Capturing value
through carve-outs
Working with you to make your
transaction a success
For business portfolio
management to be effective,
executives must understand
that the divestiture process
itself can create value for the
group and that divesting does
not mean failure.
Capturing value through carve-outs
Executive summary
Almost invariably, as companies Buyers contemplating the acquisition
reassess how to strategically manage of a carved-out asset face a different
their portfolio capital, the need or set of challenges, such as valuing
desire to divest certain assets and the assets, performing diligence on
activities arises. the seller’s financial and operating
Companies often view divestitures statements, and maintaining and
as the mark of failure, so they continuously updating their own deal
often devote inadequate resources analyses and models. A buyer must
to them. While many companies also prepare for day one and overall
have established rigorous M&A integration — which will likely entail
management, when it comes to negotiation with the seller for one or
divestitures, managers have been many transition service agreements
too eager to “just get rid of them,” (TSAs).
rushing through the sale of a business There are many issues, both
or asset or not negotiating the deal significant and subtle, that can
aggressively — potentially leaving surface without notice. While
money on the table or overlooking large, public companies often
other strategic opportunities. have dedicated and experienced
Unlike with acquisitions, most corporate development teams to help
companies do not have in-house navigate through the divestiture or
capabilities or experience executing acquisition processes, medium-sized
divestitures. It’s therefore important companies often lack the resources to
to engage external advisors who have successfully manage all aspects of
the necessary experience and can the transaction.
help you through the process. By reviewing any transaction from the
Carve-outs are often complex and perspective of both buyer and seller,
can present the seller with an array executives can avoid surprises, gain a
of challenges, including recognizing clearer understanding of where value
the needs of the potential buyers. In can be created or destroyed and, by
order to do this, the seller must be following through, make a good deal
transparent about costs, preparing even better.
thorough and accurate carve-out
financial statements and providing
sufficient and appropriate information
in a timely way.
3
Carve-out sellers and buyers
The conflicting agenda
Lower price
• Highlight liabilities and risks.
• Challenge run rates and forecasts.
• Understand sustainability.
Maximize realistic value • Develop advantage over other bidders.
• Create competitive environment • Analyze costs and synergies in detail.
among bidders.
• Limit TSA costs.
• Avoid surprises from bidders’ diligence.
• Control information release.
Common • Maximize warranties and indemnifications.
• Balance length of process against goals • Balance exclusivity and break-frees.
shareholder expectations.
• Drive a high degree of precision
• Preserve value. Buyer control
and enormous attention to details • Reduce uncertainty.
• Develop patience, thoroughness and • Create efficient tax
understanding of all value levers. structure.
• Optimize TSA structure.
• Reduce stranded costs. • Minimize distractions.
• Limit warranties and indemnifications. • Maintain credibility.
Seller control • Enhance reputation.
• Separate smoothly.
• Minimize post-closing
disputes.
4
Capturing value through carve-outs
“It may seem obvious, but buyers need to know
exactly what their organizations are getting.
What’s in and what’s out? What’s on offer and
what is non-negotiable?”
CFO of major document management company
Four steps for buyers
When the transaction closes, the seller’s work, with
some exceptions, is fundamentally complete.
The buyer’s journey is just beginning...
The most capable buyers of carved- in customer and supplier contracts boarding process of integrating the
out assets and businesses begin and agreements. new business/assets into the wider
with a clear and strong operational You should obtain a detailed inventory organization. Our experience has
awareness. They appreciate the level of the services provided to and shown that successful serial acquirers
of difficulty involved in integrating required by the carved-out entity in prepare for and make ready their
assets into an existing business or order to form an independent view legacy operations to ease the newly
operating the assets as standalone of the true economic value. Often acquired businesses into the wider
entity. the carved-out business will lose organization.
1. Come to terms with the access to important central corporate 4. With TSAs, focus
components of the assets services from vendor groups such as on the details
treasury, sales, audit, finance, human
You need to get an accurate TSAs are essential to the effective
resources, tax and IT that must now
understanding of the boundaries of integration of carved-out assets.
be replicated.
the target early in the transaction. Our advice to buyers of carved-
Only then can you identify and 3. Make readiness a priority out operations is to be specific in
validate synergy opportunities, outlining what services they want
Buyers want to maintain value and
tax implications and post-close from the seller, while recognizing
prevent its loss, gain control of the
operating options and challenges. that all the seller wants to do is
acquired operations and minimize
A full assessment of the operational get rid of the ongoing burden of
disruption to get the new operations
implications through diligence is providing services. Too often, having
productive as quickly as possible.
critical for accurate pricing and disposed of its carved-out assets, the
Even experienced acquirers of carved-
achieving the value drivers inherent seller may lose the ability to provide
out operations underestimate the
to the deal. services at the expected level due to
work required for timely capture of
changes in staff or support structure.
2. Assess upfront and transaction value drivers. Meanwhile,
This can lead to deterioration in the
ongoing costs the market is watching and ready to
quality and timing of operations,
critique the overall performance.
You must concentrate on evaluating which can seriously disrupt a newly
the accuracy and completeness Preparing to assume ownership of the launched or acquired business.
of the seller’s cost assessment. acquired entity is a critical step in the
Penalty payments for shortfalls in
While the obvious areas include IT, acquisition and integration process.
service levels are far less valuable to
real estate/facilities, human resources Proactive planning for the integration
a buyer than the quality of transition
and tax — any of which can be the ahead of deal close is a leading
services. Both sides need to reach a
source of significant surprises — it’s practice that can make a substantial
realistic consensus about what the
important to examine less obvious difference in a successful integration.
buyer needs functionally, and how
areas, such as insurance, operational Closing the transaction is a key long it will take the buyer to develop
and environmental health and safety step in the acquisition process, but the capability to perform
costs, as well as terms and conditions it is just the beginning of the on- the operations.
5
Buyer beware: six of the most
common and costly mistakes
1. Underestimating upfront 5. Paying inadequate attention
and ongoing costs can to day-one operation
be costly. can potentially result in
significant increases in
2. Relying too much on the operational costs and
seller in TSA discussions potential loss of top-line
conveys advantage to revenue.
the seller.
6. Lacking a defined transition
3. Improper planning for legal governance structure can
entity establishment can lead to a loss of control
be crippling. and a failure to achieve
4. Lacking involvement in the objectives.
carve-out pre-close can
lead to misunderstanding
and delay.
Guiding principles Common TSA areas
Service fees • IT — Infrastructure, shared services,
• The transition services need to be security, apps, etc.
priced out on an arm’s-length basis
and service levels defined • Finance — Tax, reporting, treasury,
A/R, accounting and admin,
• The recovery is based on fully insurance, etc.
loaded cost with escalation for
services beyond the negotiated • HR — Benefits, payroll, pension,
time period union contracts, etc.
Costs • Real estate — Shared offices, DCs,
• ►Gather information required to storages, leases, etc.
understand short-term costs and
the magnitude of services needed • Tax and legal — Previous issues,
post-close knowledge transfer
Exit plans • Logistics/supply chain
• ►Develop plan to exit TSAs and • Sales and marketing
minimize cost overruns early
• Order management
• Research and development
6
“Sellers must understandCapturing
who the buyers
value through are,
carve-outs
their motivation for acquiring and what they may
want in negotiations before engaging. Sellers
need to understand the buyer’s perspective in
the transaction.”
Graeme Deans, Canadian Operational Transactions
Services Leader, Ernst & Young LLP
Five steps for sellers
Proactively preparing to divest is a leading practice
1. Understand buyers’ motivations 2. Prepare carve-out financial Moreover, introducing uncertainty
There are two types of buyers for statements will only increase the number of
carve-outs: corporate strategic buyers Once you’ve identified the assets detailed information requests and
and financial buyers. Understanding to be carved out, the next step is to clarifying operational questions. This
the buyer’s rationale is essential for prepare pro forma carve-out financial may not only delay any transaction
you to execute the design, marketing statements to properly illustrate the as information is shared but distract
and sale of carved-out operations. financial performance of the carved- you from operating the carved-out
out business. These are typically operation and the remaining business.
Corporate strategic buyers are
usually seeking new operations to prepared in two formats: 3. Be transparent about costs
complement their existing business. • Retrospective audited or auditable Standalone costs are important to any
They are likely to integrate the carve-out financial statements for buyer given their impact on after-
carved-out assets into an existing the carved-out business based on tax cash flows. Often, sellers do not
operating structure and focus historical cost allocations. They apply sufficient effort in defining a
on revenue and cost synergy are prepared to satisfy regulatory standalone strategy, and the required
opportunities. requirements and enable financing costs associated with implementing
Financial buyers come in many of the transaction. the strategy. If you’re unable to
different forms and often have • Pro forma standalone financial answer detailed standalone questions
multiple agendas, often seeking statements view the business on a from buyers during due diligence,
to purchase a going concern or to look-forward basis. they may increasingly focus on that
quickly turn carved-out assets into a area and potentially gain control of
The pro forma standalone financial
standalone entity. They are typically the negotiation.
information is more appropriate
private equity firms whose goal is to
for valuation. It reflects the best You must have a clear understanding
invest, enhance, grow the operation
estimates for the buyer of the actual of the standalone value of any
and then finally exit via IPO or a
costs expected to be incurred to potential carved-out operation early
sale to another company. They are
replace services provided by support in the process. The sooner you can
primarily focused on growing the
functions that are not part of the obtain this insight, the sooner you
after-tax cash flows, reducing the cost
carved-out operations. will be in a position to confidently
structure and the management team evaluate options. Is a carve-out the
in the business. You may be tempted to downplay
best approach, or could another
costs and amplify potential
Given the varied motivations of avenue generate more value?
revenues. But if buyers detect such
buyers, it’s important for you to You need to develop a robust
a pattern — and astute ones will —
carefully consider how the sale might valuation model that will give you
they will start questioning the data
be structured, the experience and greater flexibility and speed in
you’re presenting at a much more
maturity level of the potential buyers responding to evolving scenarios
tactical and detailed level, and could
and how flexibility can be maintained or the late arrival of an unexpected
potentially increase contingency
in the process to market the carved- suitor. The appropriate model can
levels in their valuation, negatively
out operation to both financial and help a company pursue multiple
impacting the bid price.
strategic buyers. scenarios simultaneously, raising the
chances of success.
7
4. Consider the impact on
“Remainco”
The potential negative impacts
of a carve-out transaction to
Avoid an incomplete tax picture
your remaining business often go
unrecognized until it’s too late. You By itself, a divestiture is rarely For example, you should ask:
must evaluate how the carve-out driven by taxation factors.
might affect continuing operations, 1. What assets are being
Assets and business disposals
cash flows for the remaining business divested?
should make sense from a
and tax structure. For example, broader economic or strategic 2. What is the tax basis of those
underperforming assets may trigger perspective. However, paying assets?
significant impairment or an increase close attention to tax implications
in your effective tax rate. is essential, as they are complex 3. Where are the assets located?
A major concern is the extent to and can add considerable value to 4. What tax attributes can the
which a sale can lead to stranded a transaction. seller monetize?
costs (i.e., the costs that were shared
by the carved-out business) that In any disposition, a seller’s The answers to the first
must subsequently be absorbed by primary goal is often to maximize two questions can help you
the remaining business. Given that a after-tax proceeds. You should understand the potential
buyer may not want to acquire all of work through a series of amount of gain or loss on the
the personnel or supporting assets questions to identify the tax disposition. The sale of individual
after the TSA period associated with characteristics of the business or assets generates a collection of
the carved-out business, you may assets, as well as your tax needs individual gains and losses. Unless
need to consider the potential costs and those of the buyer. a company knows which assets
of right-sizing, or potentially re- are being sold, along with their
engineering the remaining operation. precise tax basis, it’s impossible
to allocate the selling price all
5. Be patient during the process
the way down to an individual
Carve-outs are a complex process and asset or inventory and determine
can take a long time to negotiate and the exact gain or loss on the
execute. Managers who are too eager
transaction.
to “just get rid of it” in their haste
to sell may lose patience and try to
accelerate the transaction process,
thereby potentially losing a significant
amount of money. You need to remain
patient during the transaction process
if you want to sell the business or
asset at the highest possible value.
8
Capturing value through carve-outs
Helping you increase deal value when
divesting or carving out
We can help structure a well-planned carve-out process For buyers, acumen in carve-out acquisitions can
that can help you boost deal value. Knowing when and dramatically improve the ability to exploit the pipeline of
deciding which assets, liabilities and intellectual property growth opportunities.
to sell through divestment or carve-out is a powerful Leading practices of serial acquirers and sellers have
means of managing your negotiation capital through a repeatable processes for buying and selling carve-outs. We
transaction. can work with you to develop a process for your business
We can bring experience, knowledge, familiarity and to give you a competitive advantage.
objectivity to identify an accelerated road map to migrate
off the TSAs for buyers and sellers, to save both parties
time and money.
We support clients at all stages
of the divestiture lifecycle
Objectives: discover value and assess negotiation range Realize value
Strategic analysis Opportunity analysis Transaction Negotiation advice Transaction
development and execution effectiveness
Announcement Close — Day 1 Day 100
Offering memorandum and data room Management presentation and negotiation Carve-out execution
• Assist in conducting • Assist in performing • Assist in refining valuation assumptions. • Assist in planning and
portfolio analysis of buy-side due diligence. managing order-to-cash
• Balance purchase price, standalone cost, and TSA
brands and/or business process.
• Identify potential risks pricing trade-offs.
units.
and upside. • Assist in managing and
• Assist in performing accounting and tax structuring.
• Assist in performing exiting TSAs.
• Assist in assessment of
strategic analysis. • Assist with TSAs, supply and commercial
accounting policies and cost • Assist in planning and
agreements.
• Assist in upfront tax- allocation methodology. managing transaction
planning strategies to • Assist in preparing buyer for seller meetings. execution and
• Assist in evaluating
minimize gain and use • Assist in activities from sign to close. effectiveness.
normalized and pro forma
net operating losses
adjustments. • Assist in preparing seller for meetings.
(as applicable).
• Assist in conducting • Develop separation road map.
standalone cost analysis.
• Assist in estimating
one-time costs.
• Assist in performing
sell-side due diligence.
• Assist in estimating
separation costs.
• Assist in developing
separation financials.
Identifying separation issues and transition support requirements
Transition/divestiture management office
9
Our primary focus is helping you realize the
business benefits and avoid value leakage
during carve-out transactions
Business extraction Business transition Business enhancement
Separation costs TSAs and commercial agreements Value enhancement estimation
• Identify, negotiate and quantify functional • Identify and negotiate services by functional • Identify and estimate sources of synergies/
and corporate costs/allocation. areas needed during the interim period. negative synergies and CAPEX.
• Identify interdependencies. • Determine the billing method to be applied • Develop detailed functional synergy plans.
• Develop governance framework from deal for the particular service (cost plus, pass
• Prioritize business case.
sign to close. through etc.).
Value enhancement realization and tracking
Standalone and one-time costs • Determine the estimated monthly cost to be
billed to the service recipient for services • Develop synergy model development and
• Identify and estimate standalone and one- under the TSA. track against targets.
time transaction costs (functional).
• Determine the term for which services will be • Prepare a summary of services to be
• Determine residual (stranded) costs (seller). provided post closing. provided under the TSA, including a
Divestiture of planning and management description of the annual service and a
recommended billing method. Identify
• Identify critical tasks, resource needs and special considerations.
gaps, value capture opportunities and high-
level risks. • Consider various term options (initial period
and renewal periods) for the TSA.
• Establish timetables, roles and
responsibilities.
• Apply leading practices in project
management and support tools.
Ernst & Young perspective
• Plan ahead and staff appropriately to • Negotiate and finalize TSAs before signing • Focus on quick synergy wins within the first
support the transaction. an agreement to avoid any surprises. 90 days.
• Get a good handle on operating expenses • Price TSAs to recover costs and provide the • Focus on income statement, working capital
allocation to estimate the true cost of right incentives to buyer to transition off and balance sheet opportunities.
separation. after the transition period.
• Consider costs and achieving synergy.
• Review current state and determine needs
for the future standalone business.
10
Conclusion
Using a well-thought-out carve-out process, you can
more nimbly address the needs of the market in a
timely and efficient way. Knowing when and how to sell
assets through carve-outs becomes a powerful means of
managing capital to increase shareholder value.
For buyers, acumen in carve-out acquisitions can
dramatically improve the ability to exploit the pipeline of
growth opportunities. With experience, you become more
adept across a range of essential carve-out, buy-side
tasks. While each transaction presents unique challenges,
strong capabilities across the full range of carve-out tasks
can deliver a profound competitive advantage.
We can help you structure and navigate through the
carve-out transaction process by bringing our knowledge,
resources, experience and discipline to increase
shareholder value.
Contact us Ernst & Young LLP
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