Carve-Out Mastery: Unleashing Value Strategic Separations

Carve-outs can unleash substantial value, but their successful execution requires meticulous planning, coordination, and expertise. The key is to present the divested operation as a self-sustained entity, free from any operational, managerial, or financial complications, to potential buyers.
This article outlines our views on key steps organisations can follow to ensure a successful carve-out.

1. Clearly Define and Set the Carve-out Perimeter

Before starting on a carve-out journey, an organisation should build a comprehensive understanding of the strategic intent behind the carve-out, the scope of separation, and the key objectives. Central to any carve-out is the need to establish the perimeter of the business being sold, identify its assets and assess the related liabilities that will be assumed.
 
2. Plan Operational Separation

The next step involves identifying the carve-out business’ dependencies or shared resources with the parent, and determining how the entity will operate independently. If the parent organisation is selling an incomplete business, it is risking limiting the types of investors that can complete the acquisition, even though the strategic buyers may be able to plug some gaps and dependencies. This may negatively impact the purchase price.   

This step requires identifying and mapping out key processes, systems, and resources that need to be separated from the parent company across functions like Operations, Finance, Technology, HR, Sales & Marketing, Manufacturing, Legal and Regulatory Affairs, etc.

3. Define TSA Requirements

The inherent nature of a carve-out necessitates organisations to implement Transitional Service Agreement (TSA) contracts for maintaining seamless business continuity during the transition period.

These agreements specify the temporary provision of services by the parent company to the carved-out business or entity, typically spanning 12 to 18 months. TSAs ensure a smooth transition by outlining services such as IT support and access to platforms, accounting and finance team assistance, etc., to prevent business disruptions. As a seller, it is crucial to strategically assess the elements within the carve-out that could potentially create vulnerabilities in the core business. However, the duration and complexity of the TSAs are dependent on the type of buyer (i.e., financial vs. strategic).

4. Initiate Separation Planning and Mobilise Resources

After defining the TSA requirements, the organisation must initiate separation planning and mobilise the necessary resources - assembling the right teams, addressing key personnel's concerns, and leading the transformation for success. The organisation needs to put in considerable efforts for the development and execution of separation plans to minimise disruption to the ongoing business and disentangle complex areas including customers and vendor contracts, legal entities, IT infrastructure and applications, HR and the external value chain.

Private equity sponsors often engage in carve-out transactions to unlock value, and careful structuring is required to address complexities in IT systems, supply chains, and human resources.

5. Establish Transaction Governance

Transaction governance is critical for the success of a carve-out. This involves setting up clear governance structures, defining roles and responsibilities, and ensuring close cooperation between the RemainCo and CarveCo/ buyer team members. Effective governance helps in streamlining the carve-out process and facilitates seamless decision-making during this complex undertaking. Leveraging technology-based and web-based tools to streamline and automate status reporting is a game changer.

6. Determine Tax Structure and Consequences

The tax implications of a carve-out cannot be overlooked. Proper planning is essential to optimise the tax structure and avoid unforeseen tax consequences.

• Indirect tax: The parent company must identify Input Tax Credits (ITC) under Goods and Services Tax (GST) regimes attributable to the carved-out business potentially involving apportionment of the ITC on shared expenses and assets as per the taxation norms. Indirect taxes, such as GST, significantly impact carve-outs, necessitating accurate documentation and compliance to avoid leakage and penalties.

• Transfer pricing: It is imperative to ensure adherence to regulations and a fair market value for intercompany transactions.

• Direct tax: As RemainCo and CarveCo entities may realise gains or losses during asset transfer, implications on capital gains tax need to be considered. Effective tax structuring can minimise capital gains tax burden.

Additionally, carve-outs entail other direct and indirect tax implications, including intangible asset tax treatment, inventory transfers, tax filings, and employee-related taxes, making comprehensive tax analysis imperative. 

7. Carve-out Financial Statements and Operationalise the New Entity

Lastly, the company needs to prepare carve-out financial statements that accurately reflect the financial performance of the carve-out operations as an independent business.
Continuous evaluation of the carve-out financial statements helps bridge the gap between audited financial statements of the whole entity and deal-specific financials to reflect any ongoing changes in the business's scope and perimeter. This is crucial for assessing the impact on the deal's overall value.

To operationalise the new legal entity to house the carved-out business, key processes at each impacted location must be understood in detail.

• Obtaining necessary registrations and licenses 

• Finalising the required TSAs and documenting how the services will be delivered and monitored along with a mechanism for dispute resolution

• Preparing a plan for IT systems’ transition to reflect new legal entities, segregate access to systems and data, address name changes and enable separate financial reporting

• Transitioning supply chain and manufacturing relationships – vendors, distributors, contract manufacturing agreements, negotiation of long-term or transitional agreements, changes in licenses/ registration and evaluating the potential impact on supply chain operations

• Transferring employee payroll and benefits and reviewing statutory requirements for pension, severance, etc.

• Ensuring continuity of financial systems and processes (e.g., order-to-cash, procure-to-pay, etc.)

Acing the process of carve-outs needs a strategic approach and diligent execution, as every step plays a critical role in its success. In today's ever-changing business landscape, organisations must seek experience-backed professional expertise in handling such transactions for effectively navigating carve-out complexities and unlocking value.