the full value of these opportunities, financials aren't the only variable in play. Here are four best practices to help PE firms succeed.
develop an end-to-end transition game plan
In the rush to close a carve-out deal, transition planning often takes a back seat. That's a mistake, because in the absence of robust transition plans, disappointments can quickly add up for buyers and sellers alike. Without an end-to-end plan in place, carve-outs can quickly go off the rails.
For starters, PE firms should focus on transition service agreements (TSAs), which help hold carved-out operations together until new systems and infrastructure can be developed and put into place. Two things to keep in mind when it comes to carve-out TSAs:
- Start with the high-level view: TSAs should clearly stipulate which party gets paid for what services and for how long.
- But TSAs should delve into the details, too. For example, if value-added tax (VAT) is incurred by the buyer or seller, is it recoverable? Which party will absorb the cost?
For PE firms, the risks of inadequate transition planning are too numerous to name — escalating costs, integration delays, customer attrition or worse. Fortunately, all of these outcomes are avoidable, provided leadership invests the time needed to address them early on.
analyze the scope of the transaction
Understanding the true scope of a given transaction is another secret to success. Yet, given the likely unavailability of audited financial statements, gaining that understanding isn't easy — and it means having the right finance and accounting professionals on staff is key.
To get an accurate read on the true scope of the transaction, dial in on the following questions:
- What's the full extent of corporate shared services?
- Will existing contracts with customers and vendors remain intact?
- How will costs associated with software licenses, leases, severances and HR play out? (These can be especially complex to untangle.)
- Which capabilities are — and which aren't — included in the deal, and how should that influence your overall strategy?
Bear in mind, any capabilities that are not included in the deal will be just as critical to the long-term success of the acquired business as those that are. So plan accordingly.
put the numbers in context
In the run-up to any carve-out, it's paramount that PE firms not only crunch the numbers, but frame that financial information in an appropriate context as well. Otherwise, those numbers can be misleading in at least two ways:
- Available financial information may not accurately represent the historical performance of a spun-off company.
- The numbers won't take into account any additional costs that might take effect once the transaction has been made.
Clearly, context is key to understanding the real value of a deal.
bring in the experts
As we've discussed, developing an effective transition plan is key — and PE firms should kick-start the process way before the ink on the contract has dried.
In particular, PE firms should begin evaluating strategic partners during the due diligence phase, with an eye toward executing the transition plan on the ground. Look for partners with expertise in project management consulting as well as previous experience orchestrating carve-outs and other M&A activities. To drive value in the face of so much complexity, it's difficult to overstate the value of having prior experience at the wheel.
key takeaways
Carve-outs are among the most complex transactions undertaken by PE firms today. And that complexity is particularly pronounced during specific moments in the deal process: Purchase-price adjustments, for example, typically require judicious input from a wide range of stakeholders — accounting and finance professionals, legal teams and more. In that light, it's key to have the right people on your team.
That's also an example of where and how Tatum can deliver enduring value to PE firms in the context of carve-outs and other complex, high-value transactions. For more than 20 years, leading PE firms have relied on Tatum to bridge leadership gaps, optimize management, lead successful transitions and overcome challenges across their portfolios. In fact, every year we help more than 50 PE firms achieve desired outcomes in the course of M&A activities and during key moments in their business cycles.
To discover how our PE transaction-support capabilities can contribute similar value for your company, set up a meeting with one of the experts from Tatum by connecting below today.
