Navigating the Challenges of Divesting a Business
When a company decides to sell part of a business, the complex separation process often requires much more preparation and resources than sellers expect. Effective planning and strategic consideration around the structure of the deal and the required financial statements are imperative.
At a High Level
The divestiture of a subsidiary or business unit often requires a company to prepare separate, stand-alone financial statements of the operations being sold. Preparing these ‘carve-out financial statements’ is a critical step in the divestment process, providing buyers with information to satisfy financing or compliance requirements as well as giving buyers confidence that the business has been properly prepared for separation.
Frequently, these historical financial statements for the operations being sold do not exist or may not completely reflect the total cost of doing business as certain assets may be shared among business units, and the associated costs are not always allocated to each subsidiary. The complexities and judgements involved in preparing these financial statements are significant. Sellers should ensure leadership is aligned regarding the parameters of a potential deal and be prepared to navigate the challenges of both preparing financial information specific to the objective of the transaction and efficiently separating the business from the larger entity.
Defining the Perimeter
Carve-out transactions can include multiple entities and business operations. Depending on the circumstances, determining which operations and business units can be a strategic and fluid process. The components that make up the carve-out entity are defined as the ‘perimeter.’ The following questions highlight key considerations to identify what is included in the transaction:
- Does the perimeter represent a stand-alone legal entity (or group of legal entities) or does it consist of operations spread across multiple entities within the organization?
The perimeter of the carve-out company, whether a single entity or operations within multiple entities, has a direct correlation with the amount of work to prepare accurate financial information and carve out the business.
- What is the tax structure of the transaction?
Weighing the benefits of a stock versus asset deal and considering various tax planning strategies is important for both the seller and the buyer in order to maximize return on the carve-out business.
- Does the carve-out business have its own management team, employees, and systems or are they shared among other businesses?
Determining whether there are stand-alone systems in place and having a set of employees and/or a management team with knowledge of the business are important factors in selling the carve-out company to ensure consistent operations are maintained through the transaction process. Additionally, the treatment of compensation, including, but not limited to, payroll, benefits, and pension can increase the complexity of the transaction.
- Is the perimeter expected to be fluid throughout the course of the negotiation process?
This fluidity can happen when a company is considering a ‘dual-track’ strategy to explore the sale or spin-off of a business simultaneously. In these instances, a best practice would be to design a flexible process to allow a refresh of data in a consistent manner for the required time periods.
Based on the nature of the potential transaction, prospective buyers may require financial information to be prepared in different formats. The company can prepare this information to attract interest from a wide range of buyers, as appropriate. The following questions will help define the financial information necessary to present the business in the best manner and to accelerate the process to closing:
- How is information recorded in the system of record?
The level of detail at which financial information is available will directly correlate with the amount of work needed to prepare and present financial information for the divestiture. If information is recorded at a higher or more consolidated level, some amount of rework to record the information on a more detailed basis will be necessary.
- How many historical periods are available and how many are appropriate for presentation to potential buyers?
Typically, three years of historical financial results is sufficient, but providing more can give additional visibility to the buyer. A seller should also keep in mind the quality and relevance of historical information available. If the way information is recorded or the structure of the business has changed in recent years, presenting less information to provide comparable periods that are more meaningful may be necessary.
- What type of financial information provides the most flexibility and optionality for the divestiture?
Preparing both deal-basis financial information and audited carve-out financial statements provides the most coverage for the range of buyers. This approach allows buyers who may be financing the purchase to have access to the required information for their capital partners.
- Does the carve-out business utilize a shared service function within the organization?
If so, an appropriate allocation methodology is necessary to properly reflect the cost of doing business as a stand-alone company. The process for allocating costs to a carve-out business can be complex and tedious. Starting this process as soon as the perimeter is set is advised.
Properly separating a portion of a business which is intertwined in a larger entity is essential to both the buyer and seller. Thinking through the following questions will help avoid surprises and unexpected complications in separating the business to be divested from the remainder of the business being retained:
- How is the transition services agreement (TSA) structured?
A TSA typically outlines the services to be provided by the seller to the buyer. Depending on the complexity of the business, a TSA can remain in effect for months or years. An extended TSA period is costly for both the buyer and the seller; therefore, planning and structuring the TSA to allow for flexibility is a key consideration in the separation process.
- Has a detailed project plan for the separation been developed?
As mentioned above, a prolonged TSA period is costly for all parties. A robust project plan and a proven project manager can alleviate the complexity by giving insight and transparency to the process.
- How will the transaction impact people transitioning with the divested business or those involved in the delivery of services under the TSA
Employees frequently choose to resign when a divestiture is announced due to the uncertainty of their ongoing employment status. In order to maintain a level of service commensurate with the pre-divestiture period, a seller may want to offer bonuses or other benefits to entice employees providing the services under the TSA to remain until the TSA is complete.
- How can the divestiture be used as an opportunity to rethink the remaining business?
Some companies evaluate the efficiency of the remaining business as part of the divestiture process. This evaluation can include redesigning the operating model of the remaining business, establishing restructuring plans, planning additional asset divestitures, executing performance improvement initiatives and much more. A divestiture presents a unique opportunity to rethink the strategic vision of a company and to consider transformative projects that will realign the remaining business with a new strategic vision.
A carve-out divestiture presents unique, complex issues that are best addressed by a thoughtful and strategic process. Whether it’s defining the perimeter, determining the proper financial presentation or separating the business, being prepared and flexible in the process will maximize value and help avoid costly mistakes.