Carving out a smaller entity from a larger one can be a unique strategy to unlock value for stakeholders and investors. During a carve-out, a new, independent entity is created that can focus on a specific product, market, or niche. This leaves the parent company free to prioritize its core business or pursue other avenues for growth. But while these transactions carry significant upside, they are also highly complex to navigate.
Separating one company from another involves disentangling people, operations, and legal structures that have likely been blended together for years, if not decades. Navigating this process is difficult, and if you’re pursuing a carve-out, we’d recommend contacting the team at Acquinox Advisors directly for personalized advice.
Otherwise, let’s explore the most common challenges and success strategies when pursuing a carve-out.
What is a Carve-Out
A carve-out is a partial divestiture of a business unit in which a parent company sells a minority interest of a subsidiary to outside investors. The parent company does not sell the business unit outright, but rather, it sells an equity stake in that business while still retaining a controlling interest. The new company then takes on its own board of directors, financial statements, and strategic direction.
Carve-outs are similar, but slightly different from spinoffs. A spinoff creates an entirely new, independent company by distributing shares of the new entity to existing shareholders (not new ones), and the parent company usually doesn’t retain an ownership stake in the new business.
Carve-outs surged in popularity at the turn of the decade, and data from Harvard Law School shows that 9,155 carve-outs were conducted in 2021, up 67% from 2020. Carve-outs will likely continue to grow in popularity, based on the current European M&A outlook for 2025.
Challenges With Carve-Outs
Carving out an entity is highly complex, and there are five common challenges associated with carve-outs:
- Assessing a Fair Valuation: Determining the fair value of the entity being carved out is exceedingly difficult, as there are many factors to consider. This process usually requires a detailed assessment of the company’s financial statements and growth projections. If you need help valuing a company during an M&A transaction, please explore our AI Valuation Tool. This tool leverages artificial intelligence to provide trustworthy valuations in minutes.
- Obtaining Legal and Regulatory Compliance: Carving out an entity also sparks a number of legal and compliance issues to ensure that the new entity is properly registered and compliant with all laws and regulations.
- Separating Systems, Products, and IT Infrastructure: Carving out a company also involves separating IT systems, operational systems, and manufacturing capabilities so that the new company can properly stand on its own. The parent company will also have to determine which products, intellectual property, trademarks, and copyrights it wants to retain, and which ones will now belong to the new entity.
- Maintaining Optimism and Momentum: The uncertainty surrounding a carve-out can be stressful for employees and stakeholders as the new company must prove that it can be a successful, viable business by itself. It’s important that the parent company helps maintain optimism and momentum throughout this process, especially among key personnel.
- Financing: The newly carved-out entity may require financial support from its parent company, an outside investor, or a lender, at least for a short period of time. Obtaining this financing from an investor or lender can be tricky, as the new business may be relatively unproven and, thus, unable to get approved for financing.
Strategies for Success
Carve-outs create an opportunity for superior returns for investors, as they can gain access and infuse capital into assets that may have been underappreciated when part of a more diversified organization.
Experts suggest three strategies for success for investors pursuing a carve-out:
- Structure Creatively: There is an almost unlimited number of ways that companies can be structured or positioned. When considering a carve-out, it’s important to start by identifying the people, processes, systems, and assets the carved-out entity will need to operate independently and structuring these assets in the most effective way. This helps reduce post-close disruption and prepares both the seller and buyer for a clean separation.
- Move Quickly: Moving through the carve-out process quickly can be crucial in building and maintaining momentum for investors, stakeholders, employees, and customers. A quick carve-out process can be a sign of excitement from leadership, which is reassuring for everyone involved in the process. However, speed does not mean that diligence should be sacrificed, which is why it’s so important to work with a team of experts who know how to navigate these types of transitions.
- Engage Multiple Teams: Successful carve-outs require close coordination across legal, finance, HR, and operations. Involving cross-functional teams early helps identify separation risks, avoid hidden interdependencies, and ensure that nothing critical falls through the cracks.
Final Thoughts: Carve-Outs in M&A
A carve-out can be a powerful tool to unlock value from a large, diversified organization by creating a new, independent company that will not just survive, but thrive on its own. While there are significant challenges in identifying and completing this process, companies that successfully navigate a carve-out will position both the parent and divested entities for long-term growth and success.
If you’re planning to pursue a carve-out, merger, or acquisition, then please contact the team at Acquinox Advisors today. We specialize in providing cutting-edge M&A advisory services with a strong focus on the rapidly evolving technology sector.
We hope that you’ve found this article valuable when it comes to learning the challenges and success strategies associated with carve-outs – thanks for reading!
