Keys to Success in Integrating a Carve-out: Navigating Complex Challenge

‍Introduction

The process of integrating a carve-out, or divested asset, into a new or standalone organization can be a complex and challenging endeavor. Carve-outs involve the disintegration of highly integrated processes, systems, applications, and data from the parent organization, requiring careful planning and execution. In this article, our key strategies and best practices for successfully navigating the integration of a carve-out will be explored. By understanding the unique complexities and risks involved, and implementing the right approach, organizations can maximize the value of a carve-out transaction.

Understanding Carve-outs

A carve-out refers to the sale of a specific business unit, division, or asset to outside investors, while the parent organization retains control of the remaining operations. This process allows the parent organization to focus on core areas of business while unlocking the potential value of the divested asset. However, carve-outs present unique challenges due to the need to disentangle integrated processes and systems, address neglected assets, and manage costs effectively. Carve-outs can be integrated into an existing organization (typically strategic product line expansion) or be stood up as a standalone company. The standalone carve-out is definitely the most complex and challenging in terms of urgency of timing, breadth of scope and the complete shift of corporate mindset.

Complexities of Carve-outs

Carve-outs are inherently complex due to several factors:

Assets: Carve-outs often involve non-core or neglected products that need rationalization, lack historical investment, maintenance, management, or staffing. Custom applications and other IT assets often come with significant technical debt.
Enterprise Applications: The carve-out typically inherits only a fraction of their enterprise apps. A carve-out which is being incorporated into an existing org typically has an easier time unless their business processes are highly integrated into a CRM or ERP package that cannot be moved to the new org. Standalone carve-outs typically have 9-12 months to standup 30-50 applications from scratch along with data migration, posing huge challenges.
Costs: Forecasting and understanding the costs associated with a carve-out can be challenging for both the buyer and seller. Often estimates are made by firms who have never actually run a carve-out standup.
Financial Statements: Unless the divestiture comprises a fully intact entity, financial statements and operating metrics may need to be created for the divested asset. Each carve-out transaction is unique and may require additional due diligence, valuation, legal, tax, and financial advisory services. This process sometimes does not complete for 6 mo.
Commercial Challenges: The new entity or business unit was purchased with an investment objective which typically requires significant top line growth and bottom-line improvement. These objectives are often in direct conflict with stand-up activities.
Talent: Sellers like to fight to keep or reassign talent prior to the transaction, leading to potential talent gaps and a higher rate of employee defections or declined offers. IT is often left with an underqualified “tech guy” to function in a CIO/CTO role for the entity and even more often left with no staff at all. Recruiting can often cause carve-out standup to be delayed or to fail.
Employee Psychology: Employees who have built their careers in a specific division may feel rejected or betrayed by the carve-out, leading to challenges in employee morale and engagement. Also, the employees may be used to “big daddy” (parent) do everything for them, and very much struggle in an entrepreneurial environment with huge commercial pressure.

Strategies for Carve-out Success

To ensure a successful carve-out integration, organizations must follow a strategic approach that addresses the unique challenges and complexities involved. The following strategies can guide organizations through the integration process:

Understand the Investment ObjectivesThe definition of what the Private Equity firm is expecting from the carve-out is critical to understand how to approach integration. If the objective is an optimize value and flip (1-3 years) then the focus is on maintenance of processes and technology. For a longer hold period, the focus is on adding value long term. This may involve innovative, go-to-market strategies, shortening quote to fulfillment cycles, cost cutting or several different approaches. This begins to form the strategy for all business areas to react and strategize, including IT.
Understand the Terms and Timing and Costs of the Transitional Service Agreement (TSA)A Transitional Service Agreement (TSA) is crucial for managing the disentanglement of integrated processes, systems, and data. The first step in successfully integrating a carve-out is to define the scope of the deal as defined by the assets being conveyed and the scope of how it is to be transitioned. Development of TSA timing and costs should be done immediately by functional areas.
Establish a Clean Line of LeadershipA carve-out is often led initially by the former division leader (or one put in place just before the sale). The leader may or may not be a strong leader or have the experience and wherewithal to lead the new organization. Standalone carve-outs often suffer from CEOs who have never built or grown a company. A standalone carve-out often includes a raft of interim leadership put in place by the PE firm to lead the organization through the transition. It is critical that the CEO or division leader completely incorporates and supports the change required by the interim leadership as well as ensures strategic alignment. Many consulting firms advocate IT transition services be run by a program or project leader. Our experience is that this is doomed to failure as the senior leadership will not treat them as a peer. The IT leader needs a title such as Interim CIO/CTO to allow them to make decisions and be an integral part of the leadership team. The IT leader also needs to form a strong bond with the CFO, often interim, to breed efficiency and success as many processes are tied to finance. The IT leader can also be the catalyst to drive organizational change that the rest of team may not be prepared to do. If the IT leader is inexperienced in either executive reporting or in acquisition integration, an interim leader is in order to be brought in to lead the transition and coach the inexperienced person on what new reality looks like – heavy increase in reporting, fiscal planning and responsibility and the strong potential of acquisitions in the 12-18 month timeframe.
Develop a Common Understanding of Current State Processes and Start Formulation of Desired StateOur philosophy is that all carve-out teams are more effective at doing what the business needs when there is a common understanding of the Lead-To-Cash cycle. We typically do that by conducting a 2-day facilitated session with all business leaders in attendance, including the CEO. After digging through the top-level mega-processes, we encourage the business leader for the section being discussed and real-time diagrammed to bring in key team members to contribute to understand. As the team sees the detailed process being defined efficiency opportunities are often identified, innovation ideas are surfaced, key data to be tracked, tools and integrations are detailed, and common understandings are achieved. The future state then can be a copy of the diagram(s) to help define how the team wants the process to work. This core process understanding is key to making sure things do not fall through the cracks, critical processes defined, and opportunities to innovate. We find this process to be the most effective tool in bringing business leaders together to achieve a common goal.
Get the Entity Set UpStandalone carve-outs have a mountain of business startup issues that plague every new business, but the new carveout entity must carry on business. Bank accounts, credit cards and state/country registrations for business tax, operating license, sales tax and payroll may be the biggest hinderances to success. We cannot stress this enough that is job one. Since IT will be the primary spend agent in the early days (outside of inventory if applicable), this can be a major hinderance to acquiring software licenses, setting up payroll, etc. Understanding the tax and entity structure is also a critical decision that must be made. It is important that the PE sets up the name of new legal entity correctly in the beginning as this can have massive downstream ramifications down the road.
Perform an Assessment of Client-Facing and Surviving Technology, Develop a Future State, Build Reference Architectures

Our experience shows that carve-outs that have custom developed software or portals have significant technical debt or have made other poor choices as a rule. It is important to complete an architectural review, security assessment and quality measurement on those platforms to determine the future path forward. Also, assessment of end user/server hardware, cloud architecture, and security are important to understand and evaluate before plans are created. This needs to be completed quickly. Once completed, the desired state Lead-To-Cash and the technology assessment should inform the final desired state for process, architecture and enterprise software suite. The future state should INCLUDE consideration for the Full Potential Plan (FPP) right up front. It does not mean that the design for separation should fully implement the FPP during the TSA but can inform decisions. Reference diagrams should be built and used as a road map for communication of requirements and with integrators. It is during this stage that most vendors are identified.
Build a Critical Path Model & RoadmapThe definition of the critical path to separation is one of the single, most important activities you can undertake. This allows thinking to determine a target separation date and what the timing for the core, critical tasks to take. A Gantt chart is often not enough to understand what the driving forces of success entail. This model should be circulated and communicated with all of senior leadership to get on the same page. The model will also refine what resources need to employed to achieve the end state at separation. A formal roadmap which timeboxes and defines when vendors & new employees are onboarded, systems are being implemented, user acceptance activities are to be completed, and when new systems will be cutover. The roadmap is a key communication device that the entire management team will work to.
Develop a Bottoms-Up Financial Model for each Functional AreaThis is a critical step of maturation as many/most of the business leaders inherited from the parent do not have a culture of accountability. This should then be reviewed in light of the deal model and adjusted accordingly. This will make the senior leader (interim or not) start to understand the reality of their new existence and to begin the adjustment process toward accountability. Even though the TSA period is chaotic, finance should work with the business leaders to understand their spend against plan and build accountability. The IT plan is incredibly complex and comprises the majority of the transition spending as a rule. It is critical to get this plan right for both one-time and operational costs.
Contract vendors and systems integratorsContrary to current Private Equity practice, the system integrator should NOT be hired first and allowed to define the future state architecture and business processes. This methodology only leads to increased costs, bad decisions and, most importantly, time from transition activities. Most large systems integrators will desire strongly to push a solution or technology that is in their best interest, AKA expensive and needing heavy resources. It is critical to identify IT experts and integrators that can help get the job done and work on the direction set by the transition leader/team. The reason an integrator is used is not because of their amazing solutioning, it is largely because they have human resources who have expertise in a particular technology or subject area. Vendors (Hardware, Software, Consulting) need to be told the requirements right up front about the timing expected for contracting, delivery and implementation. The requirements need to be detailed enough to get the job done but not so detailed as you are working on documentation longer than implementation.
Establish a Transition Project TeamA team of program and project management need to be put into place to carry out the roadmap, facilitate execution of the plan for each workstream and across the enterprise, monitor and gage activities of the vendors and system integrators, track costs for the project and program, identify risks, and prepare executive status reporting. The program/project team should be driving tasks internally and with the vendors/integrators, but not managing per se, as this is the job of the business leader responsible for the workstream. IT will fill a cross functional role in working with the other business leaders to make sure they are integrated into IT-facilitated processes. This establishes a pattern of ownership of results among the entire leadership team. The senior leadership team, including IT, will not be successful unless there is strong sponsorship from the CEO/division leader and the PE firm.
Recruitment and Organizational CultureRecruitment, particularly in IT and Finance, can be the key to success or failure. Hiring permanent leadership from the outside that has enough rounded experience to handle the Newco needs is incredibly important. Also the hiring of multi-functional employees is key as the financial model will likely not allow staffing at desired levels. Hiring a good recruiter or a suite of recruiters is critical to not making mistakes and having a qualified pool of candidates, particularly if the carve-out is not in a top 10 city. Integrating a carve-out requires a shift in organizational structure and processes. It is essential to prepare the team for this change and minimize disruption to business operations. Communicate the changes early on. Communicate throughout the transition. Engage employees by reaching out to them formally and in informal setting that solicits feedback. Change management is perhaps the most critical component during the transition as it will increase individual ownership and accountability. This clarity will help organizations understand the full operating model components required for running the divested asset and identify any potential hidden costs. Our experience is that leaders from large companies have not had to define the key measures of success for their areas of the business and are often lost. An interim leader or CEO may have to work one-on-one to define the measures and why they are important
Expect and Plan for Commercial ChangesOur experience has shown that most “held” carveouts will have significant changes put onto them by the PE firm or management in the first 18 months. Our experience says there will likely be a product rationalization, product line innovation or expansion, a price increase, a rebranding effort, some kind of organizational change, and at least 1 due diligence for an acquisition. All of these changes are typically implemented in the middle of the of the TSA period and directly impact separation activities. Greater awareness of the impact of these needs to come from the initiating business leader or PE firm. Coordination is imperative across the enterprise, particularly with IT as these initiatives can derail the TSA separation activities. If an acquisition is put into process during the TSA, the senior leaders need to study and advise on the impact to the final separation from the initial carve-out. Planning and flexibility is necessary to deal with these changes that will inevitably come. Vendors selected need to be in alignment with these kinds of plans.
Don’t Forget the DataThe carve-out needs to understand the data it owns and ensures that it acquires all of it during the TSA period. This includes data in enterprise software, email, customer interactions, cases, share drives, team sites, SharePoint sites, files in Slack, documents in document management, marketing docs and images, code repositories, and many other areas. A coordinated data migration plan is critical and a responsibility matrix on who is responsible for identifying and checking the migrated data. Also, the carve-out leadership needs to identify what data they want to report on, who will use it, and what form. The PE may have specific requirements as well, such as detailed waterfall chart for sales orders, or a correlation analysis between Units Shipped, COGS and Employee hours, or a trend graph on the cost of customer acquisition.
Plan and Drive to Separation

Final separation (TSA exit) should be target to a time prior to the end of the TSA and planned according, if possible. This allows for the plan to suffer setbacks that will likely come on critical path workstreams. By timeboxing and measuring achievement against the target plan and roadmap, assessment can be made if a red flag needs to be raised. Early identification of major conditions changes is critical to be able to adjust or to escalate to the PE firm for budget changes or extensions. An extension or major budget increase should only happen in the event there is absolutely nothing to be done otherwise. Creative thinking, gut effort from internal resources, and heavy pressure to perform and meet deadlines on vendors/integrators is critical to success. This requires constant attention to details and cannot be reliant on routine status reports as the only source of knowledge. Some separations require a relentless push from Day 0 to exit in order to complete on time and on budget.

Conclusion

Integrating a carve-out is a complex and challenging process, but by following the right strategies, organizations can navigate the intricacies and maximize the value of the transaction. Defining common understanding and ownership, acquisition of the best resources internally and externally, building a great critical path plan and relentlessly ensuring the plan’s execution, alignment of commercial needs with transition plans, building a culture of accountability, and applying best practices are essential steps for successful carve-out integration. By carefully planning and executing the integration process, organizations can achieve operational efficiency and unlock the full potential of divested assets.

Additional Information: For further support in navigating and executing a carve-out integration, organizations can seek assistance from consulting firms such as Silas Tate specializing in carve-out transactions. These firms provide expertise in finance, marketing, IT, change management, and other critical areas, ensuring a successful integration process.