Boosting carve-out sale value with holistic financial management

Buyers may require audited financials of DivestCo for regulatory, lending or investment committee purposes. This need can vary by buyer. However, preparing carve-out financial statements can often take extended time and effort to prepare due to lower materiality levels and time to complete the audit.

Regardless of whether audited carve-out financials are required, it’s crucial that sellers prepare a set of historical financial statements that represent the DivestCo business (i.e., income statement, balance sheet and cash flow) for deal marketing materials. These financials are typically prepared on a “non-GAAP” basis, which allows sellers to include adjustments for nonrecurring, unusual items and/or pro forma items to more appropriately reflect the earnings potential of DivestCo. Bridging the gap between deal and audit basis financials (if required) is critical to give potential buyers additional comfort in the numbers.

This represents the seller’s view on (1) a stand-alone operating model of DivestCo, including “run rate” costs, (2) one-time costs to achieve the standalone operating model and (3) transition service agreement (TSA) costs to help buyers operate DivestCo from close date to steady state. These costs are typically a “pro forma” input into the historical deal basis financials and financial forecasts, so they depict the standalone financial profile of the DivestCo business.

Financial forecasts provide insights into DivestCo’s top-line growth, profitability and cash flow generation story over the next five years and should be supplemented with commercial and/or market studies. Since the forecast is done on a standalone basis, the starting point for the forecast (i.e., the historical periods) is typically focused on the deal basis financials to enable a “like-for-like” comparison across all time periods. The financial forecast of DivestCo is a critical component for buyer deal models and, thus, is subject to an elevated level of buyer diligence.

There are two key areas in a carve-out sale transaction where a valuation is leveraged. From a deal value perspective, a valuation (or deal) model is leveraged to estimate a total value for DivestCo while also considering potential trade-offs with the deal perimeter and transaction structure. It is used as the basis during the subsequent price negotiations. From a financial reporting perspective, valuations are commonly required for (1) tangible and intangible assets valuation, including goodwill testing and/or allocation to DivestCo, and (2) legal entity-based valuations used for tax purposes.

From a tax perspective, financial information on a legal entity level is required for gain-loss recognition and calculating potential tax implications of the sale. It is crucial that these numbers are aligned with the latest perimeter assumptions to accurately estimate the tax impact. Like the valuation, the tax department also considers potential trade-offs with different deal perimeters and transaction structures.

A financial forecast that shows the RemainCo business post-divestiture is essential to understand the future financial trajectory of the business without DivestCo, including the capital allocation and financing strategy. The forecast should also include the impact of the dis-synergies mentioned above (as well as potential remediation initiatives) to facilitate value creation analyses of the remaining portfolio.

Depending on the strategic significance of DivestCo as compared to the total business, ParentCo may need to report the impact of the divested business as part of discontinued operations under US GAAP along with filing pro forma financials with the SEC to reflect the disposition of DivestCo. The collective analysis of DivestCo, RemainCo and ParentCo financials allows for a holistic view of the transaction, with all financial implications considered and addressed. This integrated approach is vital for a successful and efficient carve-out execution.