by John Pittman III and Brian Ottaviano:
Anyone who has ever been involved in a carve-out divestiture quickly learns that carve-outs bring challenges and complexities that other divestitures do not.
The motivation for an exit may vary (non-core business, regulatory, spin-off for shareholder value), but the level of complexity and execution risks are always high. Here are a few quick tips we have learned over the years that we share to help ease your potential pain (and it was not easy to pare down the list to these few):
- Start early: You hear this all the time with regard to exits but starting early is especially important for carve-outs. Avoiding value erosion or the inability to price properly is worth the effort of advanced planning. Start by realistically vetting exit options, your readiness to execute, and the effort associated with each. Dual track paths are possible (e.g., sale versus spin-off) and, while more costly, can enable you to start the process sooner versus waiting and can also result in leverage for the seller. Vetting as early as 24 months in advance of a potential carve-out divestiture is wise. Unlike when we first started assisting with carve-outs over a decade ago, there are now many publications for guidance and, of course, professionals who can guide you through all stages of a carve-out divestiture.
- Build your story: Carve-out divestitures represent an interesting obstacle to navigate at the onset. Why is the business you’re divesting non-core? How does splitting apart the organization create more value? When the time arrives for a carve-out divestiture, make sure the message is clear and that you do not wait until you could be considered desperate or in a compromised position to begin marketing or considering strategic alternatives for a business. Make it a point to critically evaluate the strategic direction, including individual businesses and product lines at least annually. Do not wait to make the hard decisions. Also, begin further developing your ability to market by getting more granular with your associated revenue streams and KPIs to enable you to clearly tell the carve-out business’ value story.
- Understand financial needs and the limitations surrounding the availability of data: Okay, this is a two-parter: a.) required deal financial information and b.) audit / regulatory needs.
a) Required deal financial information: The standard due diligence data requirements are often simply not available for a carve-out and often can take many weeks to months to prepare. Even worse, frequently, financial data is manually compiled for the first time just for this process. This often leads to preparers taking short-cuts via assumptions to expedite the process. Buyers, and their advisors, then enter the process and take advantage of this by finding gaps and using the lack of available information to their advantage via deal terms. They attack areas such as quality of earnings (including allocations vs specific business costs), the identification of specific assets and liabilities of the business, and the definition of working capital. The seller can avoid this type of value erosion by thoroughly understanding what deal-related data will be required, what is available, and spending more time strategically considering the effort vs cost dilemma when preparing the remaining information.
b.) Audit / regulatory needs: Often when we enter the carve-out divestiture process we quickly determine that neither the company nor its advisors are being realistic about the timing necessary to complete carve-out audits or regulatory related financial information (e.g., SEC Form 10). The majority of the time this is due to the company, and at times its advisors, not having sufficient experience with handling this specific aspect of carve-out divestitures. As with the deal financial information discussed above, management teams enter the process with a misunderstanding of the financial requirements or underestimating the availability of financial information as well as the complexity of auditing carve-out financial statements (often by months versus days in their timelines). Thoroughly evaluating your potential audit and regulatory needs will avoid missteps and potential wasted effort. The form and content of historical and pro forma deal vs regulatory (e.g., U.S. GAAP and SEC) financials vary and sometimes significantly. The most successful companies do the following when preparing carve-out financials to be audited or included in regulatory filings:
i. Identify and reconcile the differences between the different financial information views (i.e. deal/proforma vs. historical audited) when preparing carve-out financial information. Do not consider the preparation efforts separate and distinct, as there are many efficiencies that can be gained from considering both as early as during execution of the due diligence process as well as confusion that can be avoided later between the different financial presentation views;
ii. Depending on the complexity of the business being divested, they consider pre-clearing technical matters with the SEC (confidential way to obtain feedback on accounting matters from SEC staff) to avoid preparation issues during the SEC review process. This could include clearing the composition and basis of presentation of financials for a spin-off or the need to furnish financials or abbreviated financials for S-X 3-05 purposes;
iii. Do not defer preparing financials until all the facts are known. Given the nature of a carve-out, certain assets, liabilities, or products may or may not be included. This should not necessarily cause preparers to wait. There are ways of pulling information that can later be interchanged versus waiting too long to start; and
iv. Keep things in perspective during the planning and preparation process. It’s easy to get caught up in the nuances of carving-out a business (e.g., allocations of costs) and lose sight of materiality and practicality.
- Understand the degree of interdependence and ability to separate: This is somewhat stating the obvious but remains often overlooked. The separation process for carve-out divestitures will be longer than your standard exit. The degree of interdependence (shared services, personnel, IT, physical locations, etc.) is something you should begin considering earlier on in the process, as it will slow down the deal or be a source of frustration after the fact because the seller did not evaluate appropriately the stranded costs or your transition service agreement(s) will linger after the divestiture. Sellers should spend the time early in doing a self-assessment of the degree of interdependency. This can be done discretely without telegraphing your potential plans for the business.
It can be done
With all this to consider (and more) in executing a carve-out divestiture, often companies are dissuaded from doing what should be done or procrastinating until they have no other options. Take it from us, with the proper planning and experience, carve-out divestitures can be managed effectively and be a sound strategic alternative for your company. To learn more about how to make this a reality, visit www.virtaspartners.com or reach out to us at info@virtaspartners.com