If you’re new to the complex world of M&A strategy, then you may not be familiar with the concept of carve-outs. However, the truth is that this could be an option for you to consider in the future if you’re looking for innovative ways to generate additional value for your business.
Eager to find out more? Then read on, as in this illuminating guide, we’ll be shedding light on carve-outs, what they are, how they work, and their pros and cons. Hopefully, by the time you reach the final paragraph, you’ll be able to judge for yourself whether a carve-out strategy could be a ‘yay’ or a ‘nay’ for your company.
What are carve-outs anyway?
As the name suggests, a carve-out is when a parent company decides to sell some of its subsidiary shares via an initial public offering (IPO), creating a separate entity with its own board of directors and both new and current shareholders.
This brand-new entity will have its own business strategy and its own financial statements, but it will not be entirely separate as the parent company will still have a majority share.
How is a carve-out different from a spin-off?
If you’ve heard of spin-offs and you’re wondering what the difference is between these two, it’s quite simple. A corporate carve-out will include new shareholders among its owners, whereas a spin-off involves the same essential process of creation – but the entity remains governed by existing shareholders from the parent company.
How is a carve-out different from a divestiture?
Anyone familiar with the idea of a divestiture may think that a carve-out is the same thing. However, there are some crucial differences between the two, not least their connotations.
Most crucially, a divestiture involves the complete sale of an asset by a parent company, with the sold-off entity acquiring entirely new owners. This sale could be due to several reasons, but it tends to be a sign that the subsidiary isn’t performing as well as it should be, or perhaps its brand values no longer align with that of the parent.
Hence, divestitures tend to come with negative connotations as opposed to carve-outs, which carry some merit as the parent company retains some ownership and can gain fresh value from the creation of the new entity.
The benefits of this M&A strategy
Speaking of value, let’s shine a spotlight on the ways in which carve-outs can generate value, both for the parent company and the newly formed entity.
1. Access to a broader supplier and customer base
When a carve-out breaks away from a parent company, it can go on to gain a stronger market foothold and benefit from greater exposure to investors, suppliers and new customers.
This newfound autonomy and flexibility can, in turn, help it to boost its revenue, attract new talent, and bolster its unique reputation.
2. Reduced risk
One of the biggest advantages of a carve-out – for the parent business, at least – is the reduction in risk it will enjoy as a result. This is particularly true if the carved-off subsidiary operates in a very different market from the main business, or perhaps occupies an environment governed by entirely different regulations.
By separating the subsidiary from itself – while retaining partial ownership – the parent company can also reduce its own risk of incurring liabilities or draining its own resources. What’s more, creating a carve-out will free up additional finances and other resources for the parent company to put to good use elsewhere, maximising its own value while also benefitting from any achievements the new entity goes on to make.
3. Independent financing
When a new entity is created via a carve-out, that new business becomes open to a broader range of possibilities, including more diverse financial options.
For instance, the newly formed entity can opt to pursue independent financing for product lines or services that the parent company may not have wished to finance itself, and this flexibility can work wonders for its efficiency – not to mention its profitability.
And the downsides…
Of course, every coin has two sides and carve-outs do have their drawbacks for both the parent company and the subsidiary. Let’s explore what they are, so you have a more balanced picture of how carve-outs work and whether it would be an option worth exploring in future.
1. The potential for conflict
While giving a subsidiary more independence through selling some shares can bring benefits to the parent company, it also comes with a sudden and unsurprising lack of control over the subsidiary’s future operations.
As a result, the parent business could possibly find itself having to compete with its subsidiary for suppliers and customers – not to mention losing access to its resources, talent, and even its corporate culture.
With this lack of control and possibly competitive new relationship, there lies the potential for conflict, so it’s important to factor this into your decision-making if you’re pondering the value of a carve-out.
2. Heightened pressure for the new entity
Becoming a new stand-alone entity – even if the parent retains some ownership – can bring with it some significant pressures for the subsidiary and its leadership team.
After all, it will have to work hard to forge its own reputation, develop its own market foothold, and meet the requirements of both regulators and its new public shareholders.
This level of pressure is a crucible in which poorly put-together entities can burn up and eventually fail. As a result, it’s important to work hard in those early days to create a robust new business that can weather those initial difficulties and make it out the other side a stronger and more resilient entity.
How to maximise a carve-out’s chances of success
As you can see, there are significant pros and cons to weigh up when it comes to the matter of carve-outs.
The good news is that there are several steps you can take to maximise the success of this kind of M&A undertaking if you do decide to go ahead.
1. Set clear goals
Having clear achievable objectives in place should be the first task to complete on your carve-out ‘checklist’.
This is because carve-outs are a particularly complicated M&A process, certainly not to be entered into lightly, so having those goals in place to serve as a roadmap can really help your company stay on track as you begin the transaction.
2. Do your due diligence
Just as with mergers and acquisitions, it’s important to dedicate time to due diligence before you begin the carve-out. This includes working out exactly what it will cost you, compared to just making some alterations to your current methods of operation, and what value it will bring you in the long-term.
You also need to explore the various potential disadvantages, such as whether a newly created entity could have a negative impact on the parent company’s market standing.
3. Put a strong team in place
A carve-out can succeed or fail depending on the quality of the team you put in charge of overseeing the transaction. It’s a good idea to create a robust inter-departmental team with ties to both the new entity and the parent company. They can ensure that the process runs smoothly, and they can help to minimise any problems that may arise as the subsidiary branches off.
It’s also a good idea to have experienced professionals in place to help you manage the carve-out effectively. This should include M&A experts, as well as financial and legal professionals who can ensure you tick all the right boxes. Expert advice will be invaluable when it comes to navigating this complex process.
Final thoughts
So, there you have it – an in-depth introduction to carve-outs, their pros and cons, and some top tips on how to do it right.
As you can probably deduce by now, carve-outs can be a tricky form of M&A strategy to pull off, and they’re not suitable in every situation. However, if handled correctly, a carve-out could be a rewarding way to maximise your company’s value while streamlining your operations.
That’s right – with rigorous research, careful planning, and a stellar team in place, a carve-out could be a winning decision for your business.
