Carve-outs are back

By David McKee, Joseph Luke and David Morris, Accordion

While traditional deal activity remains muted, there has been a significant uptick in the volume of carve-outs. For PE sponsors and deal leads looking to acquire a new platform or add-on, carve-outs are once again becoming an important source of value. While contemplating a carve-out can feel daunting, and reliance on a seller to support the new business through a transition service agreement (TSA) creates complexity and potential risk, it also creates opportunity. In a crowded marketplace there is less competition for often under-managed carve-out targets, meaning potential for greater value creation by savvy buyers.

Here’s how designated deal leads can successfully execute even the most complex carve-out.

Plan early to set the stage for success

Carve-out planning should begin during the diligence process. Start by clearly defining the deal perimeter and developing an upfront inventory of all entangled processes, systems, people, contracts and third-party relationships. This is critical for Day 1 business continuity as well as separation and transition planning.

• Identify operational readiness risks and requirements for the standalone company – Assess segment requirements that need to be addressed prior to closing (bank accounts, insurance, payroll, IT access, for example) versus those that can be provided through a TSA.
• Design standalone operations that are in line with the buyer’s investment thesis – Assessing standalone and normalized EBITDA/QoE, buyers ensure that capital and resources are allocated in accordance with the investment thesis and the NewCo strategy.
• Ensure one-time costs are factored into the deal model – These are particularly important for IT and for standing up the business (for example, third^–party services, recruiting, severance).
• Migrate contracts and licenses from the get-go – The contract management process can be long and burdensome; an early start and dedicated focus can help mitigate risks and minimize consent costs.
• Minimize the number and duration of TSAs to shorten transition time, but structure TSAs with flexibility – Reduce Day 1 operational risks through an optimized TSA and schedule of services.

Plan, test, and communicate for a smooth Day One

With all the moving parts and competing priorities that come with a carve-out, it’s critical to ensure that the seller, target and buyer are aligned on tasks and accountabilities.

• Identify leadership early – Bring on leadership early to provide the vision, objectives, and future operating model necessary to guide the carve-out and stand-up planning.
• Launch a command-and-control separation management office (SMO) –Coordination is critical to focus on priorities, ensure early identification of long lead-time items, manage issues, and interdependencies.
• Focus operational readiness on “must-haves” critical for Day 1 continuity – This includes bank accounts, insurance, payroll, IT access, and Finance and HR processes to operationalize TSAs.
• Prioritize technology decisions – Technology is typically the “long pole in the tent.” Ensure appropriate planning for the separation of systems and data from the parent. This includes the provisioning of TSAs including enhanced access controls and security protocols and seamless end-user support throughout the transition.
• Develop comprehensive retention and communication plans – Set up retention plans and articulate a clear vision, be prepared to address employee issues, and engage stakeholders early and often, even when the message is “We don’t have an answer yet.”

Take control and stabilize operations first

Ensure focus is directed toward maintaining financial and operations control and ensuring a disruption-free Day One. Doing too much too fast without the benefit of appropriate planning and control is a significant source of lost value.

• Manage all TSA processes and service quality issues between the target and seller – Implement TSA governance processes that will ensure management visibility, identify and resolve service issues, and track costs.
• Understand cash-in/cash-out processes – This is essential for commingled cash receipts, AP disbursements, invoicing, and payroll. Focus on liquidity management by implementing a robust 13-week cash flow forecast.
• Stay ahead of reporting requirements – Financial and operational performance reporting and visibility for Management, Sponsor(s), and Lender(s) are critical.

Plan for an early TSA exit, before optimizing for value creation

Avoid the urge to transform at the outset but focus first on exiting TSAs to minimize costs and service delivery risks, and quickly establish a standalone platform to pursue value creation opportunities.

• Start TSA exit and standup planning early – Complete TSA exit plannings prior to closing, when possible. Early planning will provide sufficient time to validate the exit plans with corporate functions, and help accurately determine TSA duration, capabilities, and interdependencies.
• Implement robust technology disentanglement & stand-up plans – This shapes the longest sequence of tasks for most transactions and identifies key dependencies for synergy and cost rationalization. Make early systems decisions to replace excluded assets to reduce TSA exit timelines and stand-up costs. Rightsizing for the NewCo will likely mean a smaller, nimbler systems architecture, but this often necessitates a new set of business requirements.

The carve-out process can feel daunting, but utilizing the right structure and approach greatly enhances the probability of success. By planning early, testing, communicating and focusing on stabilizing before optimizing, deal teams can conquer even the most complex carve-outs and deliver long-term value.

David McKee is a managing director and carve-out/merger integration specialist in Accordion’s transaction execution practice; David Morris and Joseph Luke are senior directors and carve-out/M&A specialists in that same practice.