Talking to your “Seller” – Are They Ready?

It’s easy to assume that the “seller” has thought through the implications of divesting their business; however, it is often the case that they have not. This can be for various reasons, but often it is because they have not had sufficient time to prepare on their end, or because they (the seller) do not perform divestitures frequently and thus do not have many “reps” in doing so.

As a buyer, it’s crucial to recognize that the seller might not be fully mentally or operationally prepared for the complexities involved in a carve-out. They may have been focused on other priorities, or simply overwhelmed by the intricacies of the deal. Thus, approaching conversations with empathy and understanding can pave the way for more productive discussions.

How can you help? As a PE executive with significant carve-out experience, I can tell you that establishing a logical framework that can organize various parties and help drive a sense of ownership/accountability is critical to success. This structured approach is not only beneficial in terms of operational readiness but also serves to create an atmosphere of collaboration that can enhance the overall experience for both parties involved. It also allows you to avoid (generally) any “us vs. them” dynamics in the process and make it more about “us” solving issues together, ultimately establishing the carved-out entity as a standalone company.

While potentially obvious, a transparent process also builds trust and makes potential (and even likely) issues down the road much easier to deal with and resolve. First, make sure you have established a definition of success that is agreed/ aligned between both sides. This should be a collaborative effort; both parties need to express their expectations and outline what success looks like to them.

Second, identify the current state together. Engaging the seller in this evaluation will foster transparency and ensure that both sides have a mutual understanding of the existing conditions. This often consists of an inventory of actions/items that are required in order to complete the separation. When crafting this list of “services”, it would significantly benefit you as the buyer to be more detailed than less.

For example, rather than simply mentioning “finance and accounting” services, break them down into more specific elements like Accounts Receivable (AR), Accounts Payable (AP), and other accounting services. This granular approach not only demonstrates diligence on your part but also allows you to manage the transition of these services more effectively.

It will facilitate your ability to “turn off” those services individually as you stand them up within “NewCo,” thereby avoiding the hassle of paying the full Transition Services Agreement (TSA) rates for all services until you’ve successfully migrated each one. Obviously, you’ll need to determine how practical or meaningful this level of detail is and which parts of the business/services matter most.

Further, there is a foundational discussion to be had around the cost for the services. They should not be viewed as a profit center for the seller; rather, they should reflect the labor and reasonable non-labor costs associated with providing those services. This can be established through a combination of common sense and light analysis to determine the reasonable range for costs/fees incurred. Open communication regarding costs will not only align expectations but also mitigate potential disputes later in the process.

Finally, you need to think through the realistic timing of each service line item in order to establish the right period during which there are no “extension fees” charged past the initially contemplated term. The tricky part here is that many of the “services” can involve significant variability in lead time with respect to setting up “NewCo” services.

Examples include: renting new office space for a large number of employees, or relocating facilities or specialized equipment. Additionally, you may need to implement new systems prior to taking on certain activities, or hire individuals you did not receive with the transaction who need to “own” key decisions that will affect their long-term performance.

Moreover, you may also need to unbundle commercial or supply agreements that might drive their own timelines for a variety of reasons. No matter what the actual details are, you should do a (with prudent buffer) “working backwards” analysis of each service line to establish timelines that work. This analysis is crucial because failing to account for these nuances can disrupt the transition and negatively impact business continuity.

With these three basic elements in mind, you can significantly improve your chances for a successful carve-out transaction execution:

1. Agreement with the current state, future state, and key activities required to complete the TSA: This establishes a strong foundation for moving forward.
2. Alignment on the principles of cost, and how those costs should be calculated and billed: This clarity will help prevent misunderstandings and financial misalignments down the road.
3. Timelines, and the plans that support those timelines to ensure execution is successful and within reasonable timeframes: This forward-thinking ensures that both parties are aligned on expectations and can respond proactively to changes.

By focusing on these components, you will set yourself up for a likely successful outcome when it comes to carve-out transaction execution. Happy Stand-Up!