The Carve-Out Process: Six Steps for Ensuring Success

Mark Herndon of M&A Partners
By Mark Herndon
Nov 27, 2017

Over the last two years, divestitures have comprised a rapidly increasing percentage of total M&A transaction value. If your organization is like most, you've done far more acquisitions than divestitures, and you may now be responding on the fly to this renewed sell-side challenge. Conversely, if your organization is an experienced Buyer, you may now be challenged with how to integrate certain divested assets, entities or divisions divested from a corporate whole, but less than the entire company as you have integrated before. If so, welcome to the world of integrating carve-outs...one of the most challenging of all integration scenarios! 

What Is a Carve-Out? 

The term "carve-out" is typically defined as the operational and organizational activities required to complete the transfer of a business or assets in a divestiture transaction. While both Seller and Buyer have essential joint responsibilities in the carve-out process, the burden rests heavily on the Buyer to manage a host of unique and highly complex issues to preserve and maximize the deal value of a carve-out transaction. 

Why Are Carve-Outs So Complex? 

To achieve desired operating efficiency and functionality, most companies operate based on highly integrated processes, systems, applications and data that support most businesses and operations throughout a corporation. When a specific business unit, division, product line or asset is divested from the corporate parent, these highly integrated processes, systems, applications and data must be dis-integrated, e.g., "carved out" of the parent organization and operating environment.This typically creates an intricate and sometimes prolong support relationship between the Seller and Buyer, resulting in one or more Transaction Service Agreements (TSAs).

At the same time, a variety of other factors make carve-outs even more complex and risky:  

  • Assets: The assets in a carve-out may be non-core or neglected, including lack of historical investment, maintenance, management or staffing. 
  • Costs: It is often difficult to understand and forecast the carve-out and stand-up costs for both parties. 
  • Financial statements: Unless the divestiture comprises a fully intact entity, financial statements (as well as certain operating metrics) for the asset, unit or product line may not exist, and will have to be created.
  • Transaction-specific challenges: Every transaction is different, and carve-outs often present the need for additional due diligence, valuation, legal, tax and financial advisory to complete. 
  • Talent: Sellers often "cherry pick" talent prior to the transaction. If both key talent and all employees to be transferred with the sale aren't identified early and managed correctly, expect a higher rate of defections or declined offers. 
  • Employee psychology: Employees who have spent years building a career in a specific division, may now perceive that their unit is considered non-core, disposable or an unsatisfactory fit. Employees often feel rejected and betrayed. 

Six Steps for Ensuring Carve-Out Success

1. Confirm the "Four Corners" of the Deal. 

The first step to successfully navigating a carve-out transaction is to define exactly what's included in the deal. Constantly ask, "What's in, and what's out?" Determine the full operating model components necessary to run the business, and obtain very detailed asset schedules. And be sure to double your diligence to find potential hidden costs, such as new license/lease costs or legacy corporate services that were not previously changed back to the unit to be divested. 

2. When it Comes to TSA, DIY. 

It's important for the Buyer to take a "do it yourself" (DIY) approach to the TSA. Instead of relying on the Seller to drive the process, the Buyer should conduct its own independent and detailed needs analysis, along with its own costing analysis and benchmarking. Be sure to build out reasonable timelines that allow you as the Buyer to build, test, migrate and operate new systems independently at TSA exit; and to confirm any residual Byer costs and staff resources that will be required. 

3. Know When to Clone or Stand Alone. 

"Clone and go" is an important and commonly used strategy to accelerate operational independence of the Buyer with the newly acquired business. It refers to the practice of replicating the Sellers' process, system, application, data, policy or practice, and using that clone post-close. In some cases, however, it's better to stand alone, such as during a performance turnaround or asset repurposing, or when market requirements dictate a different approach to the status quo. Ultimately your approach to integration should be determined almost entirely by the type of acquisition you've made. 

4. Define Your Concept of Operations. 

In our view, defining a comprehensive concept of operations is a fundamental part of the carve-out integration strategy framework and provides an outline of the optimal type, direction and timing of integration at the enterprise, functional, and system/process levels, along with product/brand/customers and organizational culture. To define your concept of 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, classify each as short-term vs. long-term or interim state vs. end state. And classify each according to the overall approach to integration that will help you most effectively preserve, capture and maximize deal value. For example, should the acquiried company's customer service model be left as-is, perhaps with some best-practice sharing between the Buyer's and Seller's approach; assimilated into your model; or transformed to a new, improved model? 

5. Know Your Leadership. 

It's important to gain sufficient insight about 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. As the buyer, evaluate your leaders' capability and readiness to motivate and align employees through a time of substantial change. 
  • 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. The Buyer should also learn as much as possible about the leadership and decision culture at ParentCo and the to-be-divested entity. 
  • Finally, the Buyer's relationship and market orientation to both the Seller and the to-be-divested entity is a critical consideration. Are the two entities competitors? Does one offer a platform or add-on for the other? 

6. Apply Best Practices in Integration. 

Although a carve-out presents unique challenges and considerations, it still has much in common with other M&A integrations. Don't neglect the ther best practices you would apply to a different type of transaction. For example, your strategy should still guide your integration framework, and you must ruthlessly prioritize your initiatives and objectives. Over-emphasize the importance of credible, ongoing communications delivered by the right leaders. Finally, carve-outs require careful change management and culture alignment by mitigating potential flashpoints and resetting expectations for high performance. 

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