When a large company sells off a division, the buyer gets the business and very little of the company that ran it. The monthly close, the systems, the purchasing contracts and often the people who planned the numbers stay with the seller. If you are buying one, the work that decides your first year is finding those gaps before you sign, and naming who fills each one.
You may get the chance sooner than you think. Just over half of large-company CEOs, 51%, intend to sell part of their business within a year, up from 42% in May, in EY's October CEO Outlook.
Why more divisions are coming to market
I expect a good share of those divisions to land with private equity firms and with mid-market companies buying their way into a product line or a region, because a unit that was too small to matter to its parent can be a large step for a $50M to $1B company. In the same survey the share of CEOs planning to buy fell from a record high in May, which leaves selling level with buying.
The headline on a carve-out will tell you what was bought. As I wrote about reading a deal past its headline, the question for an owner is why, and for a carve-out the next question is how the business runs the day after it leaves home.
The standalone numbers were built, not reported
Inside the parent, a division's results carry shared costs the parent allocated to it: finance, IT, HR, purchasing, sometimes the sales team. Once it is on its own, each of those becomes a cost you build or buy, and usually at a smaller company's prices.
That means the standalone profit and loss you are handed is a model somebody constructed. Early in my career my job was taking business cases apart by building a parallel model on my own assumptions and setting it next to the one on the table. A carve-out deserves the same treatment. Rebuild the cost lines yourself from what it will take to run the business alone, and compare your version with the seller's.
What stays with the seller on day one
These are the gaps to look for first:
- The monthly close and the reporting your board or new owners will expect in the first quarter.
- The systems the business runs on, including the customer and order data, and whether you can operate them or have to replace them.
- Purchasing contracts and freight rates that were negotiated at the parent's volume.
- The people who did the forecasting and planning, who often sat in a shared team at headquarters.
- The decisions. A division leader who reported up to a group president may never have made the final call on pricing, capital or hiring.
Whatever support the seller agrees to keep providing for a while is a bridge, and your plan should say what replaces each piece and by when.
Put an operator on the gaps from the first day
A business that has always worked because a larger company stood behind it has to prove it can work without one. Systems that work can scale, but you cannot scale a system you do not know works, and a carve-out's systems are untested on their own by definition.
The fix is a named person who owns the gap list from close, with an agreed plan and dates, who has run a business at the size this one needs to become. That can be a hire, or it can be an experienced operator for the transition year while you find the permanent team.
When the division already runs on its own
Some divisions were run as separate companies all along, with their own finance team, their own systems and a leader who owned the full profit and loss. If that is what you are buying, the day-one gap list is short, and your diligence time is better spent on the market and the customers than on the plumbing.
Write the day-one list before you sign
Before the deal closes, list every function the parent provides to the division today, who will do it the morning after close, and what it will cost. Every blank line on that list is a gap you are buying. Fill it in your plan and your model before close, and if you would like a second set of eyes on that list, I am glad to talk.
John Wyatt · John Wyatt's page · All posts · RSS