M&A Vocabulary – Understanding the experts: “Carve-out”

Despite the ever-increasing globalization of the economy and the internationalization of markets, companies are still confronted with a “local content” requirement regarding their presence in the individual regions or even countries in which business relationships are to be established or expanded. As a result, globally active corporate groups have emerged in many areas, bringing together a wide range of economic activities under one roof. However, it is not always possible to maintain strict legal separation of the individual business lines into different legal entities.

If such a corporate group, due to a strategic realignment, is considering an inorganic change – for example through an M&A transaction – it may become necessary to break up organically grown conglomerates and transfer them into coherent, economically homogeneous structures.

This process of carving out parts of a company and consolidating them into a legally independent entity or group of companies is referred to as a “Carve-out”. Depending on the complexity of the steps required for the disentanglement, the costs associated with tax and legal planning and implementation are significant. The target, however, is to maximize the proceeds achievable in a transaction or an IPO by creating a clear structure and focusing on a specific line of business.

In addition to these economic reasons, a Carve-out may also be required in the course of a transaction for risk-minimization reasons: for example, the risks potentially associated with business in Russia may currently outweigh the income generated or achievable there, which can then lead to a buyer demanding that the parts of the company involved be excluded from a transaction.

In addition to the legal and tax issues involved in preparing and carrying out a Carve-out, the purely organizational and practical problems must also be considered in advance: to create cost-efficient and transparent business conduct, group-wide processes and centralized solutions – especially in IT and data processing – have often been implemented. To avoid granting competitors access, after a separation of business units as part of a Carve-out, to relevant economic information of the respective other market participant, very time-consuming and cost-intensive measures to separate the systems may be required.

Likewise, separating individual areas from a group-wide value chain can lead to a loss of synergies (as purchasing volumes are split off) or significant project delays if it proves difficult to find an alternative supplier and, if necessary, have them certified. As a rule, the parties address this by entering into service level agreements (SLAs), under which existing supply relationships are continued for a fixed minimum period on pre-agreed terms. This enables buyers to find alternative contracting partners to ensure business operations without permanent dependence on the other party to the transaction.

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