These can help streamline business, raise capital, or meet regulatory requirements
Carve-out transactions may represent unique opportunities for established businesses to streamline their operations, raise capital through the monetization of non-core assets, or meet regulatory requirements of a more extensive merger. Still, they also present unique challenges, say Sophie Lamonde and Olivier Godbout of Stikeman Elliott LLP.
They can be smaller transactions that are not necessarily part of a firm’s core business, “but that doesn’t make them less complex,” says Lamonde, who practises in Montreal along with Godbout.
Godbout agrees, saying that these carve-out transactions can often be a bit like “unscrambling an omelette,” as even a non-core asset can still be well integrated into the fabric of a company when it comes to areas, for example, like human resources.
The two say that carve-out transactions, which they have seen rising as more consolidation takes place in Canada and globally, calls for specialized professional advice and careful planning. They add that carve-out transactions inevitably need to address items such as shared services or commercial arrangements and contingency plans for assets or liabilities that end up in the “wrong pocket” post-closing.
A “carve-out” transaction usually involves the sale of a specific business line, unit, or division, says Lamonde. While these transactions can take many different forms, from divestitures of entire business segments to sales of single brands, the defining feature of a carve-out transaction is that the assets to be sold are partially integrated into the operational structure of the seller and its related entities.
Godbout agrees, saying current market conditions lead many companies to take a hard look at their business and adjust their strategic focus or seek new capital to adapt to new realities. On the buy-side, Lamonde says private equity has a lot of “dry powder” to make acquisitions, especially in a low interest-rate environment.
As for strategic players, Godbout says both buyers and sellers see an increased need or opportunity to make deals involving carve-out transactions. “We expect there will be many opportunities for carve-out transactions in the near to medium term,” says Godbout.
Lamonde notes that carve-out transactions require significantly more preparation and larger internal and external deal teams than other M&A transactions.
It is essential to identify potential issues from the outset to develop workarounds. If not resolvable, Lamonde says, the trick for the seller is to manage any impact on price by properly disclosing any identified issues.
Certain types of issues, like how paternity leave is dealt with by the new owner compared to the previous owner, must be well understood. There might be significant differences that management will need to communicate to the employees, or their unions, on any possible impact. If it is a cross-border deal, the laws governing certain practices might be different in the acquiring company’s home country than in the seller’s home country.
On the buyer side, Godbout says it is crucial to plan for purchased asset integration and its impact post-closing. “Having a comprehensive view of the carve-out and how the buyer can efficiently integrate the carved-out business in its structure is the only way to ensure that the deal delivers on its promise.”
How carve-out assets and related liabilities fit within the existing corporate group will impact the transaction structure. Business continuity needs, tax planning, existing integrations, potential synergies and required third-party consents and governmental approvals will also affect the deal.
Lamonde also notes that often deals that come out of carve-outs involve a longer-term relationship between the seller and the buyer than typical M&A transactions. “So, special consideration should also be given to building an efficient working relationship between the parties at the table.”
Typical areas of “friction” in carve-out transactions include:
- Financial statements: In addition to a long lead time item and complex accounting considerations, carve-out financials can directly impact transaction valuations and are subject to increased scrutiny. Representations and warranties regarding carve-out financial statements also require special attention.
- Transitional services agreements: These are a regular feature of carve-out transactions and can be vital to the buyer supporting its valuation, achieving business continuity, and successfully integrating the carved-out operations. While the purchase agreement drives the headline numbers for the transaction, the TSA can significantly impact the bottom line for both sides. Leaving negotiation to the last minute can create uncertainty and risk.
- Employees and employee benefits: In addition to agreeing on the universe of transferred employees, the buyer and seller need to allocate responsibility for any obligations, such as severance payments, arising in connection with employee transfers in the transaction. Other areas of potential HR-related issues in carve-out transactions are tied to the requirement that the buyer offers substantially similar benefits to the transferred employees post-closing.
- Intellectual property: Untangling IP rights between various business units can require considerable due diligence and planning and can create significant roadblocks if critical items cannot be effectively delineated or shared post-closing.
- Ongoing intercompany arrangements: Carve-out assets typically derive a significant portion of their value from favourable terms within the seller’s vertically integrated supply chain. Careful consideration of the parameters for the ongoing post-closing participation in that supply chain is needed. It may significantly impact the deal’s valuation, especially when the buyer does not have an existing or comparable infrastructure.
- Real estate: There may not be a clear real property division between the carved-out and retained business units. The most straightforward solution from the seller’s standpoint may require the buyer to relocate the carved-out business. However, this can be a significant source of business disruption and create valuation issues, such that complex co-ownership, leasing or subleasing arrangements may be necessary.
Lamonde and Godbout say that buyers and sellers shouldn’t shy away from a transaction that makes good business sense despite their potential complexity. Says Godbout: “It’s all about the planning and getting the right expertise.”