Preparing for a Successful Carve-Out Sale: Key Factors and Best Practices

Preparing for a Successful Carve-Out Sale: Key Factors and Best Practices

October 30, 2023

Successfully executing a carve-out transaction is a complex process that demands meticulous planning and preparation, but many firms underestimate the effort required to execute a successful sale process. Insufficient preparation can lead to various risks and uncertainties for potential bidders, potentially resulting in lower valuations, extended timelines, or even a failed sale process.

Here, we discuss the critical success factors and best practices that companies must consider when planning for and executing a carve-out divestiture.

1. Clearly Defining the Deal Perimeter

The first success factor in a carve-out sale is defining the deal perimeter accurately and thoroughly. This definition should clearly outline the products, employees, assets, facilities, contracts, and liabilities included in the sale process and what is excluded. A well-defined deal perimeter ensures that potential buyers have a comprehensive understanding of what they are acquiring, eliminating ambiguity or misconceptions. Defining the deal perimeter should be done early on to set the stage for a smoother transaction process.

A building technology supplier faced buyer questions regarding what intellectual property and engineering resources relating to an IOT platform embedded in products were included in the deal perimeter. This uncertainty extended the negotiation process, impacted the financial statements (and buyer valuation), and contributed to a delay in the sale process.

2. Identifying and Developing a Plan to Address Shared Resources

By its nature, a carve-out will typically rely on its parent company for support of certain business processes. Regardless of where these dependencies lie, either in back-office areas such as IT, HR or finance and accounting, or in more core areas such as operations, supply chain, or R&D, sellers need to develop a clear perspective on how to address these dependencies, including the potential need for TSAs, to facilitate a smooth handover to the buyer. Open communication and collaboration among teams play a pivotal role in facilitating a seamless carve-out.

A consumer products company was looking to sell a line of products it considered to be non-core to its portfolio. However, this business leveraged the broader parent company’s sales, warehousing, and logistic capabilities to serve the food service market. Because the buyer did not have an existing food service business, the seller proactively worked with the target to stand up a third-party distributor to handle sales through this channel, facilitating the transition of the business without impacting deliveries to customers.

3. Presenting Defensible Financials

Having a set of defensible carve-out financials ready is crucial for buyers to evaluate the business’s financial performance. Understanding the requirements of buyers is critical, as certain buyers may require audited financial statements in addition to pro-forma financials. Depending on the complexity of the carve-out, this can be one of the most complicated areas, as historical financial statements may not exist and may need to be created. This can require collecting several robust data sets from multiple systems along with applying a series of assumptions and adjustments to derive the financial statements.

Ultimately, these financial statements must align with the proposed deal perimeter and include a detailed basis of preparation to guide the buyers through how the financials were prepared and include underlying support. When applicable, differences between the audited carve-out financial statements and the pro-forma statements must be bridged. Transparency and accuracy in financial reporting builds trust with potential buyers and mitigates risk during the due diligence process.

Doing the groundwork early to identify and assess the complexities of preparing carve-out financial statements, including potential buyer requirements, pays off in the end, allowing the management team to confidently address buyer inquiries and present the business in the best possible and most defensible light. Ultimately, this organization helps sellers control the due diligence process.

A chemical company was seeking to divest assets with no history of preparing financial statements for these assets. Knowing buyers would require an audit, the company started the process early of identifying the relevant data sets aligned to the perimeter that could be reconciled back to historical business unit reporting. It prepared the carve-out financial statements subject to audit along with pro-forma financials.

A detailed financial statement bridge was prepared to guide buyers from the audited financial statements to the pro-forma statements accompanied by a detailed basis of preparation with assumptions and adjustments clearly explained.

This groundwork created a defensible set of financials statements with performance trends that could be explained that gave buyers comfort with the completeness and accuracy of the financial statements.

4. Preparing the Target Management Team

The target management team must be identified early and be well versed / take ownership in defending the positioning of their business, financials, and projections. This will also provide confidence that they can continue to meet their financial targets as a separate business from their parent. Engaging with the management team early on and ensuring their participation in the development of the business plan, separation approach, and financials boosts confidence among potential buyers. As a best practice, the target management team should do “dry-runs” with their advisors and other team members prior to meeting with buyers to ensure they are prepared and organized.

A building technology business was put up for sale by the corporate parent. The parent company chose to limit the involvement of the businesses’ management while the business was being prepared for sale. When management was brought in to support the management presentation, there were aspects of the deal with which they were not familiar, affecting their credibility in front of buyers.

5. Addressing Human Capital Risks

Key employees possess critical knowledge and expertise about the business being sold, making their retention vital for a successful carve-out. Establishing a communication plan early in the process to inform key individuals and other employees at the right time is a best practice to avoid employee turnover once they learn of the transaction. Retention plans can also be established to ensure key employees remain motivated and committed throughout the transition.

A large engineering and construction firm determined that one of the businesses that was acquired as part of a prior transaction was not core to their business. When the decision was made to divest this business, retention plans were put in place for key employees to ensure their support through the sale process. As additional resources were brought “under the tent,” retention packages were selectively extended to individuals whose support was critical to the sale, thereby helping to ensure their support during the sale process.

6. Addressing Stranded Costs

Selling a business that represents a significant share of the parent company’s revenues can negatively impact the retained business’ cost structure. In these cases, a stranded cost analysis should be performed to identify costs that may need to be absorbed by the parent following the divestiture and identify potential opportunities to shed costs as deemed unnecessary or duplicative..

A building services company divested a segment that represented about 30% of the parent company’s revenues. Anticipating significant stranded costs, the company proactively worked to right-size the overhead structure to reflect the needs of the business more closely after the sale. Through targeted actions, the company was able to fully mitigate the stranded cost impacts of the divestiture.

7. Structured Approach to Managing the Sale Process

The establishment of a dedicated Project Management Office (PMO) / Separation Management Office (SMO) early in the process can ensure coordination and alignment among various workstreams and advisors. While this is true in any sale process, it is especially important in a carve-out, as decisions around the deal perimeter and operational separation can have significant impacts on various functional areas, including the financial statements and deal documents. Having a centralized team to manage the process can ensure that key milestones are met and information is shared across teams, as well as with bidders, in a controlled manner.

A construction services company implemented a SMO structure to manage the sale of one of its businesses. When the private equity buyer disclosed to a seller that the entity to be acquired was going to be integrated in a newly formed joint venture, the SMO was able to quickly mobilize resources across the seller’s organization to assess and adapt the separation approach, financials, and deal structure to accommodate the buyer’s strategy, leading to a successful transaction despite the change in direction.

8. Recognize the Effort Required and Establish an Aggressive but Realistic Timeline

Executing a carve-out sale demands significant effort and support from various teams, including finance, legal, tax, and business functions. Considering the complexities involved in a carve-out, setting a realistic timeline for the sale process is crucial.

Understanding the critical path, interdependencies and the tasks needing to be completed can help determine if the company has the necessary resources to meet the timeline. The involvement of external support can complement internal resources and can also bring experience from prior transactions to the team. 

A realistic timeline allows sellers to manage expectations, allocate resources effectively, and ensure a well-prepared sale process. It provides sufficient time for due diligence, addressing potential issues, and facilitating a smooth transition.

A company holding a diverse number of businesses divested an IT services business unit. Since leadership took time to allocate appropriate resources and support the sale was executed efficiently and attracted competitive bids from potential buyers.

Getting Ready for Your Carve-Out

Selling a carve-out requires careful planning and diligent execution. By following these key success factors, companies can enhance the value of their carve-out, minimize risks, and foster a smoother, more efficient sale process.