Through the process of an Equity Carve-Out, a company tactically separates a subsidiary from its parent as a standalone company. The new organization is complete with its own board of directors and financial statements. The parent company usually retains its controlling interest in the new company. It also offers strategic support and resources to help the new business succeed.
The carve-out is not about selling the business unit outright but, instead, is selling a portion of the equity stake of that business. This helps the parent organization to retain its hold over the subsidiary by keeping the majority equity for itself. The Equity Carve-Out allows a company to strategically diversify into some other businesses which may not be its core operation.
This strategy may be used for a variety of reasons and may be preferred to total divestment. It might be such that a business unit is deeply integrated, thus making it hard for the company to sell the unit off completely while keeping it solvent. Therefore, those looking at investing in the Equity carve-out are bound to consider what might happen if the parent company completely cuts its ties with the subsidiary.
Since full divestment of a company might be a long-drawn-out affair and take several years, the equity carve-out allows the company to receive cash for the partial shares it sells now. Equity Carve-out is adopted when the company does not expect to find a single buyer for the entire business or it wants to have some control over the new business unit.
Benefits of a Carve-Out
An Equity Carve-out strategy usually benefits both the parent company, as well as the new company. One of the benefits is the creation of two separate entities out of the larger, old one with diversified core businesses. This, in turn, might just help in the separation of operations and streamline the focus on the core operation. For example, one might concentrate on production and the other subsidiary on marketing. If successful, this will increase the value of both companies due to increased profitability. Equity carve-out entities can be successful and can deliver if they are given independence over a longer period of time.
The Equity Carve-outs are initially created with the idea of maintaining indefinite corporate control over carve-outs. But it is found that only a few are able to continue doing so beyond a duration of a few years. Most go on to be acquired by third parties.
Of course, the parent companies reserve their right as long as possible by retaining over 50% equity and block takeovers or increased shareholding by rivals or competitors. This may hamper the very benefits the carve-out was intended to deliver.
Conflicts between the parent companies and Carved-out entities intensify over a period of time because carve-outs grow at a higher rate starting with their initial IPO (Initial Public Offering).
Researchers have concluded that Equity Carve-Outs raise share prices in the short-term but over the long-term shareholders are at loss. In fact, the possibility of shareholder value increases if the company follows a structured plan to fully separate the subsidiary.
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