from Thorsten Rohde, Mag. iur. (Dublin) and Charlotte Seltenreich
Carve-out transactions are becoming increasingly important as a specific form of M&A transaction in the current economic situation. Technological change, ESG requirements, geopolitical conflicts, rising energy costs and ongoing friction in supply chains are forcing companies to fundamentally rethink their strategic direction and core business activities. Added to this is a changing financing environment with higher refinancing costs, which increases the pressure on companies to utilise their resources more efficiently and focus on profitable core areas.
Against this backdrop, companies are increasingly relying on carve-outs as a strategic instrument for the targeted separation and sale of non-strategic or underperforming business units. Carve-out transactions not only open up the possibility of releasing capital and optimising structures, but also offer investors attractive opportunities to acquire and further develop clearly defined and scalable units.
As a transaction boutique, ROHDE BAIER is regularly mandated by companies and investors in the realisation of sophisticated carve-out transactions. Our experience shows: The success of carve-out projects depends crucially on comprehensive legal, tax, financial and operational planning. A precise analysis of the initial situation, well thought-out structuring and strong interdisciplinary expertise are essential in order to effectively overcome complex challenges.
This article highlights common stumbling blocks and presents practical approaches that ensure the successful implementation of such transactions.
I. Definition and meaning
In the context of a corporate transaction, a "carve-out" or "carve-out transaction" describes the separation of a part of a company or business division from an existing corporate structure. This can either be a legally independent company that is part of a group of companies and typically utilises central group services such as IT infrastructure, HR administration, accounting, finance or compliance, or a division within a company that is not legally separated. Divisions to be separated are also often integrated into group-wide cash pool systems and part of a tax group, which brings additional legal and tax complexity to the separation.
A carve-out can be carried out in the run-up to a planned transaction in order to set up and sell the business unit as an independent organisational and legal entity, or - as is often the case - as an integral part of the transaction. In both scenarios, the aim is to structure the carved-out division in such a way that it can function independently of the remaining group after the sale.
II. Key drivers for carve-outs
A central motive for carve-outs is the focus on profitable core business areas, particularly in view of the pressure that the current economic situation is exerting on companies. Companies are forced to critically analyse their business areas and focus more on those that contribute significantly to the long-term corporate strategy. This involves identifying non-strategic, unprofitable or highly risk-exposed units that can be removed from the Group portfolio.
Unbundling such business units offers several advantages. On the one hand, companies increase their operational efficiency as the complexity within the remaining structures is reduced. Secondly, the separation enables a clear strategic focus on high-growth core areas. Risks emanating from separated areas can be isolated, which strengthens the stability of the remaining company. At the same time, a focussed core business increases the company's flexibility and makes it easier to adapt quickly to market changes. Such clearly structured and focussed companies are often perceived by investors as lower-risk and faster-growing, which increases their attractiveness and valuation on the capital market.
In addition, the strategic separation of business divisions can serve as a lever for transforming the business model. ROHDE BAIER is constantly working on topics relating to digitalisation, artificial intelligence and ESG standards (environmental, social, governance). Companies are under increasing pressure to fulfil the requirements of a digital and sustainable world. A carve-out allows divisions to be separated so that the remaining company can focus on its modernisation and realignment or other transformative processes.
Last but not least, financial motives also play a role. The sale of divested units generates an immediate inflow of capital that can be used to reduce debt, invest in sustainable business areas or pay dividends to shareholders. At the same time, companies can shed inefficient or loss-making areas through the separation and thus improve their long-term financial stability.
Carve-outs thus combine strategic, operational and financial motives and offer companies the opportunity to position themselves more clearly, efficiently and sustainably in an increasingly dynamic market environment.
III Road to Success
The implementation of a carve-out transaction or an M&A transaction with carve-out elements requires careful planning and a deep understanding of the interfaces between the divested business and the remaining business. A clear operational separation and the resolution of financial, tax and organisational interdependencies are particularly crucial. A precise and well-thought-out spin-off is essential in order to minimise legal, operational and financial risks and at the same time create the basis for the long-term success of the transaction.
- Transaction structuring
Choosing the right transaction structure is crucial to the success of a carve-out. Companies are faced with the decision between a share deal, an asset deal or the use of reorganisation measures, with each of these options having specific advantages and disadvantages.
An asset deal offers the advantage of being able to select assets and liabilities ("cherry picking"). However, the transfer takes place by way of singular succession, which means that the consent of the respective contractual partner may be required for the transfer of assets (in particular contracts). This increases the complexity of the process and makes it more time-consuming.
A share deal, on the other hand, takes place within the framework of universal succession, which makes the transaction legally simpler, as all assets, liabilities and contracts of the target company are automatically transferred. The disadvantage, however, is that no selective acquisition is possible and potentially undesirable obligations or contracts are assumed.
In addition to these structural considerations, tax law aspects typically play a central role in the selection of a suitable transaction structure. These can have a significant impact on the profitability of the deal and should therefore be analysed at an early stage.
Ultimately, the choice of the optimal structure depends on what is legally possible, what makes sense in terms of sales tactics and what can be realised in terms of time. Close coordination between legal, tax and strategic advice is essential in order to develop a customised solution.
- Taking stock - "What's in, what's out?"
After structuring the transaction, analysing the current situation is the first and decisive step in any carve-out. The aim must be to analyse the operational, legal and financial links between the division to be carved out and the remaining group. This phase forms the basis for further planning and implementation.
a) Financial interdependencies
An important preliminary step that should be taken as part of the decision-making process for a carve-out is the creation of a comprehensive overview of the financial situation of the business unit to be carved out. If the carve-out business is legally independent, it usually has its own set of figures and independent planning. These figures can be prepared and normalised for potential buyers in order to create a clear and reliable basis.
If no specific financial data is available, e.g. because the business unit is not legally independent, (pro forma) figures should first be prepared to provide an overview of the carve-out business. Careful collaboration between the financial workstream and other workstreams is essential here.
b) Operational interdependencies
The operational integration of a business unit into the group structure is often comprehensive. A detailed analysis of the dependencies is therefore essential to ensure that the carve-out functions smoothly as a standalone unit after the sale has been completed. The relevant interdependencies typically include
- IT systems: Many business units share IT infrastructures such as ERP systems, databases or cloud services. As part of a carve-out, these structures must either be separated or covered by transitional solutions (keyword: Transitional Services Agreement (TSA)). IT projects are often particularly time-consuming as they require extensive migrations or the installation of new systems.
- Shared Services: Functions such as accounting, controlling, payroll, marketing, legal or compliance are often managed centrally. The separation of these services can be complex and often requires external support from specialised service providers.
- Logistics and supply chains: Depending on the business, integration into centralised logistics systems and supply chains also poses a challenge. Decoupling these interdependencies without disrupting ongoing operations requires precise planning.
c) Legal interdependencies
In addition to operational dependencies, legal interdependencies are also of central importance in a carve-out. This concerns, for example, profit and loss transfer agreements (more on this below) or the inclusion of the carve-out in overarching contractual relationships of any kind (e.g. inclusion in group insurance policies, group-wide licence agreements, etc.) or important operating contracts that would have to be separated in the course of the process (so-called joint contracts).
Identifying and dealing with these issues in good time is crucial in order to minimise legal risks and ensure the smooth implementation of the carve-out.
- Realistic target setting and evaluation
After taking stock, a detailed separation plan should be developed that includes both the operational and legal unbundling of the business unit to be separated.
If the carve-out is not fully implemented in advance of the sales process, the potential buyer is usually closely involved in the separation planning. The objectives are strongly dependent on the buyer's capacities and resources. Some issues can be fully resolved by the time of closing, such as the conclusion of independent insurance policies instead of integration into existing group policies. Other aspects, however, such as setting up in-house HR and payroll functions, often require significantly more time.
Transition service agreements (TSAs) are often indispensable for a transition phase. Such agreements stipulate that the seller company will continue to provide certain services for a defined period of time in order to ensure a smooth transition. Identifying and planning the necessary TSAs at an early stage is essential in order to minimise operational risks and continue business operations seamlessly.
- Selected topics
The following issues typically play a key role in carve-out transactions.
- Contractual relationships - In the case of universal succession (e.g. in a share deal), existing contracts are generally transferred automatically. In the case of an asset deal, however, the consent of the respective contractual partners is required. Mixed-use contracts (joint contracts) are particularly challenging, as these must be split up in carve-out transactions if both the seller and the part of the company to be sold still need them.
- Cash pooling and financial unbundling: Unbundling the carve-out area from centralised cash pooling poses a particular challenge. The cancellation of existing cash pool contracts, the handling of the resulting receivable or liability and the mapping of relevant cash flows for closing must be carefully sorted and contractually processed.
- profit and loss transfer agreement (PTA): The EAV primarily serves to establish a consolidated tax group and must be "implemented" to avoid retroactive jeopardisation. For this purpose, a short financial year is often created on the economic reference date. The necessary amendment to the articles of association and its timely entry in the commercial register must be carefully planned and coordinated, especially in consultation with the tax office, in order to avoid tax risks.
- Employees - A key decision during separation planning concerns the fate of employees: company employees who work exclusively for the carve-out business are usually automatically transferred to the buyer in the event of an asset deal in accordance with Section 613a of the German Civil Code (BGB) or comparable regulations. Other employees who do not only work for the carve-out business must be assigned individually. Individual agreements are required here that take into account the interests of both the seller and the buyer.
- IP/IT - The transfer of centrally managed IP and IT rights such as patents, trademarks and software requires clear regulations. These rights must either be transferred or licensed, often via temporary agreements such as TSAs or re-licensing. IT aspects such as software licences and data protection must be contractually secured. Close collaboration between legal, technical and business teams is crucial to minimise risks and ensure a smooth transition.
- Insurances: The part of the company to be sold is often insured via the seller's group policies, but must be included in the buyer's own policies or insured separately after the closing. There are important distinctions between "Occurrence Based Policies" and "Claims Made Policies"; the latter often require subsequent insurance cover (tail coverage) to insure against losses before the closing. The submission of tail coverage may be mandatory in the purchase agreement. In addition, co-operation agreements are essential for claims under group policies after the closing.
- Guarantees and securities: Guarantees and other securities that secure the liabilities of the area being sold must be carefully examined and adjusted in order to indemnify the seller. The buyer is usually obliged to take over or redeem existing securities, which often requires the consent of the beneficiary third parties. The purchase agreement should contain clear provisions on the redemption or transfer of collateral and the obtaining of release declarations.
IV. Conclusion
The key to the success of a carve-out transaction lies in structured planning and early prioritisation. Responsibilities for the workstreams must be clearly defined and consistently implemented. This plan creates the basis for a comprehensive understanding of the group structure and the division to be carved out.
Our role as legal advisors is often central to this: We typically act as an interface between the workstreams and ensure that all relevant information is collated in the right places and ultimately processed in the contract. Close cooperation between financial, tax, commercial and other departments is essential in order to identify risks at an early stage and manage them effectively.
The separation of individual parts of a company from the group structure is a highly complex task. With precise planning, interdisciplinary cooperation and relevant experience, the many challenges involved in a carve-out transaction can be mastered.