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The article in brief:

• Carve-outs have become a key driver of deal flow, with a 22.5% increase in volume from 2023 to 2024, driven by companies seeking to focus on core competencies and private equity firms looking for alternative investment opportunities.
• Sellers must consider valuation complexities, such as materiality, merger, and tax implications, when retaining a minority interest in a carved-out asset or undertaking a valuation of legal entities.
• From the acquirer’s perspective, carve-outs raise issues such as identifying stand-alone costs, managing master service agreements, and selecting a new management team, requiring a deep understanding of valuation and reporting processes.

Carve-outs, where a company divests a controlling interest in non-core business units or assets, often to a private equity fund, have become a prominent feature of the deal landscape in recent years. This trend has created unique valuation needs for both buyers and sellers.

Carve-outs have been a key driver of deal flow in recent years, with no signs of slowing down, as evidenced by the $23.72 billion in private equity carve-outs across 145 deals through early June, according to S&P Global Market Intelligence data. This represents a 22.5% increase in volume from $19.37 billion across 127 carve-outs in the first five months of 2024.

For companies, carve-outs offer a means to focus on core competencies, raise cash for new strategic initiatives, or return capital to shareholders through dividends or buybacks. Additionally, companies with underperforming businesses may face pressure from equity investors to unlock value by shedding these assets and paying down debt. By relinquishing control of non-core assets, companies can benefit from the potential upside while maintaining a minority stake. And finally, shifting regulatory landscapes and antitrust enforcement can also drive divestiture activity. 

From the sponsor’s perspective, the steady influx of new capital into private markets has led to increased competition for traditional buyout deals, making carve-outs a potentially appealing option.

Carve-out Valuation Considerations From a Seller’s Perspective

Before completing a transaction, sellers may need to undertake a valuation of legal entities to minimize taxes on the sale and future taxes.  

In certain situations, the seller may choose to retain a minority interest in the carved-out asset, given its potential for future growth. However, this can introduce additional complexities in the ongoing valuation process, particularly for public company sellers with a remaining minority stake: 

• Materiality If the seller is using equity method accounting and the position is determined to be material—if it significantly effects the seller’s financial statement—then it may trigger disclosure requirements or even consolidation of financial statements. Moreover, materiality can change over time. 

• Merger When a sponsor combines a carved-out asset with another entity in a roll-up strategy, the seller may find itself owning an interest in the combined entity. In such cases, shared services agreements and operational integration can add complexity to the valuation and reporting processes. 

• Tax In the case of roll-ups, tax treatment can be complex, especially in cross-border deals or when the value of one of the combined entities is stepped up after the acquisition and another is not.   

• Preferences In some cases, the acquiring sponsor’s equity may come with special rights and preferences, in which case the valuation may need to rely on option pricing models to value the minority interest. 

Valuation of Carve-outs From the Sponsor’s Perspective

From the acquirer’s perspective, carve-outs raise different issues, such as identifying stand-alone costs and managing master service agreements. Depending on the circumstances, historical data for inventory or personal property may be challenging to obtain from the seller. Often, a carve-out also requires identifying, selecting, and incentivizing a new management team, adding further complexity to the valuation and reporting processes. 

Summary

Carve-outs present unique valuation challenges for all parties involved. To navigate these complexities, it is essential to partner with a valuation firm that understands the intricacies of carve-out valuations, has a strong record of success in cross-border transactions, possesses global reach with experienced tax professionals, and is well-equipped to move quickly and provide timely guidance—all of which are essential for a successful outcome.   

If you have further questions about the valuation challenges associated with carve-outs or would like to discuss your next engagement, we welcome you to contact the article author or complete our Contact Us form with the details of your next engagement and we will be happy to discuss our credentials and capabilities.