Carve-outs: One of the most difficult transactions to deal with

The field of private equity investing is complex at the best of times, but with more firms turning towards carve-outs it would be fair to say that things have become even more complicated.

Taking the example of Sun Capital, this is a company who have now been involved in approximately 50 middle market carve-outs into independent businesses. Considering their overall track record, it would be fair to say that they have almost perfected the process, but it isn’t easy and there are a lot of questions that need to be answered before such a transaction can proceed.

Marc J Leder has mentioned in numerous interviews the company’s approach to acquisitions, and when it comes to middle-market carve-outs there are umpteen other intriguing points that have been made by the firm’s senior members.

In regards to the questions that have to be addressed prior to the completion of a transaction, let’s take a look at some of the most important examples.

What is going to form part of the seller’s continued obligations?

This is one of the easiest ways in which confusion can form as part of a carve-out.

It probably goes without saying that the majority of sellers want to disassociate themselves from the company at the earliest opportunity. Unfortunately, this is usually something that doesn’t aid the buyer at all.

Therefore, there firstly needs to be a set period in which both sides know how long the seller is going to continue with their obligations. This will at least allow the buying party to build some sort of replacement system.

The worst thing that can happen is that the seller detaches themselves immediately once the contract has been signed, meaning that the business effectively can’t function as no-one is carrying out their former obligations.

Who owns the customer relationships?

Another crucial question that needs to be asked prior to completion regards the customer relations ownership.

Clearly, this is one of the most important parts of any business. If a deal does not include such relations, it can mean that the business is actually much less valuable than anticipated.

Suffice to say, a lot of businesses rely on repeat trade. By not owning the customer relations, it’s impossible to liaise with past buyers.

Unfortunately, this is something which can commonly happen in a carve-out. The “other” part of the business takes the customer relations, leaving the carve-out with very little to work with in the future.

What is the state of the intellectual property?

Yet another critical part of the transaction surrounds intellectual property. Clearly, if the carve-out doesn’t retain these rights, it can lead to a whole magnitude of problems in the future.

However, depending on how the initial company is structured, it’s again not a foregone conclusion that the relevant intellectual property is transferred over to the carve-out. Ultimately, this is another question that needs to be asked early, to avoid any problems surrounding rights as the newly-formed business attempts to develop.

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