M&A Vocabulary – Experts explain: Carve-out

If due to a strategic reorientation such a corporate group contemplates a non-organic change, e.g. by way of an M&A transaction, it may become necessary to split conglomerates that have developed into an organic whole and to transform their components into stringent, economically homogeneous structures.

The process of separating a business unit to consolidate it into a legally independent entity or a group of entities is called a "carve-out". Depending on the complexity of steps required for such process, the costs of tax and legal planning and implementation are substantial. However, the goal is to maximise the proceeds realisable from a transaction or flotation through clear structuring and focussing on a specific line of business.

But besides the above-mentioned business reasons, a carve-out may also become necessary to minimise risks in the course of a transaction: for example, currently, the risks potentially associated with doing business in Russia may outweigh the profit realisable or realised there, so the buyer may demand that the business divisions involved in such business be excluded from the transaction.

Apart from the legal and tax matters that have to be remembered when preparing and carrying out a carve-out, it is also necessary in each case to consider in advance the following purely organisational and practical issues: For example, to create a cost-efficient and transparent corporate governance system, numerous group-wide processes and centralised solutions, in particular in the area of IT and data processing, have been implemented. In order to prevent one transaction party from accessing relevant business information of the respective other deal participant after the separation of the business units as part of a carve-out, it may be required to apply very time-consuming and cost-intensive measures to separate the systems. 

Likewise, a carve-out of individual divisions from a group-wide value chain may lead to a loss of synergies (e.g. because of a decrease of purchase volumes) or significant delays in project implementation if there are problems with finding an alternative supplier or the new supplier needs to obtain relevant certificates. As a rule, the parties bypass such difficulties by concluding a Service Level Agreement (SLA) to continue the existing supply relationships on the previously agreed terms and conditions for a fixed minimum period. This enables the buyers to find appropriate alternative contracting partners and thus to secure their business operations without relying permanently on the other transaction party.