What Organisations Underestimate In Carve-outs And M&A Transactions

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Buyers and sellers going through carve-outs and M&A transactions are underestimating certain elements of the process, which can be detrimental to the transactions and ultimately the success of the new business.
Netherlands Corporate/Commercial Law
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Buyers and sellers going through carve-outs and M&A transactions are underestimating certain elements of the process, which can be detrimental to the transactions and ultimately the success of the new business.

In an M&A transaction, especially within the complex field of carve-outs, it's essential that companies deploy a strategy to avoid the common pitfalls that can result in costly mistakes and delays.

Untangling a business from its parent company is a time-consuming and complex process that involves numerous risks. From the structure of the deal to ensure compliance and operational readiness, to the integration of people and culture, a missed step can and will affect the value of the business.

One of the main challenges that companies face in a carve-out or divestiture is underestimating the time needed to complete the many individual processes involved in integration or separation.

When the carve-out is part of a cross-border deal, companies must navigate these processes across multiple countries with tight deadlines and often minimal understanding of local compliance requirements, significantly increasing the risks.

For example, understanding labour laws and the bureaucracy around governmental requirements and cross border tax regulations can be challenging, and any mistakes made will have significant financial implications.

Businesses must consider the cultural nuances within different countries when hiring new or transferring existing employees as these have a direct impact on talent retention and staff management. Language barriers and time zones can pose communication or delivery challenges. And finally, the differences in technology infrastructure and capabilities across countries can cause difficulties when trying to align systems and processes.

Once the transaction is complete and the new entities are incorporated and operational, there are other potential complications to take into account. Compliance with accounting and tax rules in the new jurisdiction of operation, for example, should be coordinated from the beginning to avoid problems with local authorities.

The transfer or creation of employee benefits must be done correctly in a manner that is appropriate for the country in which the new business is located. These obstacles can be prevented by planning for the integration from the beginning of the transaction. Such preparation not only mitigates operational risks, but it also benefits both buyers and sellers by allowing both parties to raise more capital or generate more value for their business without delays.

A briefing paper by Harvard Business Review titled "Solving the integration challenges surrounding carve-out transactions" discusses these integration complexities in more detail:

Carve outs can quickly become complicated because the assets and people involved get severed from the seller's payroll, accounting, finance, and other back-office support systems, bringing an immediate operational burden for the buyer. As a result, buyers need to pay close attention to strategies to mitigate such operational risk and ensure that there is a smooth transition to operational readiness so that the carve out creates business value as quickly as possible.

In recent years, carve-outs have become more economically attractive as organisations look to unlock capital and structure their business for maximum growth opportunities. A recent survey by Norton Rose Fullbright shows that 59% of respondents expect their organisation's appetite for M&A transactions to increase in 2024 when compared to 2023. Carve-outs provide an excellent way to improve business prosperity, but only if both the buyer and seller have prepared properly and planned for every possible outcome.

Businesses must do their homework and pay close attention to the required steps in both the pre-transaction and post-deal phases, particularly in the first 90 days after closing.

A key element of the carve-out process is the transactional services agreement (TSA), a contract that spells out the support and assistance that the buyer expects from the seller during the transitional period and that helps to smooth the way for post-acquisition operational readiness. Business must have a solid TSA in place if they want the carve-out to be successful, but they also need a strategy for exiting the TSA. TSAs can be very useful, but they often come at a price and are for a defined period. It's very important that the newly formed business has a plan to either integrate or find new suppliers for the systems it requires.

This includes setting up operational systems – such as IT, finance and HR - to be compliant with local regulations and providing employees with training on these systems to ensure they are proficient. Contracts and data must be transferred from seller to buyer with the correct protections in place for data security. New service service-level agreements (SLAs) must be negotiated and established prior to the transfer of ownership to avoid compromising on service quality.

With so many elements to consider, the stakes are high, and mistakes can have disastrous consequences. Having a partner to support this process and ensure a smooth transition to independence is often the best solution for companies to minimise their pain points.

An operational readiness checklist is the first step in M&A transactions planning and can help ensure that buyers don't miss a crucial step.

M&A and carve-out operational readiness checklist:

  • legal entity incorporation
  • local directorships (a Board requirement in many countries)
  • employee regulations eg. TUPE obligations in Europe and similar benefits requirements
  • business licenses and tax registrations
  • bank account setup
  • payroll registrations and the provision of ongoing HR and payroll services
  • accounting systems and setup
  • corporate secretarial processes needed for local compliance.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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