Article 4: Elements of a divestment process
By Christophe Van Gampelaere, Global PMI Partners
Undertaking a divestment is an end-to-end process, independent of whether it is simple or highly complex. The divestment process depends on several elements. Global PMI Partners’ Acquisition Carve-Out FrameworkTM illustrates this as follows (Fig. 3):
Fig. 3. GPMIP Acquisition Carve-Out FrameworkTM
Every phase will be discussed below and should give you an idea of what the divestment process looks like.
4.1. M&A strategy phase
The start of any divestment process is the M&A strategy phase. For the Seller, this means a thorough assessment by the Board of Directors and management of the rationale for divestment. Ideally, management has the luxury of time to prepare the target for sale: the so-called ‘exit readiness’ process. This sets the deal up for success. As the Parent puts the Target on the market because it no longer fits in its business model, equally, potential buyers may have identified gaps in their own business model, a gap that can be plugged by acquiring the Target. Both buyer and seller go through this “M&A Strategy” phase.
4.2. Search phase
We view the ‘search phase” from the seller’s point of view: the search for a buyer. Depending on the drivers for the divestiture, a seller may have different priorities in the sale process, summarized in the next table. Depending on the priority, the search process will be different.
Table 3. Exit priorities for the Seller
|Exit priority||Driver||Negative impact for seller|
|speed||a sense of urgency, e.g.– to stop cash bleed– to generate money to enable the parent to honor debt covenants||– lower selling price– potentially lower quality of Transition Service Agreements– less visibility on stranded costs|
|high selling price||– selling the business at the top of the market– to generate money for use elsewhere in the business– opportunistic||– investing time and effort in multiple and parallel sales scenarios such as IPO, MBO, MBI, PE buyer, industry buyer– longer sales process– going through a bidding process|
|confidentiality||– finding the right buyer– protection of image– avoidance of uncertainty with suppliers, customers, strategic partners and personnel||– no bidding process– fewer parallel sale tracks– generally lower price|
We recommend any seller to invest in finding the right advisor to help with the search for the appropriate acquirer. The usual intermediaries are the big investment banks, some Big Four, and local small boutiques, specialized in an approach tailored to the seller’s industry or specifically suited to his exit priority.
Prevent the sale from dragging on too long. Extended sales processes lead to value erosion, uncertainty, competitors taking advantage of uncertain times, and key personnel leaving.
4.3. Due diligence phase
A classic due diligence process is undertaken by the acquirer. The seller’s responsibility is to prepare a physical or virtual data room in which all relevant information about the entity that is up for sale is stored. If the seller has time to prepare the sale, the quality of the data room can be enhanced, more potential buyers may be retained, and the selling price is likely to be higher. The seller may be assisted by legal, tax and financial advisers in the preparation of the data room.
Transition Service Agreements (TSA’s)
A transition service agreement is an agreement between buyer and seller in which one entity provides services (e.g., IT, finance, HR, real estate, payroll, etc.) to the other in order to ensure business continuity after Closing.
Specific for a divestiture is that in addition to the classic data room, a seller can prepare a very detailed menu of transition service agreements.
If the target is highly integrated into the parent company group, any buyer that lacks visibility of how entwined the business is with the parent will significantly discount his offer price due to the risk the transaction entails. A seller that can provide clarity of the services delivered to the target pre-deal and offer secure transition services post deal has a better chance of obtaining a higher price
Vendor due diligence
Not specific to a divestiture, but in vogue, is the Vendor Due Diligence (VDD) report. It is a due diligence report commissioned by the seller to a Big 4 advisor and made available to certain interested parties. The advantage of a VDD report in a divestiture situation is the objective opinion provided by the advisory firm. In addition to the traditional Financial Due Diligence chapters on quality of earning, on- and off-balance sheet items, working capital and net debt, a VDD for a carve-out answers specific questions like ‘does the carved out entity contain only leftovers; can the management structure hold the company afloat; where does the intellectual property reside?
4.4. Plan carve-out and transition
The approach to planning a carve-out will depend very much on both the exit priority and the complexity of the target, (see “Typology by divestment complexity”). To a higher or lesser degree, exit readiness requires certain elements we see returning in the planning for the carve-out:
Assets will be taxed and valued by the buyer, so it makes sense to clean up the fixed asset register, write off and remove any obsolete inventory, and comb through the accounts receivable aging balance.
Tying in customers, suppliers, management and key personnel
If no formal contracts exist with customers and suppliers, now is the time to formalize such relations, preferably covering the target for potentially adverse “change of ownership” clauses.
Involving key target management and personnel early on is important to avoid value leakage, and gain insights from the experts on how to conduct the carve-out.
Normalization and optimization of earnings
Any activities not belonging to the target are taken out of it, so as to present as clean as possible a business case. At the same time, management may want to present an optimum EBITDA, since deals are often at least partly valued in multiples of EBITDA.
Working capital optimization
As for EBITDA, any improvement in working capital has a disproportionately positive impact on the selling price. The longer in advance this can be prepared, the better, as working capital is often measured over a historical period of 12 to 36 months.
Process description and preparation of Transitional Service Agreements
Process descriptions provide visibility to a buyer. Such transparency typically keeps more bidders in the process, resulting in a higher sales price.
Preparation of the carve-out management office
- The elements of a carve-out management office are:
- the overall governance structure
- defining the workstreams
- the carve-out master plan
- the team charters
- the action list
- the risks and issues log
- the meeting cadence
- the communications office
- the reporting dashboards.
The building blocks of the overall governance structure are the Steering Committee, the Carve-out Management Office (CMO), and the functional workstreams, as depicted in the next graph:
Fig 4. The Carve-out Governance Structure
The Steering Committee typically consists of the Seller’s CEO, a major representative of the Target, and an independent outside advisor. It provides the major guidelines on how to separate the business, the timeline to deadline, internal and external resources dedicated to the task, and it provides endorsement of the carve-out. Steering Committee member spend 5 to 10% of their time on the separation.
The Carve-out Management Office (CMO) is responsible for the planning and executing the carve-out project. It does this by giving direction, coordinating interdependencies between workstreams, reporting progress and resolving issues. The CMO provide knowledge, insights and support while ensuring overall project compliance, risk management and Day One readiness.
The leader in the CMO can be someone with an important future role in the Target or is sometimes a retired management team member being brought back in because of his knowledge of the business and stakeholders. The carve-out leader is supported by internal or external project managers. Leading and supporting a CMO is a full-time job, right up to Day One.
The workstreams are the functional areas where the carve-out needs to be attained. These areas cover all of the Target’s business, such as IT, finance, human resources, sales and marketing, etc. The workstreams are often tailored to match the way the company is organized. TSA and communications workstreams are added, or embedded in other workstreams.
The nominal workstream lead is usually the internal head of the function. While the lead spends between 20 and 40% of working time on the project, there is often a need to complement with a full time internal or external resource to lead the effort on the ground.
A workstream has the responsibility of executing activity steps and attaining milestones, while minimizing business disruption. The workstream needs to communicate up to CMO and down to active team members.
People, processes, systems, assets, legal, financial: these are areas of focus that return in each workstream. We advise workstream leads to go through checklists and work with their advisors, focusing on these areas.
4.5. Post-close phase
The post close phase consists of three major parts: one where the Target is dependent on its parent, formalized through the TSA’s; a second where the Target either needs to be integrated in the acquirer, or needs to become a completely standalone entity; and third: in both cases it needs to wean itself off of the TSA’s.
Undertaking a divestment is an end-to-end process, independent of whether it is simple or highly complex. In this article we framed the divestment process in Global PMI Partners’ Acquisition Carve-Out FrameworkTM .
In the next article we will look deeper into the complexities of TSA’s.