Carve-Out Transactions: When the Business Has Never Stood Alone

Carve-out financial statements are not the same as audited standalone financial statements, and the differences affect how buyers assess historical performance and build projections.

A carve-out financial statement allocates a portion of the parent's shared costs, revenues, and balance sheet items to the carved-out business using methodologies that must be disclosed and that buyers will scrutinize. Corporate overhead, shared service costs, intercompany financing, and tax expenses are typically allocated based on revenue percentage, headcount, or square footage, and the allocation methodology directly affects the apparent profitability of the carved-out business. A business that appears to generate strong EBITDA margins under the parent's shared service model may show significantly different economics once standalone costs for functions the parent previously provided are properly reflected.

Buyers typically require sellers to prepare, or to cooperate in preparing, a standalone cost analysis that identifies every cost the parent currently bears on behalf of the business, confirms which costs will transfer with the business, and quantifies which costs the buyer must add to operate independently. The gap between allocated costs in the carve-out financial statements and the actual cost to run the business on a standalone basis is a valuation adjustment that is negotiated directly into the purchase price, the TSA structure, or both. SEC financial statement and pro forma presentation requirements may apply when the buyer or seller is public or when securities are registered in connection with the transaction, adding audit and disclosure obligations that affect the transaction timeline and the scope of financial statement preparation the seller must undertake.

A carved-out business that closes without a complete set of intercompany agreements does not have everything it needs to operate. The TSA is the most visible of these agreements, but it is not the only one, and the gaps in the intercompany agreement package create operational problems that appear on Day 1.

The Transition Services Agreement covers the services the parent will continue to provide to the carved-out business after closing for a defined period, including IT systems access, finance and accounting support, HR administration, facilities use, and any other functions the carved-out business has not yet replicated independently. TSA terms must specify the service standards, pricing, exit rights, and termination procedures with precision that most parties underestimate at drafting. A TSA that defines services in broad functional terms, without specifying service levels, pricing methodology, or the consequences of service failures, creates disputes within weeks of closing when the seller's team begins to deprioritize services for a business they no longer own.

Supply agreements, manufacturing agreements, and IP license-back arrangements are required when the carved-out business sources goods, components, or services from other parts of the parent's business that are not being sold. A carve-out from a diversified manufacturer may require a multi-year supply agreement for components the carved-out business has historically sourced internally at transfer prices that may not reflect market rates. An IP license-back arrangement is required when shared intellectual property, including patents, trademarks, or software, is retained by the parent but needed by the carved-out business. Facilities subleases cover space in parent-owned buildings where the carved-out business operates but does not need or want to own the real property. Each of these agreements must be negotiated and executed at or before closing, and each creates a continuing relationship between the buyer and seller that can become contentious if the commercial terms were not addressed carefully in the transaction documents.

Contract assignment and customer consent requirements add a layer of pre-closing work in carve-out transactions that does not arise in standard subsidiary acquisitions. When the carved-out business's key contracts were signed by the parent entity rather than by a subsidiary that is being transferred, those contracts must be assigned from the parent to the NewCo or to the buyer at closing. Many commercial contracts include change of control provisions or anti-assignment clauses that require counterparty consent before the assignment is effective. Government contracts, regulated industry licenses, and certain financial contracts may require regulatory approval of the assignment in addition to counterparty consent. A seller who identifies these consent requirements during due diligence and begins the consent process early can obtain the required consents before closing. A seller who discovers them after signing faces a closing condition that the buyer can use to delay or renegotiate the transaction if material consents are not obtained. Hart-Scott-Rodino filing and corporate M&A practice requires mapping the full consent requirement across the contract portfolio before signing, not as a closing condition to be addressed later.

The standalone gap is the difference between what the carved-out business costs to run under the parent's shared service model and what it will cost to run independently, and it is the single largest valuation variable in most carve-out transactions.

Quantifying the standalone gap requires identifying every function the parent currently performs for the carved-out business, the cost at which the parent performs it, and the cost at which the carved-out business would need to replicate or procure it independently. Corporate functions including finance, legal, HR, IT, procurement, real estate, and executive management each carry an allocated cost in the carve-out financial statements that may be substantially less than the cost of standalone provision. A business that was allocated $2 million per year in corporate overhead under the parent's shared service model may require $8 million per year in standalone overhead once it must hire its own CFO, general counsel, HR director, and IT team.

The standalone gap is negotiated into the transaction through the purchase price, the TSA structure, or a combination of both. A buyer who accepts carve-out financial statements at face value without adjusting for the standalone gap overpays relative to the business's standalone economics. A seller who understands the standalone gap before launch can address it by preparing a standalone cost analysis that demonstrates the gap is smaller than buyers might assume, or by pricing TSA services in a way that offsets the buyer's cost to build out the missing functions. Standalone cost analysis should be completed before the purchase price is agreed, because reopening valuation after signing creates leverage and execution risk for both sides that a well-prepared process avoids.

A carve-out transaction separates an integrated business unit from a parent company that has never operated that unit as a standalone entity and sells it to a buyer who must convert it into an independently operating business. Unlike a standard acquisition, where the buyer acquires a legal entity with its own systems, financial statements, and contracts, a carve-out requires the parties to determine what assets, liabilities, employees, and contracts belong to the carved-out business, create or contribute those elements to a new legal entity, and establish the support structures the business needs to operate without the parent. The transaction closes on the legal separation, but the operational separation continues for months afterward through TSA services and intercompany agreements.

Buyers discount carve-out acquisitions because the standalone economics of the business are worse than the carve-out financial statements suggest. The standalone gap, representing the additional cost the buyer must incur to operate the business without the parent's shared services, reduces the EBITDA the buyer can underwrite at the acquisition price. Beyond the standalone gap, buyers face one-time separation costs for IT migration, system replication, and organizational buildout that do not appear in historical financials. The TSA period creates ongoing management burden and cost. The lack of standalone financial statement history makes lender diligence more difficult and financing terms less favorable. Each of these factors compresses the multiple a rational buyer will pay relative to what the same business would command if it had operated independently.

A Transition Services Agreement is a contract under which the seller continues to provide defined services to the carved-out business after closing for a fixed period while the buyer builds or procures the independent capability to replace those services. TSA services typically include IT systems access, finance and accounting processing, HR administration, payroll, and facilities use. The TSA matters because its duration and pricing directly affect both parties' post-closing economics: a buyer on a long TSA pays for services it cannot control and delays the operational savings that justified the acquisition price, while a seller on a long TSA incurs cost and management distraction for a business it no longer owns. TSA exits that are not achieved on schedule are among the most common sources of post-closing disputes in carve-out transactions.

The most common seller mistakes are beginning separation planning too late, underpricing TSA services, and failing to identify contract consent requirements before signing. Sellers who begin planning after a buyer is selected cannot present a credibly scoped business to bidders and cannot address the standalone gap before it becomes a price negotiation. TSA services priced at allocated cost rather than fully loaded cost transfer value from the seller to the buyer in a way not reflected in the headline price. Contract consent requirements discovered as closing conditions rather than addressed during due diligence give the buyer leverage to delay closing or require price adjustments. Sellers who address all three issues before launch consistently achieve better outcomes than those who treat separation as a closing condition.