M&A: Carve Out Article Getting carve-outs right: Preparation unlocks value

C-Suite Series: Mergers & Acquisitions

Getting carve-outs right: Preparation unlocks value

Well-prepared carve-outs lay the basis for completing deals on time and giving new entities the best chance of succeeding. The earlier and more aggressive the preparation, the more likely that value will be created for all parties.

Expect complexity, avoid added cost

Savvy deal makers know that for a carve-out to succeed, they need a strong focus on people. “Part of what companies are buying in a carve-out is the contribution of the employees to the new business,” says Ms Crozier. “And sellers often require buyers to ensure that their employees are going to be taken care of and are retained.” The first order of business in addressing human capital issues is devising a communication plan. “Extended transitions may take a take a toll on staff morale and engagement,” says Mr Adewale-Sadik, and “creating and quickly communicating a plan can help avoid this.” He adds that communication delays may also impact customers and suppliers. “But if you can move through any required notification and approval processes quickly, you can minimise both internal and external business disruptions or avoid them altogether.” Mapping out the transfer of employee benefits to the new business is a major work stream. Transition service agreements (TSAs) can be used across different business areas, and HR is no exception. HR TSAs cover areas such as payroll, benefit plan administration and the accounting of benefit plan costs. “Not all HR processes and systems can be set up to stand alone in a timely manner,” says Bruno Monteiro da Silva, Executive Director at Aon’s M&A and Transaction Solutions practice. “Effective use of TSAs can ensure that the deal is not delayed while the processes and systems are put in place.” It is important to determine which services will be provided under the TSA, for how long and at what cost. Otherwise, there will be ambiguity later. “A well thought-out and constructed employee agreement is a necessary foundation for executing on the overall deal and the requirements of the sale and purchase agreement,” says Mr Monteiro da Silva. It is also necessary to address early the regulatory requirements relating to employees in order to avoid unnecessary delays to close and significant unexpected costs. For example, in deals involving entities in European countries, such as France, Germany and the Netherlands, there is a need to formally involve works councils, and this could delay close.

Planning the human capital transition

C-Suite Series: Mergers & Acquisitions Better decisions for deal value

Access More M&A Insights

Legal

Privacy

Cookie Notice

Explore aon.com

Corporate deal-making is booming as economies and markets emerge from Covid-19¹. And carve-outs feature prominently: companies are divesting business units to raise funds and refocus on core strengths, while private equity buyers deploy war chests in the hunt for deals.² But carve-outs often fail to deliver the desired pay-offs. This is usually due to inadequate preparation, leading to delays in deal completion, added transaction costs, heightened risk exposure and weakened new businesses unable to meet shareholder expectations. Companies can minimise these problems by carefully managing human capital and operational transitions – and that means doing the groundwork early. “In my experience, those sellers that plan a carve-out early leave less value on the table, create more deal certainty and have a much shorter gap between sign and close than those who leave planning until later,” says Jannan Crozier, Global Head of M&A at Baker McKenzie.

Explore the Report

What

Section 1

Why

Section 2

Find

Section 3

Visit the website

In many ways, carve-outs are more complex than straight sell-offs, because of the intricacies of separating out assets and people without compromising the seller’s core business. And then there is the web of contractual, regulatory and legal processes that accompany these transactions – particularly the ones that cross borders. “Carve-outs are a good deal more complex today than they were five or 10 years ago,” says Maria Marta Geraldes, Head of Corporate Finance at Galp, a multinational energy company headquartered in Lisbon. Due diligence and risk assessments are much more involved and thorough now, according to Ms Geraldes. “Today, we typically bring in large teams to help with a deal, including external advisors with different types of expertise – technical, market, HR, accounting and tax, and insurance,” she says. “That’s because the risk awareness and hence complexity has changed but not the timing requirements, which are always demanding.” Ms Geraldes says that IT has been the most complex element of Galp’s recent sales and acquisitions. “Separating IT systems from the seller’s existing systems is difficult,” she explains. “As is integrating it with those of the new company. And cyber risk must be assessed and managed.” (For more on the latter, see ‘Insurance, cyber and intellectual property’.) Securing multiple regulatory approvals is another major element of complexity. “You can’t rush regulators,” says Ademola Adewale-Sadik, a Principal at New York-based private equity firm BPGC Management LP. “All you can do is engage regulatory counsel across each jurisdiction and respect the process.” Carve-outs will also typically involve separating out the real estate footprint of the new entity, determining the employees who will staff it and who will remain, and allocating historical liabilities or assets. Failure to manage this complexity can lead to transaction overruns that result in significant costs for both parties. In a 2020 survey by professional services firm TMF Group, 19% of corporates and 24% of private equity firms said their recent carve-out deals took longer than expected. Delays that last more than four months cost the parties an average of 16% of deal value.³ “Companies can avoid finding the carve-out processes burdensome and disruptive if they engage early in planning and preparation,” says Ms Crozier. “They will then maintain control of their process deliver a successful deal.”

Insurance, cyber and intellectual property

“Managing risk through a carve-out is critical,” says Nick Lupica, Executive Director of Aon’s M&A and Transaction Solutions practice. Insurance is a typical risk-mitigation tool in carve-outs, but it is difficult to get suitable coverage in place in a tight timeline under difficult market conditions. It will demand considerable time and attention: not having insurance coverage on time will delay close. The main risk for day 1 placement today is cyber insurance. TSAs for information technology (IT) are typical, but insurers are becoming much more restrictive, either not offering capacity if they are on the seller programme or requiring tie-in-limits (reducing the seller’s capacity), which may impact the terms of the deal. Deal parties need to get ahead of this risk. Forensic cyber due diligence will be seen by the insurance market in the best light possible. Carve-outs have come unstuck due to cyber-attacks during and after transition. Cyber underwriters therefore need to see the IT transition plan. Getting external guidance on this is important, says Mr Lupica, as too often the drafting is left to a small group within the new business. Careful negotiation of liabilities and requirements within the share purchase agreement (SPA) is critical to reducing day 1 costs. Requirements for directors’ and officers’ liability (D&O) insurance run-off and other pre-close coverage will quickly add significant cost. “Sellers typically underestimate the costs for day 1 as their experience and rates in the market are dissimilar,” says Mr Lupica. “The larger the seller, the more pronounced the underestimation.” Intellectual property (IP) separation is another carve-out workstream demanding careful attention. Decisions must be made about the ownership and future use of IP – particularly patents. IP portfolio analysis should be conducted to ensure the new entity gets precisely the assets it needs to create value, while the parent’s multiple business units retain solid IP protection.

Home

Managing carve-out complexity, risk and transition timing is possible with thorough assessment and preparation undertaken in specific areas, including:

How to make a carve-out a success

People Communicate the objectives of the transaction and new business as early as possible to ensure employee buy-in. Map out the transfer of employee benefits and other employer obligations.

Intellectual property Determine which patents and/or other IP the carved-out business needs to succeed without compromising the parent’s IP protection.

Information technology Cleanly separate software, hardware and vendor arrangements from the parent before integrating it into the new company’s systems.

Insurance Transfer existing insurance coverage where feasible, and identify likely gaps. Ensure that cyber insurance is in place on day 1.

There has rarely been a more favourable time to carve out a business. The pandemic has helped to highlight the aspects of the group operations that are most in need of shoring up, at the same time putting a spotlight on the parts of it that could generate more value through divestment. Potential buyers, meanwhile, are flush with cash and actively looking for deals. Carve-outs are inherently complex transactions, however, and not all offer lessons that can easily be applied to others. “It is difficult to speak of a ‘typical carve-out’—they are different each time, but if you create a compelling process you can close a carve-out efficiently and effectively without value leakage,” says Jannan Crozier. In this article we have shed light on those practices that sellers and buyers in carve-outs can apply to reduce the likelihood of delays and execution problems that drive up costs and diminish value. Paramount among those practices is advance and thorough preparation. Our carve-out experience has demonstrated that significant value can be unlocked with thoughtful preparation and with effective use of existing structured instruments.

Conquering complexity

Explore the Full Interactive Report >

*This article was written by Longitude, a Financial Times company, in partnership with Aon.

Contact the M&A Team