The Finance Function is the Cornerstone for Value Creation in Successful Carve-Outs
Introduction
Both corporates and financial investors are utilising carve-outs as a means of generating superior returns as sellers or buyers. For sponsors, carving out a business unit from its parent company provides an opportunity to maximise value creation, as they can identify value levers during due diligence and kickstart transformation initiatives during the sign-to-close phase, effectively delivering value from Day-1.
What sounds simple in theory is often challenging in reality. Carve-out processes are complex as they require the build-up of a fully functional standalone organisation that was previously part of a larger group, typically within a short period of time. It is true that, with the support of the selling entity, putting the necessary infrastructure, resources and talent in place for the new company to operate effectively is very achievable, but it’s not always the case.
The finance organisation as a key value enabler
The finance function can play a critical role during and after a carve-out, helping to fully deliver the financial benefits of this type of transaction. In addition to supporting identification and delivery of a value creation agenda, the finance organisation is the key enabler as it brings financial transparency, offering an accurate view of the financial impact, as well as actual progress of any improvement programme.
Some key responsibilities of the finance function in a carve-out include:
- To establish financial baselines agreed by seller and buyer
- To develop and justify robust stand-alone adjustments (savings) on sell-side, whilst being able to challenge those on buy-side
- To work with IT and other areas to ensure the Transitional Service Agreement (TSA) is fit for purpose
- To support technical accounting requirements (e.g. closing accounts)
- To maintain and enhance management reporting
- To establish a new control framework.
In this article, we explore the four areas we see as being critical to ready a finance organisation to the challenges of a carve-out process.
1. Fast-track the model definition and set up of the “new” finance organisation
Typically, the finance organisation of a carved-out entity is designed to fit its prior purpose in supporting a business division. This means finance organisations are rarely “standalone” from Day-1, and often require support from the seller via a TSA to operate post-close.
The definition of a new finance function therefore needs to take into account changes in requirements of the newly carved-out business and its stakeholders (e.g. lenders’ reporting and managing cash), as well as short-term, transaction-related needs (e.g. preparation of closing financial statements, tracking of value creation benefits). It is also important to understand roles and responsibilities between finance and other functions (e.g. ownership of key finance and administration systems or need to set up a new ERP environment) and how this may shape the talent and skillsets required within finance and third-party providers.
Notably, due to current labour shortages in many industries, we observe that hiring qualified finance personnel can take six months or longer, further impacted by notice periods of several months. Buyers should aim to finalise the definition of new roles and responsibilities for finance teams during the sign-to-close phase and start recruitment as quickly as possible thereafter. In cases where hiring proves to be very challenging, a “plan B” scenario should be defined and executed, such as via outsourcing providers or hiring temporary staff.
2. Define common controlling principles
To ensure sensible interpretation of the numbers, it is critical to create controlling reports that are not only useful for the business but that also resonate with the priorities set out by the new investors. Prior to closing, carve-out teams on the buy-side should focus on four areas:
- Definition of reporting schedule (e.g., weekly, fortnightly or monthly)
- Alignment on financial and operational reporting KPIs
- Establishment of enhanced liquidity management and cash-flow forecasting tools. These are normally not in place in the carve-out perimeter, especially when the buyer is a PE investor
- Definition of format and tools used to prepare reports.
Post-closing, controlling approaches between the investor and the carved-out business need to be aligned as quickly as possible. While some financial terminology is part of the everyday language in most organisations, experience shows that the exact definition of each technical term can vary significantly between companies. As such, it is important to, first, analyse the differences in the definition of KPIs and other financial terms; then define a common approach and set of KPIs and implement the approach. Because there rarely is a one-size-fits-all solution for controlling, the process should consider the specific requirements of each business.
3. Efficient data migration & management
Data migration is a critical aspect of effective controlling, as migrated data provides comparable metrics from past performance, giving a solid indication of improvements achieved. One key consideration should be the required level of granularity (e.g. line item levels including attachments or aggregated data only) and any potential legal obligations. Given meaningful data migration requires an in-depth knowledge of accounting principles and policies being used, preparation should start as early as the pre-closing phase. This includes activities such as the harmonisation of general ledgers, controlling structures, and cost accounting principles. Depending on migration timing (e.g., during financial year), additional complexities can arise, such as the audit process for the transition period.
4. Cashflow forecasting as priority as of Day-1
Cash management should be a priority from Day-1. Even if the transaction is well-communicated and the business is performing well, the turbulent times around signing and closing can lead to unforeseeable cash shortages after deal-closing. For example, customers might still pay to the carve-out perimeter’s old bank accounts (possibly owned by the seller). It does take time to identify and transfer such mistaken payments to the buyer. To avoid unnecessary surprises, we usually implement a short-term cash flow forecast from the get-go. This will help a buyer not only understand the liquidity in the carve-out perimeter, but also to quickly understand the business from a customer and supplier relationship perspective.
Summary
The finance function plays a vital role in a carve-out process and represents a key cornerstone for a transaction’s success. However, we often see that affected employees are not ahead of the process and quickly find themselves in defensive positions. To avoid that risk, we recommend that roles and responsibilities of a new finance organisation are defined and implemented as early as possible around signing and/or closing of the deal, even if leading to increased costs for a limited period.
It is possible to create a set of financials that describe the business in a true and fair view whilst still meeting the investor’s requirements and supporting the making of sound business decisions, including the implementation of a value creation programme. By making the finance function a priority, the team become the enabler in supporting value creation, as any deviations from initial plans are identified easily and countermeasures defined and implemented quickly.
For more information or if you have any questions about your next carve-out, please contact our team of experts.
