Thought Leadership  •  December 18, 2023

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Equity Carve-Out Transactions

Carve-outs are a frequent part of the mergers and acquisitions (M&A) process. In a recent white paper on the modern dealmaking process, more than eight out of 10 survey respondents said they had performed carve-outs.

Respondents frequently indicated that it was more challenging to find buyers for carve-outs than for the remainder of the company. Read on to learn more about the carve-out process, anticipated challenges, and its role in M&A deals.

What Is a Carve-Out Transaction?

A carve-out is a process in which a business separates (or carves out) a minority ownership stake in a subsidiary to an outside investor, such as another business. Carve-outs frequently take place when companies want to leverage a non-core part of their business and use the equity for other purposes.

While carve-outs allow the company to reap benefits from a non-core asset, they can pose challenges. Potential buyers may see carve-outs as riskier than other types of deals. They may view the deal as having fewer opportunities than standalone deals.

Carve-Out vs. Spin-Off

Spin-off deals are similar to carve-outs. In some cases, these are lumped in with carve-outs. Let's highlight how these deals differ from one another to make the carve-out procedure clearer.

In a carve-out, the parent company targets a new buyer. It does not seek to sell ownership stakes to existing partners or stakeholders.

In a spin-off, companies transfer shares to their existing shareholders, rather than seek new buyers.

How a Carve-Out Works

Before we examine the value and challenges of carve-outs, let's explore in detail how these transactions work.

Let's say a company has identified a non-core business element that is suitable for a carve-out. The company would separate that part of the business into a subsidiary. Then the company would conduct an initial public offering or IPO to sell shares of the subsidiary. These sales would deliver an influx of equity to the parent company, which could then use the capital to fund core aspects of the business.

Speed is essential when it comes to a successful carve-out. Buyers and sellers both know that the carved-out portion of the business is not an area of focus for the seller. If the process languishes, the carved-out asset may face headwinds in the market.

When the transaction is complete, the carved-out asset is a standalone entity that must file its own financial statements. While it has its own board of directors and is an independent entity, the parent company still has ownership interest and can offer management and support.

The Value in Carve-Outs

While carve-outs have their challenges, as alluded to above, when done well they can be beneficial for both the parent company and the new entity. Here are three ways a corporate carve-out can be beneficial for both sides.

  • Separate Funding: Some carved-out companies find it easier to secure financing as separate entities. This is particularly true when smaller companies break from larger companies, since smaller companies tend to be looked on favorably by funders.
  • Strategic Alliances: The subsidiary company may be able to partner with companies that are direct competitors to the parent company. This can lead to new strategic alliances for the subsidiary that the parent company would be unable to form, due to its direct competition with those partners.
  • More Access to Suppliers and Customers: Subsidiaries enjoy greater success connecting with customers and suppliers because there are often fewer conflicts of interest, as alluded to above.

Carve-Out Due Diligence

Due diligence is an important part of any M&A deal, so it should be no surprise that carve-outs require significant due diligence. Let's take a quick look at how to undertake M&A due diligence for carve-outs.

As a refresher, due diligence requires the seller to gather comprehensive business records, including:

  • Financial statements
  • Tax information
  • Legal information
  • Tax forms
  • Intellectual property
  • Business operations documentation
  • Human resources information

These documents paint a comprehensive picture of the business's health, its relative strengths and weaknesses, and opportunities for a potential buyer.

Within the due diligence process, sellers should strive for transparency. They may seek to compare the subsidiary with market competitors to better paint a picture for potential buyers through benchmarking, case studies and the like.

Since carve-outs can be difficult to sell, sellers will want to be organized and proactive when it comes to due diligence. The last thing a seller wants is a delay because the buyer is unsure about the opportunity, or cannot easily find needed information. Because the due diligence provides a clear understanding of the business's value and potential risks upfront, it can speed the negotiation process and ultimately help the deal conclude within a speedy timeframe.

The Carve-Out Process in Mergers and Acquisitions

Now that you have a better understanding of how carve-outs work, let's look at the carve-out in M&A deals.

Carve-outs are among the more complex types of M&A deals because the subsidiary needs to be cleaved off the parent company. Thus, it's essential to stay organized.

Virtual data rooms can help both sides stay organized by providing a central repository for all documents related to the deal. Since virtual data rooms are highly secure, there is peace of mind for both sides.

Along with a data room for organization, companies should have a clear timeline going into the process, with significant milestones identified. Taking these steps at the outset can clarify the path for stakeholders and keep everyone accountable as the deal moves forward.

A carve-out M&A is more complex than other deals, but it can bring rewards for both sides. Understanding how a carve-out works in contrast to similar types of business transactions help ensure you are thoroughly prepared for the modern dealmaking landscape. Preparedness helps prevent the types of setbacks that can delay a time-sensitive deal such as this one. When it comes to preparedness, seek trusted business partners that can support your needs with world-class assistance and leading-edge technologies, such as DFIN.