The art of the

modern carve-out
Six steps to greater value

Baker McKenzie | The art of the modern carve-out

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CONTENTS
Introduction3

01. Sellers, think like your buyer 7

02. Buyers, focus on what you want and protect it 10

03. Design a deal structure 13

04. Focus on the details with a team that knows the local market 17

05. Plan your HR strategy 20

06. Put everything together 24

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In the past four years, Baker McKenzie has worked on 149
carve-outs valued at $100 million or more. Many were
multi-billion dollar deals. This has enabled us to develop
strategies that avoid loss of value.
Your biggest concern as a seller will be how you can get the
best possible price for your asset.
As a buyer, it will be how to both avoid overpaying and taking
on lots of unknown risk.
Whichever side you are on, experience tells us there are steps
you can take to create the right circumstances for success.

You are in good company if you

are considering a carve-out

In today’s low-growth environment, corporates are under At the same time, private equity investors are taking
pressure to improve returns. Add to this activist shareholders a greater interest in buying assets that they have to
and focused competition, and the pressure is unrelenting. carve out from the seller’s business. There is often fierce
competition for standalone assets, so investors are taking
It is no surprise, then, that many corporates are withdrawing
a more creative approach to building their portfolios.
from activities where their businesses are least profitable or
where there is no longer a strategic fit. Carve-outs can unlock For corporates, carve-outs can be the ideal way to pick up
value from these non-core enterprises. specific assets, such as IP or talent, that they cannot develop
themselves. Carve-outs can also enhance market share.

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 You are in good company if you
Introduction are considering a carve-out
Number of carve-outs globally, $100M-$1B and over $1B since 2009
The overall number increases every year to 2014. Carve-outs are predominantly tactical
divestitures, which is why there have been so many more deals under $1 billion than over.

Number of carve-outs
200
Value of deals
180 $1B+
$100M-$1B
160

140

120

100

80

60

40

20

2009 2010 2011 2012 2013 2014 2015 2016

Source: Global M&A/Thomson, December 2016

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 If you don’t get it right,
Introduction value can leak
Done well, these deals can generate a lot of value. But they are complex. There are many pitfalls,
especially when the transaction involves businesses that operate in several countries.

The way the deal is executed impacts directly on the value.

Four common ways value is lost:

The seller fails to create competitive The timing may not be right, or the right information may not
tension in the sale process. be made available up front. The result is fewer bidders and lower
offers for the assets.

Suboptimal structures The price you get is inextricably linked to the tax structure you
lead to value leakage. adopt, whether you package the target in an appealing way for the
buyer, and whether you can flex the structure for different buyers.

Poor cash management leaves You need to be careful about leaving cash trapped in the
money on the table. business you want to sell. Cash is not an asset. Buyers often
discount cash that is trapped in a business. They are unwilling
to pay cash for cash.

Poor communication puts even It can be easy to underestimate the cost of not keeping
strong relationships at risk. major stakeholders well briefed. Competitors are usually
ready to step in, and reputational costs can mount up.

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Case study

Unwillingness to plan left a

seller unable to justify its price
A multinational wanted to offload its contracts maintenance services
business, which was tightly integrated in several jurisdictions. However, it
was unwilling to spend money on professional fees to plan the carve-out
before signing. This made it impossible for potential bidders to carry out
thorough due diligence.

We acted for the buyer, a private equity house. Once our client became
the preferred bidder, the seller’s lack of planning became clear. We advised
our client to seek greater protection for carve-out risk in the sales and
purchase agreement.

The lack of planning by the seller enabled us to negotiate a substantial price

cut at the last minute. The seller could not provide enough reassurance that
they had prepared the carve-out properly.

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01 Sellers, think Although you may not see a future for a particular
asset in your company, to generate serious buyer
interest and the highest price, you need to identify

like your buyer how other owners may value the asset differently.

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01 Sellers, think like
your buyer
First, decide who is likely to want the asset: Address these criteria to improve
a strategic buyer or a financial buyer the level of interest from bidders:

A strategic buyer will have an operating and legal structure

into which the target asset can be fitted. The buyer may
only be interested in IP or distribution, for example, and Set out the legal structure of the asset that
therefore be less interested in other aspects of your asset. you will market. This needs to be tested so
that it strikes the right balance between tax,
In contrast, a private equity buyer will generally look for a operational and employment considerations.
standalone entity. Private equity buyers often do not have
any infrastructure to merge the target into. In some cases, Define liability transfers: what liabilities may be
the seller has to restructure the asset before the sale, and carried over and taken on by the new owner, eg
will often have to provide long-term transitional services. future pension costs.

Being able to package the asset with the flexibility to suit Call attention to intangible assets, such as IP,
both types of buyer can help you get the best price. It define them and assign them a value.
is usually helpful to extend this flexibility to transitional Retain top talent. Incentives might include
services agreements and cost analysis. bonuses that will be paid out after the deal is
done.
Buyers that have less work to do may Define ongoing supply or distribution networks.
be willing to pay more
Identify the transitional services the target will
The easier it is for buyers to visualize the asset and how it need immediately after closing.
would fit within their portfolio, the higher the price they
are usually willing to contemplate.

Also, the more accurate and comprehensive the

information you provide, the more likely you are to
maintain buyer confidence. Information needs to be
presented in an accessible manner.

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01 Sellers, think like
your buyer
Percentage of deals, each worth $100M or above, where the buyer was a financial buyer, eg private equity
The proportion of financially-sponsored buyers has risen from 10% of all buyers in 2009 to 23% in 2016.

25%

20%

15%

10%

5%

2009 2010 2011 2012 2013 2014 2015 2016

Source: Global M&A/Thomson, December 2016

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02 Buyers, focus on As a prospective buyer, you will probably
know the price you are willing to pay for the

what you want

asset as well as your objectives for the deal.
However, you may not have considered other
factors that could affect the price.

and protect it

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02 Buyers, focus on what
you want and protect it
Winning at auction comes down Work out how ready you are to
to more than price take on the new assets

The success of your bid will also depend on your You only get the synergies if you integrate
demonstrating to the seller that you will be able to effectively, but buyers sometimes fail to factor
complete the deal quickly. integration into their pricing.

It is therefore critical to focus on the most important For example, look at the footprint of the business
issues. Too many challenges or questions can erode the by country, and identify the integration support you
seller’s confidence. have to put in place.

If you plan to close down parts of the business, you

Make the most of the vendor might have to run dual operations for a while, and
due diligence process may have to follow regulations for how you can make
cuts. These can be costly in some jurisdictions.
Detailed vendor due diligence can help your pricing
strategy. You can also identify where you might have to
defer closing, and include that in your negotiations
You should focus on the needs of your medium-term
and planning.
to long-term commercial plans, on what you need
to do to achieve these, and on the reason for your
purchase.

Look at the continuity of revenue streams, for example, Buyers often hugely underestimate the
or where the most valuable IP is registered.
cost of post-acquisition integration.
Some buyers do not make the most of vendor
They often do not leverage their due
due diligence, and repeat much of the same
work again themselves. diligence and so waste efforts at the
Front-load the work you’ll have to do later anyway. integration stage.

Peter Strivens
Partner

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02 Buyers, focus on what
you want and protect it
Shape your pricing strategy by focusing on these issues:

business shape and operations implementation

strategy
The costs and synergies with The process and costs of Where cash may be trapped
the enlarged portfolio relevant HR issues, including in the structure, working
contract renegotiations and capital and cash balances by
What the combined group
redundancies legal entity
will look like after completion
Benefits and pensions Which assets and liabilities
Transitional services that will
arrangements for the current will be included in the carve-
be needed, and their cost
workforce out, by legal entity
How you want to operate in
The internal operational Whether financing will be
the future
structure and headcount: required
number of shared resources
What might lead to delays to
and standalone teams
final completion
The legal structure

Which IP, suppliers and

customer contracts are
included or excluded, and
which contracts have to be
renewed

How difficult integration of

IT systems will be. How many
systems have to be upgraded
or replaced

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03 Design a There is always an acquisition structure that suits
both the buyer and the seller. The ideal structure will

deal structure
maximize value for you and the other party, whether
you are the buyer or the seller. It will also minimize
business disruption through the separation process.

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03 DESIGN A
DEAL STRUCTURE
Sometimes the best value isn’t the cash price: Deals are often negotiated on the basis
it’s the price and structure that works best for of a cash-free and/or debt-free position
both parties
As the seller, there are ways for you to move cash out
Tax should always be front of mind. With careful planning, of the target business: dividends, loans, and ways to run
you can minimize the exit costs for the seller and set up a down cash. Options like these take time, so start your
tax-efficient structure for the buyer. planning early.

The way in which this is done depends very much on the Any cash or distributable reserves may be subject to
existing tax structures of the buyer or the seller. foreign exchange controls in the context of a deal
across jurisdictions.
Decisions on the structure may also affect the deal
timetable, depending on any local rulings or registrations Local entities may be able to declare interim dividends.
that you need, and how long it takes to set those up. If not, there are other ways to repatriate cash.

The best legal or tax structures do not

always reflect how the business actually
wants to operate

This can present a problem. The logical way to separate, Today’s more robust tax structures
from an operations perspective, might not be the most
have to be defendable at a time
tax-efficient. Our recommendation is to try to preserve as
many of the target’s tax attributes as possible while still when laws are tougher – BEPS, for
working closely with the business to sketch this out. example – and where perceptions
judge companies more harshly.

James Smith
Partner

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03 DESIGN A
DEAL STRUCTURE
Four common ways to repatriate cash in a carve-out:

Dividends Intercompany Return of capitalize

loans capital new legal
entities

Financial information Consider local law Statutory processes, Manage cash to the
will usually have or tax issues when financial information lowest possible cash
to be prepared in making an inter- and reporting may balance.
advance. company loan. be needed.
Use cash to fund
In some jurisdictions, There may be This can be the carve-out or
there will be timing restrictions on sequenced with to capitalize the
restrictions on when borrowing under other steps, e.g. new entity.
an entity can declare the deal terms or on stock transfers.
Use letters of
a dividend. cross-border lending.
Third-party audit direction to position
There may be a lack If the loan cannot be reports may be cash in other
of distributable repaid, it could be required. jurisdictions.
reserves. repositioned within
Be aware of defined
the target group.
Interim dividends benefit pension
may be available. schemes.

Treasury can review

bank accounts,
currency trades, cash
flow planning and
working capital.

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Case study

BY ENGAGING WITH SENIOR MANAGEMENT

AT THE RIGHT TIME, POTENTIAL BUYERS CAN
BUILD RELATIONSHIPS EARLY WITH THE PEOPLE
WHO ARE BEST PLACED TO LEAD THE BUSINESS
BEING ACQUIRED
Our client – a private equity investor – prefers to pick targets that need restructuring, and that
are more complex to carve-out from the seller’s business. These deals attract fewer bidders,
and tend to be businesses that have been ignored for some time, that are under-performing
and that operate on very low margins.

Senior management can often see the opportunities to improve, especially when they are
incentivized through equity allocation or ratchets. They can make life-changing amounts of
money when the private equity investor exits.

The target’s management will sometimes get a say in the auction process. Our client engages
as soon as they can with senior management during the auction process, to understand their
vision for the business and build relationships with them. This can help them win the bid, even
if they may not be offering the highest price.

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04 Focus on the Whether you are the buyer or the seller, unforeseen
delays will be costly. Small local issues can turn out
to be material to the deal, or they can change the

details With a structure of the transaction.

team that knows

the local market

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04 Focus on the details with a team
that knows the local market
Local management knows how the Local and global teams need to find
business operates in their jurisdiction efficient ways to work together

Sometimes assets do not look the same on the ground Sometimes global teams do not communicate well with
as they do on paper, so local due diligence is vital. local teams. They work from different fact patterns, or
information from different sources.
Sellers that collaborate with local management can
usually identify potential problems early, and this local To avoid a fiasco where teams end up working at cross-
knowledge helps set realistic close dates. purposes, we also recommend thinking about how two-
way communication can be most effective and what
If the buyer does not operate in that jurisdiction,
support is needed through the deal process.
you cannot always know when they will be ready.
Licenses and government approvals, for example,
can delay closing.

Local experts can translate the global

deal into a local context

A global overview is important, but local experience

is essential because laws and timeframes in different
countries can cause surprises.

Normally there are local laws or practices that differ

between jurisdictions. These may include how new
companies are set up or how licenses are awarded.

Local experts understand their market and can manage

potential problems to protect the global deal.

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04 Focus on the details with a team
that knows the local market
Number of jurisdictions involved in the sell-side of the world’s 90 largest carve-out deals, 2012-2016
Almost half (48%) of all deals involve 10 or more jurisdictions.

Number of jurisdictions

50+
1-4
Almost half (48%) of
all deals involve 10 or
more jurisdictions

25-49

5-9 10-24

Source: Global M&A/Thomson, December 2016

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05 Plan your HR should be strategic, not tactical. HR issues are
sometimes left until the implementation stage,
rather than addressed when the deal team plans

HR strategy its strategy.

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05 Plan your
HR strategy
Thinking about the HR issues early Your negotiations with employee
on makes a big difference representatives may be complex, so
prepare a strategy from the start
Keeping your people engaged is important. This can be
done through careful planning and communication. A large parent company protects employees from
economic cycles or weakening performance. This
Negotiations can go awry when deal teams leave
may not be the case when part of the business
HR colleagues out of the room at the planning
is spun off. Employees sometimes perceive their
stages while they engage more enthusiastically with
future employment to be less secure. They may lose
Corporate, Tax and Business Development.
generous benefits packages. They may have other
objections against the buyer, such as not wanting to
Don’t base your people plan join a competitor. Unions tend to focus on all these
on wishful thinking difficult issues.

Lots of plans calculate synergies, but do not look more Unions can be powerful in the EU. They often
widely at whether those assumptions are realistic. You share information. They have learned that they
should ask yourself whether the core concept works – can strengthen their negotiating positions by
with your people in mind. collaborating across borders.

Due diligence at early stages can validate the thinking Unions and employee representative bodies worry
behind the core drivers of the deal. Without this, the most when they see a private equity buyer. Such
deal plan could be based on false assumptions. buyers have a reputation - not always based on
reality - for harsh employment practices. Talks can be
combative from the start.

Consultations should be planned with care, given the

powerful positions of unions and works councils in many
areas of the world. Think about your timing and budget.

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05 Plan your
HR strategy
Communicate well, and your people
will be less likely to leave
I often see HR issues not properly
Some in-house HR teams may not have worked on a recognized from the outset of deal
transaction of this scale.
planning. I have seen many business
Deal teams should plan their consultation with care.
plans fail the reality check of tough
There are formal requirements for information and
consultation, but it is important to keep in mind unions and works councils, in
what impact the change may have on people. Good particular in the EU.
communication can alleviate a lot of concerns.
However, do not over-promise. You could create legal
liabilities if you get this wrong. Guenther Heckelmann
Partner

Decide how to package

pension liabilities

When you separate a business, benefits and

compensation are usually protected going forward. Of
all the HR decisions made in a carve-out deal, the most
complex is normally how to deal with pension plans.

Few companies have final salary or defined benefits

plans still in place. The UK, Germany, the Netherlands,
Sweden and Japan are exceptions where there are
frequently onerous rules protecting beneficiaries.

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Case study

When thinking about people,

consider both legal and cultural
issues. Experience helps.
Our client was one of Europe’s largest construction companies, with global
operations. It employs nearly 100,000 people. The company wanted to sell a
major division.

In the planning stage, it became clear that employment issues might

scupper the deal. Unions and works councils had decided that our client’s
collective bargaining structure would put employees at a disadvantage.

In Germany, employees have the right to refuse to move to a buyer. A

collective objection is a forceful tool.

We worked on the pre-planning, talking to unions and the Works Council,

about significant transfer arrangements to protect employees in Germany.
This involved several thousands of employees.

The deal was completed.

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06 put everything You want to get the best price for your
assets. It’s important to you that your buyer
and other stakeholders are confident in the

together process and not surprised as the transaction

progresses. Good planning is key to creating
this confidence.

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06 put everything together
There are many moving Customers and suppliers might
parts to coordinate… walk if not engaged early

Once the deal terms have been agreed, you embark Serious churn can be avoided if you make a point to
on the final, most complex stage of the transaction: communicate openly and regularly with your major
implementation. This is not easy when you have customers and suppliers. Clear messages from within
engaged many teams of different advisers, when the business are always important, and most of this
the deal depends on thousands of lines of data, can be planned. But this is often a source of anxiety for
and when there are local variations for transitional in-house legal teams. Shared contracts and transitional
service agreements, approvals and contracts. service agreements might cover some important areas
There are countless opportunities for errors and of the business for the short term, but not for the long
misunderstandings. term. Keep in mind that suppliers react better if they
are kept informed before the deal is finalized.

…and many stakeholders

to keep on side Landlords might decide to be difficult
about leases and hold you to ransom
You may be following due process, but if you haven’t
engaged well enough with your stakeholders, you may However, they may be more flexible if they are
find they simply walk away. consulted early and kept informed.

Valuable employees might leave

if they do not feel it is in their best
interests to stay with you

Consulting employees can help retention and prevent

the heavy costs and damaged reputation that may
result if unions or works councils take legal action.

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06 put everything together
Far from being an overhead, strong planning Great execution leads to faster completion and
underpins a successful transaction maximizes value

Given the complexities of these transactions, For large-scale and multijurisdictional projects, an
planning and project management should not be an integrated project management team is very effective
afterthought. They create confidence early on, and – lawyers, accountants and other professional advisers
make integration considerably more successful. working alongside professional project managers.

Based on our experience, the organizations that These specialists piece together the puzzle. They
achieve the greatest success with their carve-out understand the deal issues and design reporting
transactions tend to place project management at the frameworks and escalation paths for hundreds of
center of their approach. different workstreams.

With good planning they can anticipate deferred

closings earlier in the process and allow appropriate
arrangements to be made, such as escrow accounts,
working capital plans and secondment arrangements.

There are lots of quirks between

pensions in different countries. It is
important to understand the detail if
defined benefits plans are involved,
as the liabilities can be substantial.

Jonathan Sharp
Senior Associate

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Case study

Integrated project management

can lead to a faster completion
We acted on a large disposal for a multinational that wanted to divest an
underperforming business unit. The unit was tied to other parts of the business
across multiple jurisdictions.

We were brought in early enough to help design the disposal process. We

focused on implementation, and that enabled us to solve a number of local law
complications with the transfer of assets.

This clear plan instilled confidence in bidders, allowed rapid due diligence
and sped up negotiation of the purchase agreement. It enabled our client to
identify tricky areas ahead of time and prevent problem jurisdictions from
delaying the closing.

We completed the sale within a month of signing.

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ABOUT US
More companies choose Baker McKenzie Our carve-out
than any other law firm for their important
deal analysis
cross-border transactions.

Cross-border deals are often highly strategic and even For this study, we analyzed 1,160 carve-outs of at least
transformative for a company. They are significant and US$100 million in value (at that time), based on data
complex undertakings for any organization and require provided by Thomson Reuters.
experience and efficiency to maximize deal value.
The deals were either reported as intended, pending,
We are consistently ranked “No. 1” by legal directories, announced, partially completed or completed between
with more than 13,000 M&A lawyers in 77 offices 2009 and 2016. To ensure the deals reflect the subject
across 47 countries. of this study, we have included divestitures, spin-offs,
split-offs and equity carve-outs. We actively selected
Our global M&A team is fully integrated and works
deals that involve a transfer of units, department,
seamlessly across time zones, cultures and languages
division or business (up to 100%) from one seller to one
to get the deal done, manage risks and achieve desired
buyer. We have excluded property acquisitions, joint
synergies.
ventures, mergers, buy-backs, recapitalization and
We have deep experience in cross-border deals: more secondary buy-outs.
than 60 years investing in and refining our precedents
and processes to drive efficiency and provide the highest
quality standards and deal practices.

Our experience enables us to take a broad view of the

transaction, from inception through integration. We help
you identify and address potential timing issues early on to
avoid delays and increase deal certainty.

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www.bakermckenzie.com/carve-outs
If you would like to explore these issues in more detail, please speak to your
usual contact at Baker McKenzie or email [email protected].

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