Definition: What is a carve-out?
A carve-out is the spin-off or sale of parts of a company, for example a business unit, to form a legally independent entity. In other words, a specific business unit is spun off from a company, along with everything that goes with it: personnel, finances, know-how, data.
As a rule, a parent company sells a minority interest in its subsidiary to other investors. In this case, the selling company remains the majority owner of the sold parts of the company and reserves the right to continue to help shape their growth and future.
Often, after the sale, they provide both strategies and necessary resources to drive an entrepreneurial independent development of the sold parts of the company. A carve-out enables a type of corporate restructuring in which the divested businesses have their own board of directors and independently manage annual financial statements.
Why do companies use a carve-out?
The reasons for a carve-out can be manifold. Some companies divest themselves of certain parts of their business in order to be able to concentrate fully on their core business. Others hope to be able to make other investments or improve liquidity with the capital thus gained. Often a carve-out is a preparation for a complete sale.
A special form of a carve-out is the so-called equity carve-out. In this context, the shares of a subsidiary go public as an initial public offering (IPO). This solution has the advantage that a parent company can quickly obtain new capital by simultaneously retaining the majority of shares and thus the control rights over its subsidiary.
Since a complete sale of the parts of a company can take several years, a carve-out is sometimes an emergency solution that parent companies resort to in order to remain successful. However, it may also be that a complete divestment of the business units is undesirable on the part of a parent company. In such cases, a carve-out represents a strategic decision to change or expand the market position.
What are the differences between carve-outs and spin-offs?
In the corporate world, carve-outs and spin-offs are among the popular divestment strategies, each chosen according to its own priorities. The differences between the two methods are mainly in the opportunity for influence, participation in sales or profits, and methods of going public.
If a parent company wants to retain its formative influence in the spun-off subsidiary, it applies a carve-out as a divestment strategy. In this context, a desire to generate revenue from the divested parts of the company also becomes very strong. A carve-out is often used when a parent company does not believe it will find a buyer for its entire subsidiary.
In contrast, in a spin-off, a parent company separates entirely from its subsidiary, which becomes an independent company. As a rule, a parent company does not derive any revenue or profit from the new company, even though it may still have an equity interest in it. If a subsidiary goes public in a spin-off, the shares are not sold to the public but distributed to the current shareholders (stakeholders)
What makes a carve-out so technically complex?
Independently of the motives for which a company decides to carve-out, a strong awareness of the complexity of this process is required. Indeed, a carve-out from SAP or any other system can hardly be executed from one day to the next. Rather, it is important to carefully plan an upcoming project and coordinate it with all relevant stakeholders.
In addition to many organizational and contractual precautions, companies must ensure a clean separation of data, IT systems and processes as part of a carve-out. This is because these are the backbone of all business activities. After identification and selection, the data and information assigned to the part of the company to be spun off must be transferred to a new, independently operating system.
Furthermore, project planning must be tailored to the respective IT architecture, structures and data volumes. Finally, companies should ensure that both the data transfer and the data deletion from the previous source system are carried out in compliance with the law. In this regard, the documentation and retention obligations currently applicable by law should not be ignored.
What questions should you ask before performing a carve-out?These questions will help prepare for a carve-out:
- What data to extract?
- How can the data to be extracted 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 have to be factored into the process?
- Is there data that has to be anonymized or deleted before extraction due to the EU General Data Protection Regulation (EU-GDPR)?
- Is there a specified period of time in which the extraction of data must be completed?
- What is the best way to transfer data to a new system?
- When is the entire process scheduled to be completed?
What can a carve-out project look like?
A carve-out is a complex process, in which the following phases are distinguished:
- Analysis: It starts with a careful examination of the existing data and systems.
- Planning: The data and system analysis is followed directly by the creation of a detailed project plan, taking into account Milestones and deadlines.
- Test run: Now the programs for data migration are checked for functionality and security.
- Execution: If a test run went well, the individual milestones are implemented step by step according to the project plan.
- Validation: It is now important to validate the data transferred to a new system and the status of the previous systems check.
- Documentation: In the last step, all project activities carried out including the application end tests logged.
4 success factors for a carve-out
Whether a carve-out is to be made from SAP or another system, it is recommended that the following points be considered in all cases:
1. Careful planning
Good planning is half the battle. A carve-out project will only register 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 making serious mistakes, incurring unnecessary costs, and experiencing time delays during a carve-out.
2. Internal know-how
A carve-out is also almost inconceivable without intensive and close cooperation with the IT department. This is primarily because IT experts have a deep understanding of databases and tables, which is essential for clean data separation. They are also very familiar with the existing linkages and interfaces (APIs) and can help ensure that the data migration is carried out smoothly.
3. Choice of software
Software allows business interruptions due to a carve-out project to be kept to a minimum or even avoided altogether. This is especially the case when a transformation software or ETL tool is tailored to specific needs of a company. Here, maximum automation and a high degree of flexibility are very much in demand for streamlined implementation of all project steps.
4. External expertise
It can happen that the necessary know-how is lacking internally and the success of a carve-out is at risk. In such a situation, it is worthwhile to take full advantage of support from external experts. They can support a company with technical advice and expertise by comprehensively accompanying a responsible team through all phases of a carve-out project.
IT costs in a carve-out: What factors should be taken into account when estimating costs?
IT managers are thus faced with the challenge of preparing a concrete cost estimate within a very short time. If it turns out in the course of the carve-out that the estimated costs were too low, additional financial resources must be made available for the IT area, which may be planned for and needed in other areas of the company. If the costs for the IT carve-out are set too high, financial resources will be tied up unnecessarily. At the same time, the estimate must be prepared in the short term to enable overall planning of the carve-out. However, experience shows that the IT carve-out is one of the most complicated and long-lasting processes, which means that hidden costs often only come to light during the separation process. In order to nevertheless determine these costs early on and as accurately as possible, IT managers can apply a few measures and thereby support the overall process in the best possible way.
Get an overview
At the beginning, 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, on the one hand, the monthly costs of the TSA (Transitional Service Agreement) itself, licenses and other IT contracts, the ERP system, other non-ERP applications, the IT infrastructure, and hardware and costs for telephony. In practice, it has been shown that companies benefit here from a consistently managed inventory in conjunction with the associated historical data. Through this initial analysis, various cost points can be identified and necessary priorities can be set.
Definition of target state (baselining)
After IT management has obtained a general overview (baselining) and thus a suitable starting point has been generated, it is necessary to determine what the future IT landscape should look like. Among other things, this is largely dependent on the type of deal (e.g., asset or share deal) and whether the buyer’s IT components will be taken over. Another option is a so-called green field approach, whereby the IT landscape must be completely rebuilt.
The most complex and time-consuming part of the process follows with the actual cost estimation. This is best managed through a combination of bottom-up and top-down analysis. Practice shows that the final estimate is often somewhere in the middle of the two approaches. Typically, costs are estimated by the IT management using the top-down approach, often drawing on the extensive experience of external consultants.
Due to the heterogeneity of the individual transactions, the result of this analysis is only partially correct and should be be supplemented by a detailed bottom-up cost analysis. In addition, the responsible IT managers within this approach benefit from further input from the lower hierarchical levels and thus avoid cost items being completely forgotten. A pragmatic approach should be chosen for issues of a smaller scope and the costs should be roughly quantified and based on the overall estimate in proportion.
In addition, the necessary personnel 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 as a result, additional costs for external specialists may have to be taken into account.
Finally, a cost buffer should always be taken into account in the event that costs are higher than expected or there are cost items comes, which were not recognized or not visible at the beginning of the carve-out. This avoids discussions in case the budget goes over and more funds are needed.