Carve-out, or separation of a business division

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Above a certain company size – especially in the case of complex businesses operating more than one division – the need to separate business divisions from the core activity can often arise for various reasons. This process is called a carve-out. The reasons for a carve-out can include the declining prospects of a given business division, an ad-hoc opportunity for selling the division under favourable conditions, as well as just a simple portfolio restructuring. Whatever the case, separating a business division at growing companies is usually done in preparation for the potential sale of the division.

In a legal and business sense, a carve-out is a simple procedure that typically occurs through a separation, more often than not with a spin-off, but business division transfers are also popular solutions. Either way ensures that the business division, constituting an integral part of a company so far, henceforth functions as a separate legal entity, independent of the owners of the company. In the case of a spin-off, this is realised by establishing a new company, while the sale of a division leads to a merger with another legal entity.

From an operative point of view though, this can be somewhat more complicated depending on the internal processes, resource needs and administrative tasks of the division to be carved out. Another significant aspect is whether the separation happens as a prerequisite for a transaction already in progress or because of a prospective sale in the future.

Carve-out strategy 

In many cases it is difficult to define precisely which functions need to be transferred to or shared with the newly-established business entity. It is much more straightforward with a decentralised structure than with a centralised one. Even if we assume the division operated relatively independently up until the point of separation, there are certain tasks where all rational arguments advocate centralisation, as long as the operation is incorporated in a legal entity or is within a group. These are typical administrative areas without which an independent unit is unable to conduct its activity in the long run, or even in the short run for that matter.

The carve-out strategy has to identify such areas and define the ways these tasks shall be carried out.

Separating a business division 

Based on the provisions of the carve-out strategy, a solution for the temporary lack of resources and infrastructure at the carved-out division needs to be drawn up until a permanent solution is identified. If the separation is due to a sale that is not immediate, it is worth keeping certain functions temporarily at the “parent company”, i.e. assigning such functions to the parent, since they have the required knowledge and resources to operate the separated division properly. In such cases the term, scope and form of settlement between the parties in relation to such services must be incorporated in a contract.

If a carve-out has to be conducted quickly, much depends on the capacities available at the party taking over the division. If necessary, it is recommended to entrust certain functions, such as accounting, tax or HR, to an external service provider, even if only temporarily.

It is also important to review all existing contracts. Besides concluding new contracts for crucial services, it is also inevitable to identify the services for which no contractual relationship was transferred to the carved-out business division. It is important for the separated division to contract a service provider that is suitable given the structure, size and needs of the newly-established entity.

Separating business divisions due to market processes puts a substantial burden on the company’s employees. It requires the design of new procedures and an approach vastly different from the everyday routine, all while carrying out day-to-day tasks. Under our restructuring management services, WTS Klient Hungary can advise you on the strategic considerations of separating a business division and the operational issues involved, i.e. on the entire carve-out procedure. And with our interim management services we provide active support to solve temporary problems related to a lack of resources.

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