Get your valuation right in a carveout

Sellers

Any valuation is heavily dependent on historical financials and balance sheet information, but this information can be difficult to determine when the asset that’s being carved out is heavily intertwined with the rest of the seller’s financials. No matter the difficulty, though, sellers should provide this information.

“They’re going to be a lot further along if they can produce some kind of historical carveout financial statements and some kind of forecast,” said Grant Thornton CFO Advisory Managing Director Maryellen Galuchie. “Obviously, the seller and buyer are both going to do their own forecast, but the seller should have something to start with. Otherwise, they might not get the best price for the asset.”

Sellers should also consider:

• How overhead and stranded costs affect price: If the seller plans to incur the overhead and stranded costs associated with the deal, the transaction might be more attractive to a buyer and fetch a higher valuation of the asset and sale price. When thinking about buyers, sellers can expect that:
  • Strategic buyers might have the back-office and other functions in place to support the carveout after purchase. “If you sell to a strategic buyer, the seller will almost certainly keep those costs,” said Grant Thornton CFO Advisory Principal Sylvia Cho.
  • PE and other financial buyers might need to bring over more back-office support from the seller in the deal.
  • When a PE buyer acquires the carveout and adds it to an existing platform, however, the support functions for the carveout might already exist in the platform company.

“From a valuation perspective, sellers need to properly identify those costs and, of course, the buyer has to agree with your assessment,” Galuchie said. “If they’re not properly identified, the valuation will be affected.”

Any support the seller is providing through transition service agreements also might affect the price.

Buyers

A buyer’s valuation starts with understanding as fully as possible the business that’s being carved out. If a seller says it is impossible to produce standalone financial information that reflects the carved-out entity, be prepared to walk away from the deal or demand a steep discount. You can’t truly evaluate what you can’t measure.

Next, buyers need a clear-eyed understanding of their own business and the synergies they can bring to the new business unit after the transaction. They need to ask:

• How much will it cost to stand up the asset once it’s acquired?
• How much time will it take to integrate? Or, do you perhaps not want to integrate?
• Can another buyer bring the same synergies to the deal that you can?

The answers to all these questions will help determine the value the deal can bring and the price you want to pay. And third-party diligence is just as important to buyers as it is to sellers. These services of course need to dig deeply into details about the carved-out entity, but they also should include an intense analysis of the buyer to figure out how the deal will drive value in the future.

Valuation pre-work can help the buyer validate their thesis and understand the impact of enveloping a carveout. Post-deal valuation work is also valuable, as organizations need to record all assets, including intangibles, and liabilities at fair value. Additionally, valuation professionals can assist both before and after the deal with determining the fair value of contingent consideration (such as earnouts).

Buyers also need to consider:

• How are you financing the deal?: Buyers who borrow heavily to finance a deal need to consider the effect on their overall business. Although valuation essentially is a measure of what a deal is worth, buyers also need to ask themselves what they can afford to pay without putting stress on their remaining business.
  
  At times, earnouts and contingent payments can benefit buyers more than sellers if earnouts significantly reduce the upfront price of the deal. It can be preferable to pay more at a later date with the knowledge that the deal delivered the value you expected — or even more. Buyers also use deferred payments on deals, which helps to finance the transaction.

• Are there cross-selling opportunities?: Many times, a carveout will be complementary to a company’s existing business, and cross-channel promotion can create a rising tide that lifts all ships.
  
  For Disney, for example, purchases that delivered properties such as ESPN and Lucasfilm created an almost endless array of cross-pollination opportunities that benefit everything from streaming services to amusement parks.
  
  The one caveat is this: If you buy an asset that’s too similar to an existing asset, you might end up cannibalizing some of your existing business.