The stats have a story to tell private equity firms and their portfolio company CFOs.
According to Deloitte’s 2019 M&A Trends Report,76% of M&A executives at US corporations and 87% of M&A leaders at PE firms expect the number of deals their organizations will close to increase. Closing a deal is one thing; successfully integrating it is quite another. Indeed, a recent Accordion survey found that more than 40% of PE firm partners and their portfolio company CFOs believe CFOs need significantly more operational guidance around merger integration to make the post-close period successful.
This guidance is of particular importance given the increasingly nontraditional nature of the assets being integrated. We’re talking about carve-outs. Once considered a vehicle to unload underperforming businesses, carve-outs have found favor as companies seek a more cohesive, strategic vision for their business – meaning that the noncore assets carved-out can be real, viable growth opportunities for interested and experienced PE buyers.
Integrating a carve-out is a unique animal, which poses complexities far beyond integrating a typical acquired asset or standing up a carved-out business. Doing it is not for the faint of heart CFO, nor is it a task for the inexperienced buyer — at least not one that should be undertaken without a roadmap for tackling the five issues that are specific to the integration of a carve-out.
Walking the Synergy Start Line. In a typical merger integration scenario, there is no need for a Transition Services Agreement (TSA). (A TSA is an agreement between a buyer and seller whereby the seller contracts with the buyer its services and know-how for a specified period of time to allow the buyer to acclimate to its newly acquired assets, infrastructure, systems, etc.) All typical merger deals are focused on short- and long-term synergy realization.
Conversely, when standing up a carved-out business, there are no synergies to consider. The prioritization is squarely on TSA and Day 1 readiness. But, in the merger of a carved-out business, the buyer must walk that synergy-start line … and carefully, at that. A lopsided focus on realizing the benefits of merger synergy distracts from the critical importance of continuing day-to-day business operations of both the divested company and the buying organization.
The smart, experienced buyer and CFO will understand the need to resist pressure to strip all costs from the start. The smart buyer will, instead, focus on crafting a well-negotiated TSA to ensure business continuity, while strategically selecting the synergy planning that should be accelerated because it won’t cause undue business distraction.
Salesforce optimization is a particularly good example of a synergy that can be tackled prior to deal-close. Getting a sense of product overlap and compliments upfront and using the pre-close phase to train and onboard the existing salesforce on cross-selling opportunities will ensure early value is realized, without disrupting an existing customer base.
Walking the Talent Line. In a straightforward merger, the buyer absorbs all employees. The focus is on reducing redundancies by identifying and nurturing the best players from both parties to the deal (and, of course, on overall workforce reduction). When standing up a carve-out, there is no talent integration. The singular focus is on getting enough resources to maintain business continuity.
The integration of a carved-out company, though, is a whole different ballgame. The buyer must ensure that the arrival of the conveyed team (the employees coming over with the carved-out organization) does not result in overcapacity (offsetting cost synergies), while also protecting against the opposite issue (too few resources to maintain the day-to-day business).
The focus must, instead, be on self-assessment. “How does our current talent map to the new products and services we’ll be absorbing through the merger? Where are the talent weak spots that we can address with a conveyed team? Where/how can we use the TSA to guard against redundancies where we have existing talent that can absorb carve-out operations?”
The nuance here is on employee assessment, identification, and negotiation. Not “How many do we need?” or “Can we cut?’ but “Who is it that we must have?”
Walking the System Selection Line. There’s an IT system default in straightforward merger scenarios. In a carve-out, there is no existing system – the IT infrastructure will need to be purchased anew. In a merger, there’s a default to the optimal system, without concerns about the overhead of an expensive TSA as it relates to borrowing the seller’s IT during the TSA period.
There’s no carve-out integration default. The buyer’s system will need to be assessed to understand whether it can effectively handle the needs of the newly merged entity. The seller’s system – which may be a better match – is not owned. Instead, it’s (expensively) on loan via the TSA. The goal here should be to jump-start IT decisions and quickly align on a conversion strategy to accelerate TSA exit. It will require extra effort and strategic planning during diligence to make educated assumptions about future-state IT needs.
Walking the TSA Line. There are, obviously, no TSAs during a typical merger. Conversely, since a carve-out has no existing infrastructure, TSAs are generally welcomed in all areas. But, in a carve-out integration scenario, the TSA needs are more nuanced. There are existing buyer systems, but those systems may not be equipped for Day 1 readiness.
Think, for example, of corporate travel programs. All companies have some system to book travel and process expenses. Is the buying company equipped to place conveyed employees on their travel program on Day 1? What are the tactical requirements that will need to be addressed pre-close to ensure a smooth transition (app education, new travel policy, pre-issued employee identification cards, etc.)?
The goal here is to find creative solutions to ensure that the newly merged company is not spending unnecessarily (and giving away value), while minimizing disruption to the conveyed employees’ workplace experience.
Walking the IMO/SMO Line. In both typical mergers and carve-outs, there’s an “us” and a “them.” In a merger, an Integration Management Office (IMO) is led by the buyer with target team involvement. In a carve-out, a Separation Management Office (SMO) is led by the seller.
The integration of a carve-out is, again, more nuanced. There’s the “us” and “them” (in the form of both the SMO and IMO) and then there’s the “conveyed” (in the form of carve-out employees who live in a state of limbo, or pre-merger purgatory, serving two masters simultaneously).
This buyer/seller/employee landscape has complex dynamics and more overall stakeholders to navigate. To navigate it well – and to ensure value retention – the smart buyer will engage external, experienced experts who can help create robust governance and communications policies, while being mindful of the interests of all stakeholders, including the often-overlooked parties.
These issues, when proactively identified and solved for, can ensure that a carve-out merger integration translates into real bottom-line value for private equity firms and their portfolio companies. When ignored — and further, when value creation is not accelerated during short-hold PE timelines — well, that’s a whole other chapter on carve-out chaos.
Ofri Porat is a Managing Director with Accordion, the private equity financial consulting and technology firm focused on the office of the CFO.