Corporate Carve-outs are an increasingly frequent type of transaction between private equity firms and corporate sellers.   These deal opportunities arise when mid to large size companies determine they want to divest a business unit or business segment for any number of reasons.  Private equity firms that have the right internal knowledge and third-party relationships are often best suited to be the buyers of these assets given their operational know how and ability to move quickly. 

Extracting the child organization from the parent company is both an art and a science with respect to planning and execution – here are some of the reasons why these private equity transactions are particularly nuanced:

1. Executing corporate carve outs well requires exceptional skills in coordination and planning (i.e. third parties, internal teams, seller representatives, etc.).  It is not uncommon to coordinate the work of ten to fifty people or more across a dozen workstreams for several months.  This can be done internally or with a closely aligned third party (with ultimate accountability resting with the investment firm.

• Completing a carve out that is minimally disruptive to the seller requires deep knowledge of how both businesses operate and an appreciation for the spectrum of outcomes from “do it now” to “do it right”.  These two are not mutually exclusive – you may only have enough time to “do it now” and need to come back at a later date to “do it right”. 

• Significant operational engagement required by the private equity investor is significantly beyond what many firms are either capable of or have an appetite to take on

Corporate Carve Out Logistics and Planning:

From the time the CIM or Teaser arrives, a thoughtful seller will make an attempt to identify the elements of separation that are required in order to stand up a new company.  More and more sellers are going to the next level and having third parties perform assessments of the one-time and ongoing costs associated with establishing a new business.  Buyers should review these materials carefully as they proceed through the transaction. If you’re experienced, you can also potentially advance yourself in a competitive process by giving the seller confidence you know how to perform the extraction work and help them improve the structure of the TSA.

A focused set of sessions with functional representatives from the seller is a best practice.  Engage their IT, HR, Legal, Facilities, Supply Chain, Commercial etc.…leaders in a set of meetings or calls where you can receive answers to questions regarding key carveout considerations and start the planning together. 

Corporate Carve Outs and the TSA:

The aforementioned meetings are where the development of your TSA (Transition Services Agreement) starts.  The TSA is a core document that governs many aspects of the carve out (in combination with your purchase agreement and potentially some additional addendum documents or schedules).  The seller will likely have a “first draft” of the TSA that you can markup but ensure that you agree on the philosophical reason for the TSA at the start:  The TSA is a document to expedite and enable the separation of newco from parentco on terms that are a pass-through of identifiable costs from the seller, not to function as a profit center for the seller.  As time passes and if you miss the dates for separation it is reasonable for the seller to increase the cost of services as a means of motivating the buyer to expedite completion of the carveout.

Here are some examples of considerations as you review and draft the TSA:

Finance and Accounting:

Many times, a corporate seller will centralize functions like transactional accounting (Accounts Receivable collections, Accounts Payable management, other elements of accounting, treasury and liquidity management and tax).  You should identify exactly how each of these processes works in a working session with management and also validate what the seller tells you with the people that are coming with the new entity (your new management team that will be inclined to give you the straight scoop).

Enterprise Systems:

Another big area to tackle is ERP.   I’ll use the term ERP loosely to describe systems such as accounting, warehouse management, planning, allocation, and supply chain execution.  There are a few questions you should get answered asap:  Will the seller let you “clone” a version of its ERP and/or can they remove data that is related to other entities if there is commingled data (or agree to let you keep that data if it is not material to them or sensitive in any way)?  Do you need to stand up a process or system immediately that will let you begin operating the most critical functions (invoicing, payroll, accounting) in a manner that is “right now” vs. “the long term way”?  How long do you have to complete the ERP or systems separation, and what level of support is the seller setup to offer during the transition?  Setting up new enterprise systems will likely be the long lead time item(s) most corporate carve outs.

If you’re lucky, the company runs a separate instance of ERP for the division you’re buying and does few things centrally, however this is less and less the case as companies move towards integrating their acquisitions to drive efficiencies post deal. 

Payroll & Benefits:

We’ll assume a one-country transaction for the sake of simplicity (though that is often not the case).  Your new employees will expect to be paid without interruption and will want to know what their benefits are in detail.  Having a system setup that can quickly accommodate the new employees and ensure that there is a fixed cut-over date is essential and making a determination on year 1 (first year of ownership or first re-enrollment period) on benefits is also key. 

Corporate Carve Outs – Getting it Done:

If you don’t have the internal resources or expertise to dedicate to the carve out and stand-up process, then engage a proven consultant who can help you get that done.  In most cases it will make sense to hire a trusted partner to help you through this process for several reasons, including the fact that the perceived “lift” may evolve significantly as you start going through the extraction process.  The ideal partner will have capabilities across the spectrum of IT, Finance, Enterprise Systems, HR and Tax – effectively giving you a one stop shop to work with.

Summary:

Being successful in the short term is an important part of setting you up to be successful in the long term.  Besides the multiple opportunities for operational and relationship disruption that can occur if the carve-out is not executed well, there are additional intangible costs associated with management’s inability to focus on the “go forward” plan and external considerations like customers, competition and key elements of the investment thesis.  On the other hand, executing the extraction well can speed up your ability to tackle external considerations and get ahead of the original timeline while invigorating employees with an early “win”.   Set yourself up for success by doing the right planning, engaging the seller as much as possible and establishing a project management and execution process that involves the right people in the right configuration.