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— Industry Insight —
Buying a business is rarely easy. Buying a piece of a business, such as a division, plant or product line can be even more challenging. However, given current market conditions, companies are looking for ways to generate additional liquidity by divesting noncore or undermanaged business units. While this is creating many interesting investment opportunities, it is critical that investors understand all the facts and buy at the right valuation. For strategic buyers, this represents a unique opportunity to expand existing businesses and realize economies of scale. Private equity investors can bring new resources and strong executive management capabilities to optimize processes and help these "black sheep" flourish. For financial and accounting purposes, these transactions are commonly referred to as carve-outs. When reviewing the financial and operational data of the carve-out unit, potential buyers should be aware that information is often not subjected to the same scrutiny as corporate data prepared for investors, lenders and other constituents and may not be in accordance with generally accepted accounting principles. In addition, financial information used to manage a division of a business is affected by intra-company transactions, corporate allocations and financial adjustments, which may not be relevant to a potential buyer.
To get the true financial picture, a detailed analysis should be performed to consider the impact and nature of intra-company transactions, allocated costs and shared services. The analysis should include a thorough consideration of the potential costs for the carved-out business to operate on a standalone basis. This could include personnel costs, infrastructure requirements, IT needs and other operational costs. Only after completing such an analysis can profitability, quality of earnings and financial forecasts be evaluated. A similar analysis should be performed on the balance sheet in order to understand cash flow trends and working capital requirements of the standalone entity, which are often very different from the larger organization. Notwithstanding the operational challenges, other financial considerations of the standalone business should include the following: Both buyers and sellers consistently underestimate how much time
and effort are required to complete a carve-out. Further, the
disruption caused by this process can lead to missed business
opportunities for the entity being divested as well as management
fatigue. Regardless, it is imperative that buyers have a complete
understanding of the aforementioned issues before entering into a
definitive purchase agreement. Performing a detailed analysis of trial
balance level accounting information is necessary to understand the
true operating performance of the business being purchased. Beginning
this effort early in the transaction process allows buyers to more
quickly assess value and identify key negotiating points. Further, if
the carve-out analysis reveals a negative result, buyers can avoid
wasting time on unattractive investment opportunities. Patrick S. Martin and Mark A. Coleman are partners with Laurus Transaction Advisors LLC, a boutique financial and accounting due diligence firm. |
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