Steps to a quicker and less painful carve-out ROI process

By Paul Lennick, SVP of M&A Services, ContinuServe

Carve-out transactions tend to drag on too long, waste money on expensive management consultants and ultimately exhaust both buyer and seller teams. Far too often, by the end of the transition service agreement period, former colleagues in the parent and carved-out entity turn negative, frustrated with the outcome and process. However, if a well structured approach is taken, the carve-out can result in shortened TSA periods, accelerated ROI and win-win relationships.

Carve-outs occur when a parent company decides to divest a unit for either financial, strategic or operational reasons. Deloitte indicates that 66% of the time, a parent will divest a business due to it not being core to the company’s future strategy. Acquirers such as financial or strategic buyers can then acquire the divested business and endeavor to increase the investment value over time. Since the carved-out business often requires renewed market focus, investment and the creation of a new back-office, the risks and rewards are higher than traditional acquisitions.

In the US, in the second half of 2021, and with the EU and APAC to follow in 2022, we are seeing an increasing volume of PE firms engaging in carve-outs in the post-covid era as the M&A structure becomes mainstream. Historically, few PE firms had the resources and risk tolerance to take on carve-outs. Now, a breed of new mid-market PE firms are entering the fray. With so much dry powder and rising multiples for “clean” deals, firms are seduced by the more complex carve-out plays, often including platform ambitions. However, there is caution here as executing carve-outs requires a proven playbook to be successful in delivering on the deal thesis and ROI expectations.

The Carveout Consortia has been formed to take on such efforts working with PE firms that do not currently have the internal-staff to execute successfully. The Consortia, formed in 2021, brings together a dozen PE-focused service providers aligned to drive carve-out transactions at deal speed. Simply put, the objective is to execute effectively by bringing a turnkey playbook to the table.

The capabilities of the Consortia focuses on solutions in the back-office, including information technology, finance, accounting and human resources. The capabilities span the M&A life-cycle, with engagement beginning in diligence through sign-to-close, to supporting the new business, to exit. Consortia members represent best-of-breed players across these functions, providing structure, execution templates, outsourcing solutions and ROI enhancing capabilities.

Three guiding principles govern the approach to executing carve-outs successfully:

First, at the top of the list is governance supported executive leadership. Executives need to be held to account for making decisions at deal speed in a process that is highly transparent on both buy and sell sides. Minimizing the spin by the working teams is critical to stabilizing the effort, focusing on what matters and locking in key decisions early in the process. The effort can not be seen as a distraction, but instead as a core responsibility. If this is instituted early, one can expect the acceleration of TSAs by 50% to 75% versus typical carve-out efforts that lack sufficient governance supported executive leadership.

Second, establishing a separation management office (SMO) is also a necessary tool to ensure success. By identifying functional specific and domain area leads from both sell- and buy-side organizations, the effort can accelerate. Priming the effort with pre-populated templates that detail the typical separation steps and dependencies, requiring minimal customization for the specific effort, can save weeks if not months of work. This, combined with centralized control of task and action item management and structured reporting cadence processes ensures everyone is on the same page. Best-in-class approaches are to have experienced external resources support for these efforts, augmented by internal teams that represent the “A-team players” that have the specific knowledge of the inner workings of the company.

Third, and finally, ensuring that a comprehensive and clearly documented transition service agreement (TSA) is in place to minimize ambiguity. Taking the time to document the services to be provided by the parent (or the carved-out entity in the case of reverse TSA services) will go a long way to reduce conflict as the process plays out. The services minimally should include the owners, costs, penalties for non-performance and the detailed service level performance expectations.

Certainly not overpaying up front and negotiating a quality purchase agreement will directly impact ROI. However, once that occurs it is all about execution effectiveness as the mechanism to monetize the effort and deliver returns that exceed expectations. By working with the dozen firms included in the Carveout Consortia including ContinuServe, the ROI of the effort can be improved, the TSA exit accelerated, allowing management of both the buy and sell sides to get back to business that matters, namely, growing their respective organizations and winning in the marketplace.

Paul Lennick is senior vice president of M&A Services at ContinuServe. For more information on the Carveout Consortia, Mr. Lennick can be reached at 619-761-9301 or Paul.Lennick@continuserve.com.