Completion accounts in carve-out deals: Careful planning will yield results
January 29, 2018
Carve-out deals are an attractive way for corporates to improve shareholder value by selling underperforming or non-core parts of the business. Since 2010, there have been over 100 carve-out deals per annum valued at $100m and above [Source: Thompson]. The new normal of low growth and economic uncertainty coupled with increased shareholder activism and greater interest in carve-out deals from PE buyers all point to this activity continuing.
Although carve out sales can be an attractive way to create shareholder value, they also tend to be more complex, and pose a greater risk of value erosion for Sellers (see Andrew Cann’s blog ‘Selling a business is substantially more difficult than buying one’). One of the ways in which value can be eroded is the price adjustment mechanism that is often present in carve out deals. By their nature carve-out deals tend to require a completion accounts mechanism, whereby the headline (debt free, cash free) price is adjusted following completion to reflect the actual debt, cash and net working capital in the carved-out business as at Closing.
Typical issues which can chip away at value
Due to their complex nature, carve out deals present some particular challenges when it comes to agreeing and executing a completion accounts mechanism. Typically, there are no historical stand-alone financials for the business being carved out, which can make it difficult to establish a normal level of working capital and to identify debt-like items. Often special purpose carve-out accounts need to be prepared to facilitate this process, however the quality of carved out financial information varies, and with it the degree of reliance that can be placed on that information. In addition, carve-out accounts, prepared some time before the business is in fact carved out, may or may not be a reasonable basis for determining what the balance sheet of the carved-out business will look at Closing.
These challenges could chip away at value and a seller’s opportunity to get the best price possible for the business can be frustrated if issues are not identified up front and dealt with.
For anyone who’s experienced the difficulties encountered in a sizeable carve-out process, it will come as no surprise that planning for a complex carve out sale should start up to two years prior to the expected disposal date. The groundwork involved in separating the business to be carved out into a new division and preparing for a sale certainly makes a sale process easier and more likely to deliver the right value to the sellers.
It’s not just the planning stage that’s important. Once a deal closes there is further risk of value erosion during the Completion Accounts process, when the final price to be paid for the business is established based on the financial position at completion. We often encounter significant practical challenges during the Completion Accounts process in executing the requirements of the sale and purchase agreement. If you haven’t had the luxury of running the sale business as a separate division for two years, these might include:
- Difficulties in splitting out balances relating to the carved out business - this is particularly challenging in a well integrated business and sellers should consider the use of technology, for example, data analytics or artificial intelligence powered assistance, to help with this;
- Complex methodologies to allocate assets and liabilities to the carved out business which are difficult to apply in reality - sellers should consider what financial and non financial data is available and how data analytics could be used to provide insights into tackling this;
- Determining how the carved out business will receive and pay cash for the assets and liabilities post completion - there is typically a period post Completion where a transitional services agreement is in place. These arrangements should dovetail with the requirements of the sale and purchase agreement;
- Variances in the application of accounting standards and policies across different territories or entities which could drive an unexpected movement in the final price; and
- People with detailed knowledge of the deal and commercially agreed items moving on to other projects or leaving the business.
What will planning ahead achieve?
In our experience, thinking ahead and tackling the practicalities of the Completion Accounts process early will:
- Allow you to take control of the Completion Accounts process;
- Provide greater clarity over the balances that will transfer, the eventual purchase price and the level of day 1 funding required by the purchaser; and
- Uncover potential problem areas early and focus management time on those areas where value could be eroded.
If you'd like to discuss any of the issues we've raised here in further detail please do get in touch: