Companies are sometimes approached by interested parties that want the company (i.e. “Seller”) to sell a segment because there is an interested buyer on the other side.
WHILE A CARVE-OUT COULD CREATE VALUE FOR BOTH SIDES, CORPORATE SELLERS SHOULD TREAD CAREFULLY WHEN EMBARKING ON THE EXERCISE.
On one hand, for the Seller, the rationale for the transaction could be better focus on the core business and the ability to generate cash that could be used for other purposes.
However, on the other hand, there are many costs associated with a separation, that could add up quickly and leak value.
Based on my work with prior such transactions, here are a few observations and things to watch for.
For clarity, in the below:
“Seller” represents the corporate selling a piece of the business
“Segment” represent the portion of the business being sold, and
“Buyer” represents the acquirer of the Segment.
1) OPERATIONAL AND TRANSACTIONAL COSTS ADD UP QUICKLY
From an Operational perspective, nearly every aspect of the Segment’s business needs to be carved out – people, technology, process integrations to the rest of the Seller’s company, as well as contracts with suppliers and customers.
From a Transactional perspective, the financial costs (due diligence, QoE) and legal costs (contracts, negotiating the agreements) are usually the biggest expenses. These costs can be as high as as 5% – 7% of revenues (or higher, for especially complex businesses).
2) TRANSITIONAL SERVICES AGREEMENTS (TSAS) CAN BE USED PROVIDE INTERIM SUPPORT TO THE BUYER
The Seller typically agrees to provide some interim support to the Buyer (the TSA) so that the Segment’s operations are not disrupted.
Generally, this relates to back office functions such as finance, marketing, procurement / supply chain, and the agreements can go from 3 months to as long as 1-2 years post close.
The TSAs are heavily negotiated, but even after recouping costs, the Seller’s management team is still burdened with administering this support and this can distract them from running the rest of the Seller’s business.
3) THE SELLER’S BUSINESS MIGHT HAVE STRANDED COSTS THAT ARE HARD TO MEASURE AND REDUCE
During the TSA period, the Seller has personnel who are responsible for providing the interim services to the Buyer.
It can be difficult to objectively measure how much time the TSA team is working on the Seller’s residual business vs. on providing TSA services to the Buyer.
And in order to keep the TSA team motivated, the Seller also needs to factor in additional short term incentives, such as a retention bonus.
As described above, the carve out process can be expensive both in terms of financial as well as operational overhead.
And its important to not let the headline transaction value not distract the Seller from the work involved in the execution of the divestiture.
SELLERS WHO ARE PURSUING A CORPORATE DIVESTITURE CAN ALLEVIATE SOME OF THESE ISSUES BY:
1) SETTING A CLEAR BUDGET AND FINANCIAL CONTROLS TO MANAGE THE ONE-TIME (LEGAL AND OPERATIONAL) COSTS, THE TSA SERVICES AND POST-TSA COST STRUCTURE
Investing in a Transition Management Office (TMO) helps, especially if the Seller believes that future segment sales could occur.
The TMO can generates accountability, enables nimble decision making related to transition budgets and controls over-spending
2) TAKING A PROACTIVE APPROACH TO REDUCING STRANDED COSTS AND DIS-SYNERGIES
The Seller should set in place clear direction for the TSA team pre- and post- TSA, and keep the TSA team engaged in the core business by providing them opportunities for advancement once the separation is complete.
The Seller should also factor in dis-synergies (from loss of scale post close) into the valuation… and continue to proactively correct for this (by structuring new agreements) as the transaction moves to a close.