Carve-Out

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Carve-Out Meaning

Carve-out refers to the business strategy whereby a parent company decides to partially divest one of its business units by selling minority interests of the subsidiary to an outside investor or a group of investors. In other words, the parent company does not sell the business unit outright but rather sells an equity stake in the business or relinquishes a controlling stake while retaining an equity stake. In essence, a company uses the carve-out strategy to capitalize on a business unit that is not its core competency.

Generally, carve-outs are excellent investment options for financial buyers, such as private equity funds, because these are invariably good businesses with experienced management. Still, they do not fit into the parent companyā€™s value proposition. In some cases, these carve-outs are the troubled child of the parent company that the new buyer can turn around through some financial or operational support. There are also instances where the existing management senses the opportunity and amasses capital to purchase the business unit, resulting in a leveraged buyout.

Table of contents
  • Carve-out means the business approach that a parent company decides to partially dispossess one of its business units by selling subsidiary minority interests to an outside investor or an investors group. 
  • It is an excellent investment option for financial buyers like private equity funds because these are invariably good businesses with experienced management. 
  • The spin-off is another form of carve-out in which a new independent entity appears from the parent company.
  •  In this case, the parent does not sell the business unit shares but instead makes a separate entity out of the business unit to make a standalone or independent business with the management and shareholders.

Example of Carve-Out

Now, let us look into the spin-off of Lehman Brothers by American Express as an example of carve-out. In 1994, American Express announced the spin-off of its investment banking unit (Lehman Brothers) to form a new independent entity jointly owned by shareholders of American Express and employees of Lehman Brothers. The unit's core business included corporate services, signature charge cards, travel, and financial planning. They marketed the benefits under the brand name American Express. American Express also infused more than $1 billion into Lehman Brothers as capital to financially support the newly formed company. Although the former parent had no directors on the board of Lehman Brothers, it continued to get a share of the entity's future profits.

How Does Carve-Out Work?

Carve-Out

Step #1

The seller needs to understand the motivation of the buyer to invest in the carved-out business unit. The buyer will usually have their reasons for purchasing the business unit, and the seller should be aware of them. Based on the buyer's objective, the seller will then market its assets or the carved-out unit to the potential buyer accordingly.

Step #2

The seller will then have to prepare the Pro-forma financial statements of the carved-out unit for valuation, funding, and compliance. It should indicate the costs involved before the carving process and immediately after. Effectively, the potential buyer should know what they are investing in and whether or not it makes sense financially.

Step #3

The seller should maintain transparency about the cost of purchasing the carved-out unit. Typically, the seller should be aware of the carved-out unitā€™s valuation and ensure that all the valuation factors are taken into account and that nothing gets overlooked. In addition, it helps in packaging the carve-out assets and marketing them better.

Step #4

Finally, the seller needs to assess the impact of the carve-out on the remaining business. Especially the negative ones are analyzed to understand how the remaining divisions will go about their business after the divestment. In addition, assess the cost structure and profitability of the remaining companies.

Spin-Off as a Carve-Out

The spin-off is another form of carve-out in which a new independent entity arises from the parent company. Over time, that new entity is split from its parent to acquire legal, commercial, and technical independence. On the other hand, in this case, the parent does not sell the shares of the business unit but rather creates a separate entity out of the business unit to form a standalone or independent business with its management and shareholders.

Most of the new entity's shareholders are from the parent company's existing shareholders. Further, the parent company has an equity stake in the new entity to have a share in its potential future profits.

Frequently Asked Questions (FAQs)

What is a carve-out in insurance?

Carve-out is a term that refers to the coverage elimination of a particular category of benefits services. These most common medical services are not added to a standard health insurance contract. Moreover, they are paid separately for vision, dental, mental health coverage, or prescription drugs.

What are carve-out financial statements?

Carve-out financial statements" is a general term used to express financial statements obtained from the larger parent entity financial statements.

What does an equity carve-out do?

In an equity carve-out, a business sells shares in a business unit. The company's eventual objective may be to sell off its interests entirely, but this may not be for a few years. It allows the company to obtain cash for the shares that it now sells.

How do carve-outs create value?

A spousal carve-out is a health insurance plan for employers to regulate health care costs by restricting coverage for an employee's spouse. "Working spouse rule" is another term used for this plan type. Generally, spouses use several spousal carve-out design alternatives.