TaxMatters@EY - February 2013

Divesting for value: How to make the most of carve-outs

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Excerpts from our publication Capturing value through carve-outs

Almost invariably, as companies reassess how to strategically manage their portfolio capital, the need or desire to divest certain assets and activities arises.

Companies often view divestitures as the mark of failure, so they often devote inadequate resources to them. While many companies have established rigorous M&A management, when it comes to divestitures managers have been too eager to “just get rid of them,” rushing through the sale of a business or asset or not negotiating the deal aggressively — potentially leaving money on the table or overlooking other strategic opportunities.

Unlike with acquisitions, most companies do not have in-house capabilities or experience executing divestitures. It’s therefore important to engage external advisors who have the necessary experience and can help you through the process.

Carve-outs are often complex and can present the seller with an array of tax and non-tax challenges, including recognizing the needs of the potential buyers. In order to do this, the seller must be transparent about costs, preparing thorough and accurate carve-out financial statements and providing sufficient and appropriate information in a timely way.

Buyers contemplating the acquisition of a carved-out asset face a different set of challenges, such as valuing the assets, performing diligence on the seller’s financial and operating statements, and maintaining and continuously updating their own deal analyses and models. A buyer must also prepare for day one and overall integration — which will likely entail negotiation with the seller for one or many transition service agreements.

There are many issues, both significant and subtle, that can surface without notice. While large public companies often have dedicated and experienced corporate development teams to help navigate through the divestiture or acquisition processes, medium-sized companies often lack the resources to successfully manage all aspects of the transaction.

By reviewing any transaction from the perspective of both buyer and seller, executives can avoid surprises, gain a clearer understanding of where value can be created or destroyed and, by following through, make a good deal even better.

For further insights, please read our report, Capturing value through carve-outs.

Avoid an incomplete tax picture

By itself, a divestiture is rarely driven by taxation factors. Assets and business disposals should make sense from a broader economic or strategic perspective. However, paying close attention to tax implications is essential, as they are complex and can add considerable value to a transaction — or erode value if they’re overlooked.

In any disposition, a seller’s primary goal is often to maximize after-tax proceeds. You should work through a series of questions to identify the tax characteristics of the business or assets, as well as your tax needs and those of the buyer.

For example, you should ask:

  1. What assets are being divested?
  2. What is the accounting and tax basis of those assets?
  3. Where are the assets located?
  4. What other taxes may be payable (PST, GST/HST, land transfer tax)?
  5. What tax attributes can the seller monetize?

The answers to the first two questions can help you understand the potential amount of gain or loss on the disposition. The sale of individual assets generates a collection of individual gains and losses. Unless a company knows which assets are being sold, along with their precise tax basis, it’s impossible to allocate the selling price all the way down to an individual asset or inventory and determine the exact gain or loss on the transaction.

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