Additional Issues Regarding Carve-Outs
In the course of assisting our clients in evaluating potential acquisitions, target companies are typically “stand-alone” entities that lend themselves to fairly direct analysis. However, in numerous instances, our clients have contemplated the purchase of individual business units that were part of larger corporate organizations. These types of transactions are referred to as carve-outs. In March, I highlighted several important items that we observed during our work on carve-out acquisitions. Part One discussed understanding reasons for divesture, the importance of brand recognition and customer relationships and key business processes and systems.
Continuing our series on carve-out acquisitions, we will highlight some additional issues for consideration based on buy-side due diligence work that we have performed. The considerations are as follows:
- Evaluation of Corporate Cost Allocations: The first part of this analysis is to identify all costs allocated from the corporate parent and/or other related operating subsidiaries to the carve-out. These costs often include items such as human resources, employee benefits, accounting, tax, legal and information technology costs. In many instances, such costs are charged to the business unit on a monthly basis, using any number of allocation factors (i.e., head count, revenues, transactional volume, etc.). Management must estimate what these related costs will be on a stand-alone basis subsequent to the transaction in order to evaluate the net financial impact to historical reported EBITDA of the carve-out for deal valuation purposes.
- Employee Pay and Benefits: We have observed that large corporations generally have more generous benefit plans (including profit sharing, deferred compensation, defined benefit pension plans, stock options, etc.) than privately held companies. This can pose a challenge when a privately held company is considering the acquisition of a carve-out because it is important for management to retain key employees (i.e., making them whole post-transaction from a compensation and benefits standpoint), while balancing the existing compensation and benefits structure for current employees.
- Supply Chain Issues: During one engagement, the target business unit, a consumer products company, sourced its product from the Far East. The parent company had a number of other business units engaged in the consumer products industry with similar sourcing arrangements. The parent company even had a large team of individuals in several offices in the Far East to manage procurement and quality control with respect to product sourced from there. Therefore, it was important for our client to determine how it would manage this part of the supply chain in the immediate and longer terms post-transaction, including related normalized costs/margins and additional required investments. The results of this analysis had a significant impact on the valuation and negotiation of the deal.
Schneider Downs has extensive experience in providing due diligence services. To learn more about how Schneider Downs can help you, please contact Joel Rosenthal, Shareholder, or Marc Brdar, Senior Manager, at (412)-261-3644.
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