Carving out beauty

“Welcome to Yamaha,” begins an old observation. “Would you like a grand piano or a motorbike?” Some companies and brands seem almost farcically diversified, either for historical reasons or due to more modern consolidations and acquisition sprees. But while many corporates extol the benefits of bolting on, other companies and their shareholders are equally keen to carve out.

The eighth annual Carve-Out Survey, published by Aurelius at the start of the year, suggests corporate carve-outs will continue to rise in prevalence this year. Almost 80% of the advisory, private equity and corporate senior professionals interviewed predicted an increase in the number of global corporates looking to divest non-core businesses.

“The more instability there is in the world, the more it tends to encourage companies to sell things,” says Tristan Nagler, an Aurelius partner and head of its investment advisory team. His experience suggests the macro environment is spurring companies to sharpen their focus and divest any non-core areas they identify: “Carve-outs were a much more predominant topic at our 2025 fund raise. It makes a lot of sense to our institutional investors.”

Corporate governance issues are also a factor, he believes: “Big listed corporates are expected to look at their portfolio of activities during every annual planning cycle, and determine whether they’re all fit for purpose, meeting the long-term aims of the group, and driving shareholder value. Invariably, it’s hard to hold every single part of the business as vital and valuable. And as soon as you start rationalizing your capital, you have to make decisions. I think we’re just seeing this phenomenon of corporate governance driving best practice.”

Mala Shah, a partner in KPMG’s deal execution team who specialises in separations and carve-outs, echoes this sentiment. “In a difficult market many businesses are looking at which parts of their business are the right strategic fit and how to focus and make the best returns on their capital.”

“In certain circumstances we are seeing buyers be more innovative about how they’re thinking about approaching the acquisition and how it will be funded,” Shah adds.

Active interventions

Jason Caulfield, head of divestments at Deloitte, pinpoints two key drivers of the surge in sales. First, economic factors: “We had a long period post-Covid where companies were generally ‘risk off’. High interest rates meant it was not a great environment for selling assets, and finance was difficult.” But when interest rates were lowered, the taps were turned back on. “There was a surge of divestments then, because companies had pent-up demand,” he adds.

The drive to carve out assets also comes from activist investors, says Caulfield: “These investors have been saying it makes sense for companies to divest, to simplify your business, which enables you to re-rate the shares of the rest of the business.” He sees activist investors as a phenomenon that “can be a positive force, an important American export” when they not only encourage the strengthening of the core business, but also enable buyers, often PE firms, to “buy that unloved asset, buy that division, that product – whatever is being disposed of – and give attention to it, make it a very focused business, and provide the capital it needs to grow”.

For Nagler, activist investors are taking a view on the assumptions and methodology underpinning the corporate valuation versus the rest of the market: “They are running their eyes over businesses where the sum of the parts is more than the corporation’s market valuation, and saying to companies that you shouldn’t have this activity, or shouldn’t be putting any capital behind it.”

The annual planning cycle encourages shareholders to force management to focus on the core, rather than having their attention “distracted and spread over too many things”, says Nagler. “When the non-core begins to demand your time and capital, or when there’s pressure externally, you begin to think you could help your business by generating some cash to put back into the core. The best practice for a large, well-managed corporate that wants to focus its conversation with shareholders on growth is to show that they’re being proactive in pruning their portfolio periodically.”

At a time when many companies feel the need for capital investment, to explore AI potential, for example, “there’s a race to invest, and that money has to come from somewhere”, he adds.

Who gets what?

Preparation is key for any deal, but perhaps even more so in the case of a carve-out. To ready itself for the diligence process, the sell-side must start early and get a very clear view of what is being carved out, what services will go with it and how the carve-out will be done.

There are specific diligence challenges for carve-outs too, given that shared core functions remain at the parent company, as Nagler points out: “There’s a whole industry that provides carve-out financials.”

Shah tells clients they can’t expect to just make a decision and go into a marketing phase straight away. “You need to have a clear view of the perimeter, and a robust plan of how you will carve out the business in a document such as a separation blueprint,” she says.

“Typically, unless we know that the buy pool is only going to be strategic, we’ll always do that blueprint on the basis of it being a standalone business, which enhances the opportunity to think about the business differently, in order to identify opportunities to right-size it, or do things in a leaner and more efficient way.”

Ideally, those conditions would create a competitive tension between corporate and PE buyers. But Scott McCubbin, partner at EY, says most carve-outs are snapped up by PE: “They’re natural buyers. PE has made money, quite frankly, by buying really good carved-out assets and making them better. That’s what they’re looking to do.”

There are, of course, challenges from a legal perspective. Lee Harris, M&A partner at Eversheds Sutherland, says the central challenge at the preparation stage is to identify the carve-out business perimeter and then “horizon scan” and plan for any legal roadblocks to implementation of the carve-out: “You identify which assets, contracts, liabilities and employees will transfer, and ensure those assets and employees can be transferred without impacting the carve-out timeline or deal certainty. That requires careful contractual, regulatory and legal analysis, broad stakeholder interaction and input, employee transfer and consultation considerations, and the coordination of a multi-specialist, often multi-jurisdictional team to ensure coherent, consistent delivery without surprises.”

One element of sell-side work unique to carve-outs is the stranded costs that remain with the parent company after the deal. “The margin of the remaining business drops because shared costs, systems and services are no longer absorbed by the revenue that’s left the business,” says Caulfield.

Matthew Woodgate, operational deal services partner at Grant Thornton, agrees that these stranded costs “where sellers are almost always going to be left with surplus capacity in some areas” need careful attention.

Woodgate and his colleague Chris Sharpe, who have drafted the forthcoming ICAEW best practice guide to carve-outs together with Eversheds Sutherland, see separating key resources as a central challenge of a carve-out process both for the buyer and the previous parent. “The vendor needs to do a lot more work in advance of a sale process,” says Sharpe, “both in agreeing the specific trade and assets to be included in the perimeter and in preparing accurate and robust carve-out financials for that perimeter. If this isn’t clearly in place in advance of a sale process, buyers aren’t going to have comfort around what they’re buying.”

Back to the drawing board?

Jonny Bethell, a partner at Taylor Wessing, says carve-out transactions can become longer and more complex due to operational and legal challenges: “I’ve worked on carve outs where the buyer needs to create the back office from scratch,” he says, “and on ones where the business is not neatly packaged up in a company and the buyer has taken everything.

“You do have to try and get confidence you are getting everything and everyone that you need. Sometimes it’s a completely independent business, and therefore monitoring past performance is relatively simple to do. Sometimes the business is fully integrated into a wider operation, in which case it is more difficult to analyse, model and forecast.”

Bethell believes a carve-out can give an ‘unwanted’ business a shot in the arm: “I’ve seen quite a few businesses transformed after being carved out,” he says. “In theory it could have undergone the same transformation under the existing ownership, but it’s more likely to be effective with the carve-out.” Specialist PE houses “know what to look for” as buyers and “can often incentivise and retain a high-calibre management team”.

For Nagler, PE “has an edge in this market, because it’s a specific skill set”. But long lead times can mean that there is relatively little competition for carve-out assets – and that can be an added attraction. “Some investors may choose not to have the bandwidth of two or three people tied up for 12 months plus, working on a carve-out,” says Bethell. “So, by virtue of there being less competition, those investors who are able and willing to invest the time could get more value than they would for a similar business which is neatly packaged-up in a competitive auction process.”

Patience pays

On the flip side, integrated business functions can be a big stumbling block for potential carve-outs. Caulfield cites a Deloitte survey of 1,500 vendor companies that found nearly a quarter have had a divestment that failed. “When we asked them what they’d do differently, most said that they would give themselves more time before interacting with buyers,” he says. “You’ve got something that’s been wired into the business for decades, maybe forever, and you’re having to unpick it. It takes a long time to get really prepared before you can hit the market.”

“Fail to prepare, prepare to fail,” is McCubbin’s advice for vendors. “Don’t just turn to your advisers and expect to get started today. Getting ready is absolutely critical. Being told to prepare your asset and get it dressed up appropriately to run a process is the best advice you’ll ever get.”

Eversheds Sutherland’s Harris says carve-out success can rest on the strength of the transitional service agreement: “A well-drafted TSA should provide operational stability for the buyer while giving the seller a clear path to disengagement at its earliest reasonable point.”