Before the COVID-19 pandemic brought mergers and acquisitions to a standstill, dealmakers increasingly turned to carve-out deals –the sale or divestiture of a business unit or division from a company. Our research shows carve-outs have increased by 200% since 2016, demonstrating the attractiveness of these deals.Our research shows carve-outs have increased by 200% since 2016, demonstrating the attractiveness of these deals.
But carve-outs are far from straightforward, especially across borders. The more jurisdictions involved, the higher the degree of complexity firms must navigate. (Complexity, in this case, refers to the headaches and distractions that arise when complying with new regulations, language barriers, borders, currencies, and laws.)
The increased complexity of a carve-out creates both opportunity and risk for buyers. On the one hand, not many firms have the expertise or resources to re-incorporate a business from a parent structure, meaning the few companies able to do this have a natural advantage. On the other hand, the execution risk is increased significantly, and value can be quickly lost from carve-outs if not executed correctly.
A recent survey by TMF Group found that 34% of senior executives from private equity firms with buy-side experience and 27% from corporations said their most recent cross-border carve-out failed to deliver on expectations, with 24% and 19%, respectively, saying costly overruns significantly impacted the deals. If a deal is delayed by more than four months as a result of business entanglements across jurisdictions, the average resulting cost overrun comes to about 16%.
Consider how one financial executive in India described an overrun deal: “We hadn’t expected it to be seamless, but we weren’t prepared for the effect on costs, and we had to make some hasty financial decisions to get the deal over the line.”
If a transaction takes place across jurisdictions, the complexity of those deals increases once local regulations come into play. Examples of regulations that, though innocuous, can significantly delay the deal-making process include:
-In some markets, it can take up to 60 days to open a bank account
-In others, business licenses are required before the new entity can register for VAT, while the company may need a local fiscal representative or director
-Some markets, such as the U.S., carry significant differences between states for regulations pertaining to licenses, tax registrations, and employment regulations
If these complexities aren’t accounted for at the start of the deal-making process, the monetary value of the deal can decrease, as evidenced by the 1 in 5 deals that create millions of dollars in extra costs. Take it from a head of finance at a Finnish corporation: “Complying with the domestic requirements, such as legal, accounting, and taxation, were the most difficult aspects for us to manage…rather than solving complex operational issues, we were more concerned with getting the company ready for various compliance items.”
Conversely, having a presence in the country in which a deal is conducted increases the likelihood of a deal going well. Those with a limited or no presence in the target’s country were more likely to have disappointing outcomes, with 38% of respondents who had limited or no presence at all in the carve-outs jurisdiction noting their most recent carveout had been mostly unsuccessful in terms of reaching its strategic goals.
There is, of course, the question of when deal activity will return to a pre-COVID-19 pace. It’s a question of when, not if, because private equity firms are sitting on large cash piles, interest rates are historically low and companies are distressed. Companies facing a cash flow crunch may be more likely to sell off non-core assets than consider an outright sale of the entire business. The environment is ripe for carve-outs in the near future, although valuations may look a lot different than six months ago.
Randy Worzala is Head of Business Development – North America at TMF Group, a multinational professional services firm based in Amsterdam, providing accounting, tax, HR and payroll services to international businesses. The company has around 7,000 employees in 80 countries.