Carving out a business or assets from the parent company is an extremely complex process that requires multiple business stakeholders to define the deal perimeter (ring-fence) and execute the divestiture. The stakeholders typically include C-Suite leaders, Corporate Development team, business leaders, functional leaders and often external advisors to assess separation requirements, risks, costs and timing.
Separating the business while limiting impacts to the carved business and parent company involves detailed planning during the pre-deal phase. A key step in this process requires establishing a separation office and leader to work with the deal team early in the transaction process, prior to due diligence, if possible, to both minimize operational risks and enhance deal value. In addition, operational separation activities can provide input to carve out financials by identifying specific stand-alone costs or benefits resulting from the transaction.
Separation Readiness Planning
An operational separation readiness plan is an essential tool for ensuring a smooth and successful separation process when a parent company is divesting a business. Developing a detailed separation readiness plan entails early engagement with the deal team to understand the deal perimeter, alignment with separation strategy, expected timing, and buyer profiles (Financial or Strategic). In addition, a separation roadmap with discrete milestones and deliverables by functional area will enable the separation team to manage the overall exit process.
Ring Fence / Deal Perimeter
Ring-fencing the deal during a divestiture is critically important to ensure that the process is successful and to minimize risks for the seller and buyer. Ring-fencing refers to the process of creating a clear and legally enforceable boundary between the assets and liabilities being divested and the remaining assets and liabilities of the selling company. This helps to protect both the divested entity and the parent company from potential risks or liabilities that may arise after the divestiture is completed. There are several reasons why ring-fencing is important during a divestiture:
- Protecting the Divested Entity: Ring-fencing helps to protect the divested entity by ensuring that it is legally separate from the parent company. This can help to minimize the risk of the parent company being held liable for any issues or liabilities that arise after the divestiture.
- Minimizing Risks for the Parent Company: Ring-fencing also helps to protect the parent company by ensuring that it is not held liable for any issues or liabilities associated with the divested entity. This can help to minimize the risk of the parent company’s reputation being damaged or of it incurring financial losses.
- Facilitating Due Diligence: Ring-fencing can facilitate the due diligence process by providing a clear boundary between the assets and liabilities being divested and those of the parent company. This can help potential buyers to assess the risks and benefits of the divestiture more effectively.
Define the scope and objectives of the separation: The first step is to define the scope and objectives of the operational separation. This involves identifying the business or assets that will be divested, as well as the specific goals and objectives of the separation. Next, the organization will need to establish an operational separation structure, program management office and governance model to manage the divestiture and get to a successful Day 1 exit. The separation management office is typically led by a parent company business leader supported by functional leader. A detailed separation plan with specific timelines, milestones, and responsibilities should be developed that outlines the steps required to separate the business unit or subsidiary from the parent company.
Conduct a Detailed Entanglement Mapping Assessment
Assessing the level of entanglement between a parent company and the carved out business is a critical step in the divestiture process. A comprehensive entanglement mapping assessment is necessary to identify the areas of the business that are dependent on the parent company and that may require support after the separation is completed.
The entanglement mapping is a process to gain a comprehensive understanding of the dependencies and interrelationships that exist within the business unit or subsidiary and to develop a plan for managing these dependencies during the divestiture process to enable business continuity post-close.
Entanglement mapping typically involves a comprehensive review of the business including its organizational structure, operating model, operations, IT, functions, legal and regulatory requirements. The mapping process can be complex and time-consuming, but it is a critical step in preparing for a successful divestiture. The goal is to identify business functions and processes that are entangled with the parent company or other entities and to develop a plan for addressing these dependencies during the separation process. This outcome is often achieved through workshops conducted with key stakeholders from the parent and carved-out business leads to identify processes to be supported by the parent post-close (TSAs), investment to build new capability or currently existing in the divested business.
Entanglement mapping will help to ensure that the divestiture process is as smooth and seamless as possible, with minimal disruption to the operations of carved out business and parent company. It can also help to minimize the risk of post-divestiture issues, such as legal or financial liabilities, by identifying potential risks and developing risk mitigation plans.
Establish Target Operating Model (TOM)
A target operating model (TOM) process in a divestiture refers to the process of defining the desired operational environment of the business after the separation from the parent company. It involves defining the future state operating model, which includes the people, processes and systems and organization structure required to support the desired stand-alone business outcomes. These outcomes are informed by the entanglement mapping activities and the buyer profile.
Overall, a TOM process in a divestiture is critical to ensuring the success of the stand-alone entity after the separation from the parent company. By defining a clear vision and future state operating model, and developing a detailed implementation plan, it is possible to achieve a smooth transition and position the standalone entity for success.
Define Operational Risks
Operational risk management is the process to identify and manage operational risks associated with the separation, such as production impacts, supply chain disruptions or regulatory compliance issues. During the risk assessment process, the teams will highlight changes to the current state operations to identify, manage and propose solutions to mitigate risks. Potential operational risk issues can include employee transitions, shared manufacturing facilities, product licensing requirements, contract novation or conveyance, legal entity structures and intellectual property ownership.
Overall, developing an operational risk strategy for a divestiture requires a thorough understanding of the business risks associated with the separation process and a proactive approach to managing those risks. By identifying and managing risks effectively, it is possible to achieve a successful divestiture with minimal disruption to operations and minimal impact on stakeholders.
Develop Stand-Alone Cost Model
Developing a stand-alone cost model for a divestiture involves estimating the costs associated with operating the business unit as a standalone entity after the separation from the parent company.
Stand-alone operating models can help sellers package the business being carved out to maximize its value. Developing the cost model requires the seller to understand the estimated stand-alone costs of running the business when developing their deal models. It can be a very complex activity especially if the current cost structure includes non-direct costs for services provided by the parent including allocations for corporate and shared services costs.
A well-designed model will incorporate a clear understanding of stand-alone costs, estimated investments, one-time costs and the effort it will take to carve-out the business. The stand-alone cost model allows sellers to clearly communicate a detailed future state cost and operating structure to potential buyers which can increase buyer confidence and enhance deal value.
Define TSA requirements
A transition services agreement (TSA), is a contract that outlines the terms and conditions of the services (e.g., Finance, IT, HR) that will be provided by the seller to the buyer during the transition period after a divestiture. TSAs are necessary in most carve-out transactions as buyers are not positioned to stand up all systems and processes required to ensure business continuity on Day 1.
Developing a TSA strategy early in the divestiture process can help sellers determine what services they will or will not provide and what can be done to minimize TSAs or avoid them altogether. This starts with understanding the divested business complexity and the level of entanglement with the parent. A proactive TSA strategy provides sellers an opportunity to lead the TSA negotiation process with the buyers. All drafted TSAs should include specific TSA exit requirements, including terms and costs, allowing buyers a clear understanding of the exit requirements. Additionally, it should also provide buyers a line of sight to focus their investment efforts to build internal capability and avoid prolonging the TSA duration. Sellers should negotiate for short durations where practicable to minimize business distractions, costs and delay stranded cost impacts. By creating a TSA strategy early in the process, the seller can design effective TSAs that support a smooth transition to the buyer on Day 1.
In conclusion, creating value in an operational separation requires a strategic approach that focuses on optimizing the cost structure, improving efficiency and productivity, focusing on core business activities, capitalizing on growth opportunities, and developing a strong brand and reputation. By taking a proactive approach to value creation, companies can maximize the value of the divested entity and achieve a successful separation.