Mutual benefits can be gained from a divestiture
For buyers, sellers and those making a transition to a new parent company, carveouts and divestitures offer an opportunity for a brighter future if the transaction is handled appropriately.
The growing prevalence of these transactions can be seen in recent U.S. private equity deals, where carveouts and divestitures represented 10.7% of buyouts in the fourth quarter of 2023, nearly doubling their 5.8% share from the fourth quarter of 2021 after a fairly steady two-year climb, according to PitchBook data.
The popularity of these deals illustrates their value to both sides. When done right, a carveout relocates an asset or business from a parent company where it doesn’t quite fit to a new organization that is better positioned to maximize the asset’s production.
A carveout also creates an opportunity to create goodwill.
“You want to be known in the marketplace as a respectable seller who is fair to the people who have supported you for a number of years,” said Grant Thornton Transaction Advisory Managing Director Sonny Origitano. “And then, from a buyer perspective, you want to bring new people in and make them feel important to the transaction right away in their new organizational home.”
Successfully completing a carveout requires great care, however, because both sides need to agree on the transaction perimeter and precise details, including:
- Which employees will be transferred and who should not be included in the deal.
- Which assets are included — and not included — in the deal.
- How many items should be subject to transition service agreements (TSAs) and how long the TSAs should last.
- How and when to communicate the details of the deal throughout both organizations.
- How long it should take to close the deal — particularly if it needs regulatory approval.
Compounding the difficulty is the fact that carveouts and divestitures are not everyday occurrences for many companies.
“From both a seller and buyer perspective, carving out and divesting of assets is not something you do frequently as a business process,” Origitano said. “So having a third party help you through that process can be extremely valuable.”
Doing it right requires sellers to coordinate across strategic, operational, commercial and legal functions to perform the right activities at the right time. These groups need to collaborate and determine where interdependencies exist between the parent company and the departing business unit to facilitate a smooth transition to a buyer.
“From a seller perspective, you want to make sure the people in transition are taken care of properly. As the buyer, you want the people to be excited to have new ownership.”
Buyers need to determine how the acquired organization’s assets will fit most comfortably into their operating model, how to successfully integrate and what costs will be associated with the transaction. If a PE buyer is creating a standalone organization, a whole new operating model may need to be created.
It’s often not easy or familiar work, but it can be rewarding for the buyer, the seller and the people who are transferred during the transaction.
“From a seller perspective, you want to make sure the people in transition are taken care of properly,” said Grant Thornton Transaction Advisory Partner Eric Burgess. “As the buyer, you want the people to be excited to have new ownership that can fully reap the benefits that they can bring.”
Identifying carveout opportunities
Divestitures typically consist of assets that either aren’t generating the value you expect or don’t align with your strategic goals or core operations.
But a divestiture only works if there’s another organization (strategic or PE) that has either the means to deliver better value from an asset or has goals and operations that align more closely with the asset.
Once such an asset is identified, it’s important to determine the boundaries between the asset and the parent company. Does the asset have separate human resources, finance/accounting, IT, supply chain, or sales and marketing functions that will be part of the sale? Or do those functions belong only to the parent company? And what will happen to the insurance policies of both organizations once the transaction is completed?
Answering these questions is imperative so the organization can present an accurate description of the asset to potential buyers.
Buyers who are considering purchasing a carveout need to scrutinize that description closely to determine what they’ll actually be getting as part of the transaction — and what they’re not getting. They also need to evaluate the costs associated with the transaction closely, and not just the upfront costs.
For example, it may be easy to identify redundancies in personnel and anticipate that you’ll be able to decrease the operations costs of the acquired entity through headcount reductions. But imagine that you’re only taking on the people who work in operations for the carved-out entity, and that ultimately, they will add 20% to your workforce. Are you adding 20% more work for your human resources, finance and IT support staff as well? If so, there’s a cost associated with that.
Similarly, the entity that’s divesting needs to consider its cost savings opportunities and the stranded costs that will remain with the seller after the carveout occurs. If your staff is being cut by 20%, you might not need as much HR, finance and IT support. Or perhaps you have a corporate suite at an entertainment venue or a corporate jet whose annual costs are allocated across your business units. The carved-out entity’s portion of those costs would then need to be re-allocated across the remaining business units.
“You have to work across the business, identify stranded costs, and try to eliminate or reduce them as much as possible.”
“You have to work across the business, identify stranded costs, and try to eliminate or reduce them as much as possible,” Origitano said. “In the instance of the corporate jet, you might determine that you don’t need an airplane anymore if you reduce your business by 30% or 40%.”
Sellers can either attempt to find a buyer on their own or use an investment bank to locate potential buyers. Sometimes amicable conversations at industry forums can lead to serious discussions of a business unit that doesn’t fit one party’s business strategy and/or financial thesis but is perfect for another company — perhaps even for a competitor. A divesting company’s corporate development team is also sometimes aware of buyers who may be interested and may contact them individually.
More commonly, a seller who identifies a divestiture opportunity hires an investment bank to determine which buyers might be interested in a deal. In this case, multiple buyers may be identified and may bid against one another for the asset.
While the investment bank route to a carveout may yield a higher transaction price, it typically takes much longer to complete than a direct conversation with an industry peer that may be less lucrative.
“You have to decide which direction you want to go,” Burgess said. “The direct route may be quicker but could yield less of a return. The investment bank option could be more disruptive over a longer term, but it’s likely to generate more value.”
Should it stay or should it go?
The purpose of a divestiture is to refocus on core businesses and/or to raise capital, which may require transferring the people, processes, systems, assets and contracts heavily used by the carved-out business to the buyer.
But there may be certain assets or contracts that the seller doesn’t want to part with.
“So strategically, I’m going to look at whether I can bifurcate or split contracts or assets,” Origitano said. “In some instances, I can’t. And then I need to determine how valuable the contract or asset is to me as a seller. Whether those particular contracts or assets are within the perimeter of the deal may become a point for negotiation with the buyer.”
Where intellectual property or systems are involved, the buyer would want the key people who are making the transition to identify the assets that are important to bring to the new company and make sure that those assets are included in the purchase agreement. When the carved-out entity is dependent upon systems that will belong to the parent, the purchase agreement should state how use of those systems will be maintained so the divested entity will continue to be able to operate.
Determining which people will come over in the transaction can be a delicate negotiation as well. The buyer wants to acquire the right people to support the business, but there may be people or functions that aren’t needed or can be sourced through the buyer’s existing workforce.
One common challenge for buyers to watch for is parent/seller views of the divested entity that diverge from how management of the carved-out business sees its resources and prospects. The parent company’s executives may believe the divested entity has all the resources, assets and funding it needs to be instantly profitable. But the divested entity’s management may not be as optimistic. A thorough due diligence effort can help identify such discrepancies and enable them to be considered in the deal pricing decision.
“This is often a balancing act that takes place in a carveout,” Origitano said.
Keep TSAs manageable
Particularly in deals with short timelines, TSAs are almost always necessary to provide the support in areas such as IT, HR, finance and payroll that the divested entity needs to get up and running.
But it’s in the best interest of the seller to limit the number and duration of TSAs as much as possible.
“As a seller, you’re not in the business of being an outsourced provider,” Origitano said. “The more you can minimize TSAs and push services such as systems changes to the buyer, the sooner you can realize value and benefit from the carveout. Providing TSA services is disruptive because you’re effectively acting as an outsourced provider when that’s not your core business.”
Buyers also benefit when TSAs are kept short. Although buyers want to make sure they have an appropriate amount of time to implement systems and processes, the purpose of TSAs is to allow a seamless transition. The buyer’s goal in a transaction is to obtain control of the transferred asset and establish business as usual for the future, and that can be delayed when a lifeline with the previous entity is maintained.
Make people feel welcome
The people who are transferred as a result of a carveout or divestiture can experience a wide range of emotions and ultimately, employees want to understand the game plan.
“Understanding the impact to employees and creating harmonization strategies for compensation and benefits will go a long way in calming fears.”
Nobody likes to be told they’re not wanted, but unfortunately, a carveout can make people feel like castaways. It’s important for the acquiring company to make its new employees feel needed and appreciated.
“Up to a third of acquired employees leave within the first year,” said Grant Thornton Transaction Advisory Managing Director Angela Nalwa. “There are a variety of reasons, such as culture, a sense of lack of job security, benefits and compensation, and overall communication and relationship with their new leaders and managers. Understanding the impact to employees and creating harmonization strategies for compensation and benefits will go a long way in calming fears.”
“You need to socialize the value of the business you’re getting and your short-term and long-term plans for the business.”
Communication is an essential engagement and retention tool. The buyer needs to explain the thesis for the deal, the value the business will bring to them and the role the transitioning employees will play in building that value. “As a buyer, you want to communicate as much as the seller will allow before the deal,” Origitano said. “And then on Day One in the integration meetings, you need to socialize the value of the business you’re getting and your short-term and long-term plans for the business.”
The seller has a role in this, too, as its reputation and the morale of its remaining people can be affected by its treatment of the people who are leaving in the divestiture.
“Employees need to understand what will change and what will stay the same. It is also important for the buyer to create the opportunity often for employees’ voices to be heard,” Nalwa said.
Choose the appropriate timeline
A quick transition is usually preferred because it takes everyone out of flux and gets them started promptly on delivering the value of the deal.
But a speedy resolution to a carveout is not always possible. A deal that needs regulatory approval can be slowed by months as the Department of Justice or other regulators review the details.
Because this process is outside the buyer’s and seller’s control, it’s sometimes best to communicate an ambiguous closing date when announcing a deal. “In the second quarter” may be a better closing date to announce than “May 1.” After regulatory approval is received, the buyer and seller can work together to set a firm, precise closing date.
In the meantime, though, both sides should be working hard to prepare for the deal, even if approval hasn’t been received and the date is uncertain.
Make it work for all sides
A carveout or divestiture is ultimately like moving from one home to another.
It’s not something you do often. It takes a lot of hard work. It may be unsettling for some of the people involved.
But in the end, hopefully, the move is the right thing for everybody, and all parties will prosper as a result.
“The benefit is that it works for both sides,” Burgess said. “The seller benefits by parting with an asset that’s not core to their business. And the buyer is embracing this group of people who are excited to see how they fit in with their new organization.”
Contacts:
Sonny D. Origitano
Managing Director – Strategic Solutions
Sonny has extensive experience in pre-close and post-close integration and separation strategy and execution including; one-time cost identification, stand-alone financial and operating models, synergy identification, stranded-costs reduction, transition service agreements (TSA’s), day 1 readiness and contract analysis to maximize or preserve value throughout the transaction life cycle.
Chicago, Illinois
Industries
- Healthcare
- Manufacturing, Transportation & Distribution
- Transportation & distribution
- Retail & consumer brands
- Private equity
Angela Nalwa
Managing Director, Transaction Advisory
Angela is a Managing Director in Grant Thornton’s Transaction Advisory practice with over 25 years of experience focused on Human Capital Strategy and the People aspects of Transactions.
San diego, California
Service Experience
- Transaction advisory
- Human Capital Services
Eric Burgess
Partner, Transaction Services
Eric is a Partner in our Transaction Services practice. He has developed extensive transaction experience serving as an adviser to multinational companies, middle market private equity firms and local corporations. He has been involved in more than 400 transactions with more than 100 different private equity investors, multinational companies, lenders and strategic corporate acquirers. Eric has significant M&A experience across many industries.
Dallas, Texas
Industries
- Healthcare
- Manufacturing, Transportation & Distribution
- Transportation & distribution
- Energy
- Hospitality & Restaurants
Service Experience
- Transaction advisory
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