Why Carve-Outs are Ideal for Private Equity, Family Offices

When an operating unit is no longer strategically important to a company’s overall direction, a carve-out sale may be in order.

In today’s market, private equity and family offices are eagerly pursuing these deals to capitalize on the untapped potential of carve-outs. Over the past 10 years, private equity firms alone have undertaken 463 carve-out deals worth $68.5 billion, according to an E&Y report, and we find the middle market is ripe for this type of transaction.

When Carve-Outs Make Sense

In a survey of business executives by Deloitte, 66% said the primary motivation for a carve-out was that the unit was not central to the overall business strategy. The second most common reason to carve out an operating unit is to generate additional capital, often to pay down debt or improve the company’s financial position.

From a buyer’s perspective, carve-outs represent high-potential businesses just waiting to be maximized. Often, a carve-out’s customers, suppliers, and managers are already in place.

At Copper Run, we are well versed in advising both buyers and sellers with carve-outs transactions. We recently assisted a large metals manufacturing company with the carve-out of an agriculture and oil-and-gas tank manufacturing segment that was non-core to overall operations. Like many carve-out deals, this proceeded more quickly than traditional M&A deals, taking only a matter of months.

Executing Carve-Outs

Although carve-outs can proceed quickly and prove beneficial to both buyers and sellers, they are not always simple.

From a seller’s perspective, selecting the right buyer is critical. Among factors to consider are the buyer’s ability to secure financing, the offer price and the amount of upfront consideration.

Integration also can prove more challenging than in a traditional M&A transaction. The key is having a detailed Day One strategy. For a buyer, this means first and foremost knowing exactly what you are getting, from executives and employees to customers and suppliers. There should be a strategy to analyze sales and costs, and to add value right from the start.

Buyers should consider how they will bring value to the carve-out, and think about what legacy functions—information technology, human resources, enterprise resource planning—the carve-out still relies on.

Management and culture should not be overlooked in these transactions. For instance, employee morale can be affected by the transition, as they try to align with the buyer. To help organize your Day One game plan, McKinsey suggests analyzing four key areas: people, processes, platforms, and places.

Communication is critical throughout the process, especially during the transition period in which the carve-out still relies on functions of the seller. Transitional Service Agreements are helpful, allowing for a period in which the seller supports the buyer, and vice versa, after the deal closes.

Of course, it helps to know what to avoid. Deloitte surveyed businesses and found the following challenges were most likely to derail a deal:

• 67% could not obtain the price they sought

• 38% said the buyer reduced the terms during negotiations

• 33% could not find a buyer

• 32% said the buyer was unable to come up with funding

• 22% reported a change in their financial situation

• 14% retained for strategic reasons

• 14% retained due to a potential negative reaction

• 11% cited inadequate due diligence

• 11% said it was too difficult to unwind

Partnering with an Advisor

Buy-side advisors are instrumental in that they bring proprietary deal flow of carve-out opportunities, which may not be publicly available for sale.

From a sell-side perspective, advisors will be helpful in properly valuing carve-outs—which often lack their own financial statements—and managing a convoluted process that can be more complex than traditional M&A deals. Some sellers may even get the initial idea for a carve-out from their sell-side advisor.

In addition to transaction advisory services, carve-out deal participants should consider seeking professional services to advise on legal negotiations, conducting a carve-out audit, assisting with tax structuring, and conducting sell-side due diligence. Deloitte found that only 10% of firms surveyed did not use professional services or advisors for carve-outs.

Copper Run can answer any questions you may have regarding the carve-out process, from either a buyer’s or seller’s perspective.

Andy Hays is President and Co-founder at Copper Run. He oversees firm strategy, operations, client services, and business development.