Six lessons for risk limits when a seller divests a carve out business

How can transaction purchase agreements help sellers divest carve out businesses while reducing execution risk and surprises?

In brief

• Well-crafted transaction purchase agreements help align operational needs and lower costly risks for both buyer and seller.
• These transactions face challenges like valuation gaps, unclear obligations, misaligned reps, governance issues, covenants and vague closing terms.
• Close coordination of advisors and legal counsel streamlines transitions and improves deal outcomes.

That gap can turn into an economic issue fast. If the agreement does not clearly define which assets and liabilities move with the business, items may be priced but not transferred — or transferred without being priced. A strong “wrong pockets” clause gives the parties a way to correct those mistakes after closing; without one, they are left to negotiate after the fact, often with more friction and less leverage.

Purchase-price adjustments can compound the problem. A mismatch between the closing balance sheet and the deal-basis financials can raise or lower proceeds and strain financing or cash needs, particularly when the seller retains payables or employee compensation liabilities the buyer is expected to fund.

2. Misaligned representations and warranties

Sellers may inadvertently include expiring agreements and non-transferable licenses or overlook employee obligations within representations and warranties (reps). In carve out transactions, financial statement representations are particularly challenging. The seller is often asked to provide deal-specific carve out financials, which may be unaudited and based on allocations and estimates.

Incomplete diligence can surface late-stage surprises, from overlooked liabilities to key contracts that fail to transfer before close because of customer delays. In carve out transactions, buyers and representations and warranties insurance (RWI) underwriters often scrutinize financial-statement representations, focusing on how the statements were prepared, the allocation methods used and any stated limitations. Sellers may face claims if the carve out financials fail to reflect how the business was operated — or if the related representations are not properly qualified.

3. Post-sign governance and stand-up responsibilities

Transaction agreements often spell out governance rights and responsibilities for stand-up activities, including one-time costs such as recruiting and system migrations. When those expectations are unclear, post-sign activities can become flashpoints — slowing execution, triggering disputes over financial obligations and eroding deal value.

4. Post-close agreements, covenants and extended obligations

Buyers may ask sellers to take on post-close obligations, from transition service agreements (TSAs) to non-compete clauses and other extended covenants, but vague terms around their scope, duration or pricing can create ambiguity and constrain the remaining business’s future strategy.

5. Interim operating covenants

Buyers often seek interim operating covenants and approval rights to protect their interests between signing and closing, but overly restrictive terms can limit a seller’s ability to run the business, weaken performance and complicate routine decisions such as hiring, vendor management and internal restructurings. Broad or long-running covenants can also constrain working-capital management, payables and cash flow, potentially affecting closing working capital and other purchase-price adjustment metrics.

6. Broad or vague closing conditions

Buyers may seek broad closing conditions beyond standard regulatory and third-party approvals, such as requirements that all consents be obtained or that closing remain subject to the buyer’s satisfaction. Ambiguous or expansive conditions can delay closing, invite renegotiation or give buyers grounds to walk away, while a shifted closing date — such as a mid-month close — can complicate the closing balance sheet and working-capital calculation, raising the risk of purchase-price disputes. Closing conditions also should not unnecessarily limit the seller’s ability to manage the business and prepare for separation, including through soft-close procedures or other operational changes.

Proactive coordination reduces M&A execution risks and surprises 

Carve out mergers and acquisitions (M&A) present unique execution risks that go beyond the legal language of the purchase agreement. Close coordination between the seller’s operational and financial advisors and legal counsel can support the identification of potential risks and pitfalls. By proactively addressing these six critical watch areas and embedding financial and accounting discipline throughout the process, sellers can significantly reduce execution risk, avoid costly surprises and drive better outcomes for all parties involved.