Definition: What is a Carve-out?
A carve-out refers to the divestiture or sale of parts of a company, such as a business unit, to form a legally independent entity. In other words, a specific business area is separated from a company, including everything that belongs to it: personnel, finances, know-how, data.
Typically, a parent company sells a minority interest in its subsidiary to other investors. In this case, the divesting company remains the majority owner of the divested business units and retains the right to continue shaping their growth and future.
Often, after the sale, they provide both strategies and necessary resources to promote an independent business development of the divested business units. A carve-out enables a kind of corporate restructuring, where the spun-off business areas have their own board of directors and manage their annual financial statements independently.
Why Do Companies Use a Carve-out?
An IT carve-out is always a burden for companies because the unit should be sold as quickly as possible, with as little effort as possible. This is a very high burden for the target, i.e., the object of sale, both financially and in terms of work.
The reasons for a carve-out can be diverse. Some companies separate from certain parts of the business to focus entirely on their core business. Others hope to make other investments or improve liquidity with the capital gained. Often, a carve-out serves as preparation for a complete divestiture.
A special form of carve-out is the so-called equity carve-out. In this context, the shares of a subsidiary are listed on the stock exchange as an Initial Public Offering (IPO). This solution has the advantage that a parent company can quickly access new capital while retaining the majority of shares and thus the control rights over its subsidiary.
Since a complete divestiture of business units can take several years, a carve-out is sometimes a stopgap solution that parent companies resort to in order to remain successful. However, it may also be that a complete divestiture of the business areas is undesirable for a parent company. In this case, a carve-out represents a strategic decision to change or expand the market position.
How Do Carve-out and Spin-off Differ?
In the business world, carve-outs and spin-offs are popular divestiture strategies, each chosen according to their own priorities. The differences between the two procedures mainly lie in the possibility of influence, participation in revenue or profit, and methods of going public.
If a parent company wants to retain its formative influence on the spun-off subsidiary, it applies a carve-out as a divestiture strategy. In this context, there is also a strong desire to generate revenue from the divested business units. A carve-out is often used when a parent company does not believe it can find a buyer for its entire subsidiary.
In contrast, in a spin-off, a parent company completely separates from its subsidiary, which becomes an independent company. Generally, a parent company does not generate revenue or profit from the new company, even if it may still have a capital stake in it. If a subsidiary goes public as part of a spin-off, the shares are not sold to the public but distributed to the current shareholders (stakeholders).
What Makes a Carve-out Technically So Complex?
Regardless of the reasons why a company decides to undergo a carve-out, a strong awareness of the complexity of this process is required. Indeed, a carve-out from SAP or another system can hardly be carried out overnight. Rather, it is important to carefully plan an upcoming project and coordinate it with all relevant stakeholders.
The particular challenge with an IT carve-out is thus the complexity that needs to be managed in an extremely short time. This is because the sold business unit must intensively deal with how to proceed as an independent company within short deadlines.
In addition to many organizational and contractual preparations, companies must ensure a clean separation of data, IT systems, and processes as part of a carve-out. This is because these form the backbone of all business activities. The data and information assigned to the business unit being spun off must be identified, selected, and transferred to a new, independently operating system.
Furthermore, the project planning must be aligned with the respective IT architecture, structures, and data volumes. Finally, companies should ensure that both the data transfer and data deletion from the previous source system comply with legal requirements. In this regard, one must not disregard the currently applicable legal documentation and retention obligations.
What questions should be asked before carrying out a carve-out?
These questions help to prepare for a carve-out:
- Which data needs to be separated?
- How can the data to be separated be identified? Is this done via a client or a company code?
- Which systems contain data that require (digital) archiving?
- Are there certain developments within the systems that need to be factored into the process?
- Is there data that needs to be anonymized or deleted before extraction due to the EU General Data Protection Regulation (GDPR)?
- Is there a specified timeframe in which the data extraction must be completed?
- What is the best way to transfer data to a new system?
- When is the completion of the entire process planned?
What can a carve-out project look like?
A carve-out is a complex process in which the following phases can be distinguished:
- Analysis: The process begins with a careful examination of existing data and systems.
- Planning: Immediately following the data and system analysis, a detailed project plan is created, taking into account milestones and deadlines.
- Test run: Now the data migration programs are checked for functionality and security.
- Execution: If a test run goes well, the individual milestones are implemented step by step according to the project plan.
- Validation: At this point, it’s important to check the data transferred to a new system as well as the status of the existing systems.
- Documentation: In the final step, all project activities carried out, including user tests, are documented.
4 Success Factors for a Carve-out
Regardless of whether a carve-out is to be performed from SAP or another system, it is advisable to consider the following points in any case:
1. Careful Planning
Good planning is half the battle. A carve-out project will only achieve the desired success if it is carefully prepared and coordinated with all relevant stakeholders. Without a clear overview of the entire transformation concept and the individual project steps, companies risk serious errors, unnecessary costs, and time delays during a carve-out.
2. Internal Know-how
A carve-out is also hardly conceivable without intensive and close collaboration with the IT department. This is mainly because IT experts have a deep understanding of databases and tables, which is essential for clean data separation. They are also very familiar with existing links and interfaces (APIs) and can help to carry out data migration smoothly.
3. Choice of Software
Software allows business interruptions due to a carve-out project to be kept to a minimum or even avoided entirely. This is especially the case when transformation software or an ETL tool is tailored to a company’s specific needs. Maximum automation and a high degree of flexibility are in high demand for a streamlined implementation of all project steps.
4. External Expertise
It can happen that the necessary know-how is lacking internally, jeopardizing the success of a carve-out. In such a situation, it is worthwhile to fully utilize the support of external experts, such as digatus. They can assist a company with professional advice and expertise by comprehensively guiding a responsible team through all phases of a carve-out project.
IT Costs in Carve-out: What Factors Should Be Considered in Cost Estimation?
IT managers are thus faced with the challenge of creating a concrete cost estimate within a very short time. Often, the infrastructure costs are higher than expected: for example, if the sold business unit does not have its own IT infrastructure, this can quickly drive up costs. If it turns out during the carve-out that the estimated costs were too low, additional financial resources must be provided for the IT area, which may be planned and needed in other areas of the company. If the costs for the IT carve-out are set too high, financial resources are unnecessarily tied up. At the same time, the estimate must be created at short notice to enable overall planning of the carve-out. Experience shows that the IT carve-out is one of the most complicated and long-lasting processes, which often reveals hidden costs only in the course of separation. To determine these costs early and as accurately as possible, IT managers can apply some measures and thus support the overall process in the best possible way.
Gaining an Overview
Initially, it is crucial to analyze the existing cost structure and divide it into individual areas. The main cost drivers within the IT carve-out are the monthly costs of the TSA (Transitional Service Agreement) itself, licenses and other IT contracts, the ERP system, other non-ERP applications, IT infrastructure, hardware, and telephony costs. In practice, it is evident that companies benefit from a consistently maintained inventory in conjunction with the associated historical data. Through this initial analysis, various cost items can be identified and necessary priorities set.
Definition of Target State (Baselining)
After the IT management has gained a general overview (baselining) and thus generated a suitable starting position, it is necessary to determine what the future IT landscape should look like. This depends, among other things, on the type of deal (e.g., asset or share deal) and whether IT components of the buyer will be adopted. Another possibility is a so-called Green Field Approach, where the IT landscape must be built completely from scratch.
Cost Estimation
The actual cost estimation follows as the most complex and time-consuming part of the process. This can best be accomplished by combining a bottom-up and top-down analysis. Practice shows that the final estimate often lies in the middle of both approaches. Typically, costs are estimated using the top-down approach by IT management, often drawing on the extensive experience of external consultants.
Due to the heterogeneity of individual transactions, the result of this analysis is only conditionally correct and should be supplemented by a detailed cost analysis according to the bottom-up principle. Additionally, the responsible IT managers benefit from further input from lower hierarchy levels within this approach, thereby avoiding completely forgetting cost items. For topics with smaller scope, a pragmatic approach should be chosen, and costs should be roughly quantified and proportionally aligned with the overall estimate.
Additionally, the necessary person-days must be estimated together with the responsible managers for the individual segments. Depending on the size of the company and the internal resources available, additional costs for external specialists may need to be considered.
Finally, a cost buffer should always be included in case costs turn out higher than expected or cost items arise that were not recognized or apparent at the beginning of the carve-out. This avoids discussions in case the budget is exceeded and additional funds are needed.
Conclusion
There is no universally valid recipe for the success of an IT carve-out in the context of M&A. Therefore, it is advisable for companies to align their project entirely according to individual needs and requirements. Nevertheless, compliance with data protection and data security laws must be maintained. To accelerate the entire process and make it run smoothly, companies can rely on proven approaches and tools.
Christoph Pscherer
He has been working in the IT environment for almost 30 years, gaining experience in various roles and areas. Through his years of experience as a Service Manager, he knows the challenges and needs on the customer side. He has been applying this deep understanding and knowledge at digatus for more than eight years. As Head of BU IT M&A and Transformation, he and his team support all IT topics along the value chain of M&A projects. This includes due diligence, carve-out, and integration projects.
