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Capturing value through carve-outs - Four steps for sellers - EY - Global

Capturing value through carve-outs

Four steps for sellers

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The seller can enhance the potential value for the buyer by highlighting initiatives in progress, or other matters not evident to the buyer.

Four steps for sellers

  1. Understand buyers' motivations
  2. Prepare carve-out financial statements
  3. Be transparent about costs
  4. Consider the impact on "remainco"

1. Understand buyers' motivations

Understanding a buyer's rationale is essential for the seller to execute the successful design, marketing and sale of carve-out assets. There are two types of acquirers for carve-outs: corporate strategic buyers and financial buyers.

The first group is usually seeking assets to complement their existing business. They may integrate the carved-out assets into an existing operating structure and focus on synergy opportunities.

The second group often seeks to purchase a going concern, or to quickly turn carved-out assets into a stand-alone company.

They are typically private equity (PE) firms whose goal is to invest, enhance, grow and then exit. They are primarily focused on after-tax cash flows, the cost structure and the management team within the business.

Given the varied motivations of buyers, it is important for the seller to carefully consider how the sale might be structured and how flexibility can be maintained in the process to market the asset to both financial and strategic buyers.

2. Prepare carve-out financial statements

Once the seller has defined the assets to be carved out, the next step is to prepare pro forma carve-out financial statements. These are typically prepared in two formats:

  • Retrospective audited or auditable carve-out financial statements that present revised financial statements for the business based on changes to historical cost allocations
  • Proforma financial statements that view the business on a look-forward basis

The pro forma financial information is more appropriate for valuation, but both the seller and buyer may require audited (or auditable) financial statements for funding or compliance purposes. Note that a carve-out entity will constitute part of the larger group and, as a result, will use services provided by the larger group.

The new carved-out entity may need to reacquire these services post transaction, and the carved-out financial statements need to accurately portray the initial and ongoing costs associated with those services.

A seller may be tempted to downplay costs and amplify potential revenues. But should buyers detect such a pattern – and astute ones will – they will start questioning data presented by the seller at a much more tactical and detailed level, and potentially discount the bid.

3. Be transparent about costs

Stand-alone costs, derived from an analysis of existing direct and allocated costs, are important to any financial buyer given their impact on after-tax cash flows.

Often, sellers do not apply sufficient effort in defining a stand-alone strategy, and the required costs associated with implementing that strategy. If the seller is unable to answer detailed stand-alone questions from the financial buyer during due diligence, the buyer will increasingly focus on that area and potentially gain control of the negotiation.

The seller must have a clear understanding of the stand-alone value of any potential carve-out early in the process. The sooner a seller can obtain this insight, the sooner he or she will be in a position to confidently evaluate options.

  • Could packaging the assets differently make them more attractive to the list of likely investors?
  • Within the expected time horizon, should the seller invest time (and money) to enhance the market value? Is a carve-out the best approach, or could another avenue generate more value?
  • What is the potential impact of different approaches on the seller's overall tax profile and which is likely to generate the most after-tax value?

Sellers need to develop a robust valuation model that factors in variables such as whether to add or exclude certain assets, stand-alone costs, conditions of TSAs, tax considerations and potential synergies with different buyers.

4. Consider the impact on "remainco"

The potential negative impacts of a carve-out transaction to a seller's remaining business often go unrecognized until it's too late.

Sellers must evaluate how the carve-out might affect continuing operations, cash flows for the retained business, and tax structure. For example, excising underperforming assets may trigger significant impairment or an increase in the seller's effective tax rate.

A major concern is the extent to which a sale can lead to stranded costs that must be absorbed by the remaining business.

Given a buyer may not want to acquire all of the personnel associated with the carved-out business, the seller needs to consider the potential costs of right-sizing, or potentially reengineering the remaining organization.


 Case study: avoid an incomplete tax picture


 Include the right people at the right time

Case study: avoid an incomplete tax picture

A carved-out business included land and buildings in a number of jurisdictions. In the past, the choice had been made to enable recovery of value-added tax (VAT) incurred in connection with some of these properties.

This meant that the properties in question should have been subjected to VAT when they were sold as part of the carve-out. But the seller had no tax history of the properties and did not establish its VAT status as part of carve-out planning.

Therefore, no VAT was charged and the seller was surprised to learn that the tax was due on the sale.

To make matters worse, the purchase contract was silent on the VAT, so the tax could not be passed on to the buyer. Eventually, the buyer shared the VAT cost in return for a more favorable TSA.

But the problem could have been avoided if the seller had given careful thought to the tax profile of the carved-out assets before the transaction.


Include the right people at the right time

Timely and appropriate communication is essential to an effective carve-out process. Early on, sellers must determine whom to involve and when. At first, the exploratory team should be small.

But as the likelihood of moving forward increases, the group needs to expand to include functional expertise in IT, human resources (HR), accounting, tax and other essential disciplines. This is especially important during the TSA definition and negotiation phase.

Effectively managing the chain of communication is also critical. Sellers must preempt potential issues with proactive, clear and concise communications that address major stakeholder concerns. Conveying the messages in a positive, well-structured and properly vetted manner will reduce countless concerns.


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