An “Eyes-Wide Open” Approach Engenders Carve-Out Success
Carve-out businesses can offer significant performance upside for a new owner. However, they are typically challenging in the first 6-18 months due to the unique complexity of separating from the seller and integrating into the buyer's business. The newly independent company must extricate itself from the parent company and become fully functional in a short period of time. Without the parent company's governance, processes and expertise, the carve-out may face unanticipated issues across its value chain. It may not have the requisite talent, processes or technology to operate effectively on Day 1 and deliver the projected performance improvement.
It is vital to strive for early recognition of issues and drive swift action/investment to overcome them. Otherwise, there could be significant risk of adverse business impact. This separation process can take anywhere from 3 - 18 months depending on complexity. In addition, the buyer and management teams need a clear view of how to achieve full potential performance.
Critical Success Factors
Across all types of carve outs, there are certain critical success factors which improve the speed and performance outcomes of separation and integration and enable full performance upside.
1. Prepare for a new way of working
Before a deal is signed, both parties are equally inclined to work towards a successful carve-out. However, once the deal is completed, the seller and buyer need to prepare for new ways of collaborating. The relationship will become more transactional with a supplier-customer feel. Deal teams should write governance structure into their transition service agreements (TSAs) - milestones, meeting cadences, contact points, etc. to head off discord and hold the seller to account for delivery of key separation milestones. To successfully navigate conflicts that arise between the seller and the carved-out entity, someone neutral besides the seller's CEO or CFO must own the conflict resolution process. The new company should designate an impartial party to facilitate disagreements and ensure a smooth transition.
2. Focus on talent
A concerted emphasis on the people side of the deal from diligence through the first year is crucial. Leaders transitioning with the carve-out may not be the right fit to drive the business, even in year 1. At least one of the top 3 executives in the carve-out, ideally the CEO or CFO, should be an outside hire with prior experience in a PE-owned business. Some members of the new company's management team must have experience running a full enterprise, not just a division. Divisional roles lack exposure to certain instrumental skillsets (e.g. debt and working capital management for a CFO). The management team requires "heavier weights" all around with broader operational experience to reflect the complexity of moving quickly from separation to performance improvement. Finally, within the first 6 months, the new company’s leaders should prioritize culture and organizational assessments, including understanding the talent at middle management levels, to build out the most effective workforce strategy.
3. Establish proper governance to closely manage the business transition
An exhaustive capability assessment must be undertaken during diligence to review future capabilities required in the new organization, including value levers in IT, finance, sales, pricing, and digital. Once the deal is completed, new leadership should outline a comprehensive transformation plan addressing gaps flagged during diligence. Establishment of a governance process with KPIs that drive gap closure unifies the leadership team, provides visibility into problem areas, and enables rapid action to resolve issues before they become insurmountable. Aligning the equity incentive plan to achievement of the transformation plan facilitates execution. Appointing a neutral executive to run the transformation lends objectivity to the process.
4. Remember to focus carefully on the separation process
Before the new business can focus on future growth, there are two important milestones to navigate: “Day 1” operations, where the business will run independently of the seller (with some TSAs in place) and “Day 2” independent operations where the TSAs are exited. The primary success measure for both milestones is smooth operational running. IT should be included across all processes, not treated as a separate workstream. Adequate time must be taken to ensure finance and operations are disentangled and able to operate independently. It may prove beneficial to appoint a transformation lead or leverage an experienced consultant for a meticulous reckoning of action items. Their expertise in managing complex divestitures can identify potential pitfalls and ensure a seamless separation from the parent company. A diligent, cross-functional approach will ensure the carve-out operates as a fully self-sufficient entity.
Bringing it to Life: Case Study
One of our UK-based portfolio companies, a global assurance provider, recently underwent a carve-out. Given the legal complexity of the transaction, the period between sign to close was longer than usual. We used the time to progress both readiness for separation and the performance improvement plan. VA advisors were deployed to advise management on how to tackle the complexity. As neutral experts, this was welcomed by management and by the seller since much of the guidance was also helpful for separation activities. Specifically this included:
1. Governance, planning and risk management of separation
- Governance best practice to ensure management were formally validating the quality and timeliness of separation activities delivered by the seller and assessing their own progress and capability to prepare for day one separation.
- Proactive risk reviews of the separation, identifying risks and remediation which were then proposed and accepted by the seller.
- Creation of detailed plans for all separation activities which were accepted by the seller.
2. Talent assessment and operating model design aligned to the post carve out strategy
- External parties supported management with an independent assessment and coaching.
- Resulted in clear roles, KPIs, leadership development gaps, and succession plans.
3. Creation of a detailed performance transformation plan
- With support from VA advisors, a new Chief Transformation Officer and interim CDIO.
- Worked on the strategy and detailed execution including risk assessment of in-flight projects which needed remediation and previously unidentified short-term wins.
- Rapid response to specific challenges arising, providing expertise and know-how (e.g. outsourcing contracts, net revenue management improvements, technology choices).
- Enabled management to start executing before closing, making progress in year one against all aspects of the long-term plan.
This approach achieved the carveout to independent business transition with minimal disruption.
Conclusion
Entering a carve-out transaction with eyes wide open shortens the transition and builds the capability necessary for the new company to achieve its business aspirations. Adherence to the critical success factors delineated above will render the process smoother from the outset. Our VA experts support deal teams and affected companies to ease this transition period and unleash the value creation promised in the carve-out thesis.
