The value of corporate ‘carve-out’ deals has been on the rise in recent years, with private equity funds having acquired over £10.1bn of corporate carve-outs in the last year, up from just £765m in 2019 (Mayer Brown).

Typically carve-outs involve the purchase of non-core assets from a corporate. The reason for sale may be that the part of the business being sold may no longer be strategically important or is underperforming or that the corporate is looking to reduce debt by generating cash from disposals.

In the majority of cases, carve-out deals are more complex than an acquisition of a stand-alone business. This additional level of complexity tends to reduce the buyer universe and can present opportunities to acquire assets at a lower price-tag in mitigation of these additional complications.

However, the additional array of complexities associated with carve-out deals, means that they are typically perceived as higher risk credits, so arriving at the most appropriate funding structure can be more involved. But, for private equity sponsors with a track record of successful carve-outs, there is strong appetite to complete further deals in the immediate aftermath of coronavirus, particularly from lenders who understand the space and who have had positive experiences funding carve outs in the past.

In this article we look at some of the key concerns funders look to get comfortable with when looking to fund carve-outs.

A primary consideration for funders will be why the business is being divested, and even if the disposal is badged as a strategic non-core disposal, funders will put strong focus on understanding any adverse trends in trading performance.

Additionally lenders will want to understand how integrated (into the Parent) the entity to be carved out is, what is included in the deal perimeter (e.g. which staff and what assets are being transferred and whether there are potential issues around the legal ownership of specific assets) and what the scope and costs is of the transitional support. Funders will want to particularly understand the current arrangements around IT, platforms and systems and how these will be dealt within the Transition Service Agreement (TSA).

On this last point, a key question will be around any remaining reliance on the Parent post the end of the TSA. For example, branding (or associated brands) and licensing arrangemen

Alongside the track record of the equity sponsor, management team will be another key area of focus, who is coming across and who is not. For the management team coming across, where appropriate will they be rolling over equity. How will management gaps be filled, how will the new management team be incentivised, and what level of interim support will be used.

Diligence requirements are typically heavier than on other deals, with lenders looking to piggy back on both external due diligence done (including financial, commercial, legal and IT) and internal due diligence done by the sponsor. On the legal side funders will want to understand the potential recourse back to the vendor for breaches to the TSA and ensuring the reps and warranties are appropriate for the transaction. Linked to this will be transaction structure and the use of deferred consideration (and/or rolled equity – less common) to create a vested interest for the seller to make the standalone carved out business a success.

Linked to the diligence point lenders will want to really stress test forecasts and understand what this means for debt serviceability and what level of unexpected disruption would ‘break’ the forecast to ensure that there is sufficient cash buffer on day 1 and adequate headroom in the forecast covenants.

Ultimately funders will want to ensure the right alignment between them and the equity sponsor, and that their returns correlate with the level of risk they are being asked to take.

Advisers can provide expert knowledge on which lenders are most likely to have the appetite to get involved in a carve-out situation and how to present the deal to lenders, including for example how assets will transfer as part of the deal and what this means for a potential lender’s security and risk.

In addition, advisers can provide an early steer to potential bidders on carve-out assets to give them an informed view on potential debt structures, debt capacity, likely terms and key areas of focus/risk from a funder’s perspective.

ACP Altenburg Advisory is part of ACP, a leading independent debt advisory association for SME and mid-market companies, advising clients on the options available to them and providing hands on support from day one all the way through to drawdown.

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