Transactions in the business world are a common occurrence, including those where companies merge, acquire other companies, and buy and sell off divisions. There are multiple reasons why an independent company would lop off one of its units, and similarly, there are various flavors of divestitures, one of which is the carve-out.
What Is a Divestiture?
A divestiture is when a company sells off one of its assets. Understand that the asset can be any number of things, including a product, a service, a division, hard assets or even intellectual property (IP). The selling (and buying) of these assets is a common business practice — companies are always shedding and adding these assets. These types of deals often occur during the merger and acquisition (M&A) process, before, during and after. Of course, there are many reasons for this, often to satisfy business and legal compliance. The bottom line for most of this activity is to increase value for the shareholders of the company.
4 Reasons for a Divestiture
As is the case in most business practices, there are multiple reasons for going through the divestiture process, as well as several types of divestitures. The reasons for a divestiture include:
1. No synergy
One of the most common reasons for a divestiture is that a division (or product or service) no longer aligns with the parent company’s core competencies and is not synergistic.
2. Need for cash flow
This could stem from many reasons, but the end game is to increase shareholder value with cash flow. Trimming the fat and spinning off a division may remedy that situation by losing a less profitable portion of the business, or simply avoiding pouring more resources into it.
3. Legal reasons
There are rules and regulations that stipulate what you can and can’t do in business. Some of these are tax laws, which often change, and a change for the worse may render a certain division (or product or service offered) far less profitable. In addition, anti-competitive and monopoly laws also can affect divisions of companies.
4. The M&A process
Businesses that are looking to be sold may want to tighten things up so that they will become more attractive fiscally in the market. And on the back end of an M&A, there may be overlap or redundancy that needs to be spun off.
What Is a Carve-Out Divestiture?
A carve-out divestiture, or equity carve-out, is a partial divestiture of a business unit. In this scenario, the parent company sells a minority interest in the new company. It’s not a case of totally letting go; the parent company still retains an equity stake in the new entity. It’s often used when a parent company sells off assets that are not in its core competencies, but in which it can still capitalize on.
The Carve-Out Divestiture Process
The parent company sells some of its holdings in the subsidiary (usually via an IPO), which establishes the subsidiary as its own standalone company. However, the parent company still retains a stake in the new company, which allows the parent company to capitalize on the business segment of the subsidiary. The difference between a carve-out and a spin-off is that in a spin-off divestiture, the parent company transfers all its existing shares in the new subsidiary company, therefore relinquishing its equity stake in it.
The Purpose of Carve-Out Divestitures and Why They Are Used
The purpose of a carve-out is not necessarily to jettison the business unit from the parent company but instead to sell a part of the equity stake in the business. By doing so, the parent company is able to maintain the majority stake in the business, which allows some control over it. Another reason the equity carve-out is used is that it allows the parent company to get a cash inflow for the “partial” sale of the business unit but still maintain some control over it.
Where a Virtual Data Room Comes into Play
Naturally, all this business dealing takes time and plenty of back and forth between the parties involved. Because of the complex nature of the equity carve-out, a virtual data room (VDR) can help streamline the process. A VDR is a secure, online repository where the players in the deal can store, share and edit the documents required for the deal. CapLinked, an industry leader in the space, provides VDRs that are secure yet simple to manage. To see for yourself how a CapLinked virtual data room can help streamline your carve-out transaction, sign up for a free trial to see its management features, document collaboration controls, customizable permissions and more.
Chris Capelle is a technology expert, writer and instructor. For over 25 years, he has worked in the publishing, advertising and consumer products industries.