The PE sector continues to face challenges in 2023, with overall levels down from 2023 and fundraising predicted to remain difficult in the short term at least.
For some, the investment focus is now shifting from ESG to impact; from later stage deals to early and even pre-seed; and from individual investments to portfolios of complementary businesses. A key underpinning of these changes is a renewed and increasing focus on carve-outs.
Carve-outs are born out of a desire to unbundle dissimilar businesses, realise/acquire higher-value assets, and generally adopt a best-parent approach to corporate value. However, like M&A in general, many carve-outs present the buyer with as many challenges—often unforeseen—as opportunities.
Ideally, the newly formed standalone company should have the necessary infrastructure, resources, and talent to operate effectively. Private equity firms need to be proactive in identifying and mitigating the risks around this not being in place or completely prepared.
In our experience, carve-out due diligence de-risks the process, accelerates the timeline for the carved-out entity to become standalone, and significantly improves the chances of a successful outcome for the carved-out business, saving both the investors and the new standalone entity millions.
In this article, we explore the dos and don’ts of successful carve-outs and steps the buyer and seller might take to ensure that the challenges are reduced, or at least identified, while exposing opportunities for the new owner and their value upside.
FACTORS TO CONSIDER DURING SEPARATION PLANNING
Separation planning considers what is required for the new entity to get to deal completion in a state of readiness. In this transition state, they would be able to function effectively until they are operating as a standalone business. This is outlined in a TSA (Transition Services Agreement), which is time-bound and outlines the services to be shared and paid for until the carved-out business has a fully operational, independent infrastructure in place.
The accuracy of any TSA is worth testing as it relies on a full understanding of the business’ dependencies on its parent company’s infrastructure, an accurate outline of the Target Operating Model (TOM), the resources required to get to this final state, and the business impact of the journey to the TOM and standalone status.
A carved-out entity will inevitably be smaller than the parent and have different requirements and may not be constricted by the original technology choices of the parent company. However, it may also lack the buying power and negotiating clout to obtain a commercially favourable position that comes from being part of a larger organisation.
TSAs have time limits and financial penalties for failing to meet the deadline. This makes it crucial to establish whether the timeline in the TSA is realistic based on existing resources and the challenges of establishing the new TOM in the suggested timeframe. Some of this will be dependent on the parent organisation’s key stakeholders being committed to the timeline of events, and managing that change can be difficult—and can even require an experienced programme manager to govern the process.
CREATING THE TARGET OPERATING MODEL
The TOM consists of services the carved-out entity requires to operate on a standalone basis. This includes any changes that accommodate the nature of the carved-out entity’s business being different from that of the parent company. Creating the TOM should also include indicative CapEx and OpEx costs to obtain, create, and run this new technology environment.
SO, WHAT COULD POSSIBLY GO WRONG?
In many cases, carve-outs do not go smoothly, and the aftermath is fraught with risk, rising costs, and drifting timelines for the carved-out business.
The TSA can often be incomplete, with an unrealistic timeline and gaps in resources, governance, and CapEx/OpEx estimations. A typical scenario would be that the carved-out entity needs a new CRM or an ERP system, as their current system will be retained by the parent company.
This process raises questions around the following:
Location and ownership of the data
Migration of the data
Specifications for the new system
Individuals responsible for writing the RFP and vetting responses
Length of time to select a new system
Length of contract negotiation, procurement, and implementation
Individuals responsible for overseeing the process
Cost
While these questions are all critical to the carve-out’s success, business as usual must continue for the standalone entity. Those who will form the new entity’s IT department need to be fully engaged in keeping the business running, with no time for additional workload created by the separation.
HOW WE CAN HELP
The biggest hurdle to overcome for any carve-out, spin-off, or separation is the inexperience of those running it. If they have never worked through this before, the team may not be able to anticipate challenges and costs accurately. There’s a great deal to consider and plan for, particularly when it comes to managing communications and ensuring the project stays on time and on budget.
Our team of experts includes those who have been through this multiple times as a CTO or CIO and have a practical approach to assessing an organisation’s readiness for a successful carve-out. We’ve helped multiple funds, such as Bridgepoint, Triton, EMK, Carlyle, and BC Partners, and can provide expertise on the entire carve-out ‘life cycle’, from initial assessment to post-Day 1 support.
