Navigating the Challenges of PE-Backed Carve-Outs: Lessons from the Frontlines

In the evolving landscape of private equity transactions, carve-outs have transformed from being considered “too hairy” for most firms to becoming mainstream strategic plays. Drawing from my experience guiding companies through these complex transitions, I’ll share key insights on navigating the challenges that continue to define carve-out transactions.

The Evolution of Carve-Out Transactions

Fifteen years ago, carve-outs were the domain of a select few specialized PE firms. The complexity and risk associated with extracting a business unit from its parent company deterred many investors, with the common refrain being “that’s a very hairy deal, too complex for our operating team.”

Today, the picture has changed dramatically. With specialized consulting firms developing carve-out playbooks, these transactions have become accessible to a much broader range of PE sponsors. Whether handled in-house or outsourced to experts, there’s now a clear pathway to accelerate the carve-out process, transition away from Transition Service Agreements (TSAs), and drive completion on behalf of the new management team and buy-side sponsor.

Core Challenges in Carve-Out Transactions

1. Operational Entanglement

   Challenge: Business units rarely operate as truly standalone entities. They often share IT systems, facilities, supply chains, and administrative functions with the parent company.

   Strategy: Conduct thorough operational due diligence to identify all dependencies. Create a detailed separation plan that prioritizes critical functions and establishes realistic timelines for achieving operational independence.

2. Financial Clarity

   Challenge: Carve-out financials are notoriously difficult to isolate from parent company financials, creating uncertainty around the true financial performance of the target business.

   Strategy: Implement advanced financial modeling that accounts for allocated costs, shared resources, and potential stranded costs. Work with financial advisors experienced in carve-outs to create pro forma statements that accurately reflect the business’s standalone economics.

3. Talent Retention and Migration

   Challenge: Key talent may be hesitant to transition to the carved-out entity due to uncertainty, or the parent company might resist releasing critical personnel.

   Strategy: Develop comprehensive retention plans with clear incentives for essential employees. Create a compelling vision for the carved-out entity’s future and communicate it effectively to build confidence among transitioning staff.

4. TSA Management

   Challenge: Transition Service Agreements often become complex, costly, and difficult to exit, creating dependency on the parent company longer than anticipated.

   Strategy: Negotiate TSAs with clear exit criteria, reasonable cost structures, and built-in flexibility. Establish, or contract with a third-party to serve as, a dedicated TSA management team focused on systematically replacing each service with permanent solutions ahead of schedule.

5. Cultural Transformation

   Challenge: Business units typically reflect the parent company’s culture, which may not align with the PE sponsor’s vision for the newly independent entity.

   Strategy: Begin cultural assessment during due diligence and develop a deliberate cultural integration plan. Identify cultural elements worth preserving while introducing new values and operating principles aligned with the go-forward strategy.

Modern Best Practices in Executing Carve-Outs

1. Accelerate Value Creation

   Today’s successful carve-out investors don’t wait until separation is complete to begin value creation initiatives. Instead, they pursue a parallel path:
   • Lay out a plan to ensuring operational continuity from Day 1
   • Launch value-creating improvement initiatives immediately post-close
   • Methodically focus on achieving independence from the parent sooner than is needed

2. Capitalize on Digital Transformation Opportunities

   The separation process presents a unique opportunity to leapfrog off legacy systems and processes:
   • Implement cloud-based solutions rather than migrating legacy systems
   • Adopt standardized, automated processes rather than replicating complex customizations
   • Build data capabilities from the ground up with modern analytics architecture

3. Implement Cross-Functional Governance

   Establish a carve-out management office (CMO) with:
   • Comprehensive workstream coordination
   • Integrated decision-making processes
   • Regular cadence of progress reviews
   • Clear escalation paths for critical issues

4. Adhere to Realistic Timeline Management

   Successful carve-outs balance the urgency to separate with the reality of complex dependencies:
   • Focus on critical path items that drive TSA costs or operational risks
   • Create contingency plans for inevitable delays in key workstreams
   • Establish clear metrics for measuring separation progress

Conclusion

While carve-outs have become more accessible in the PE market, they remain among the most complex transactions in the private equity playbook. The firms that excel in this space understand that the key to success lies in meticulous planning, cross-functional execution, and the ability to simultaneously manage separation activities while driving value creation.

By approaching carve-outs with a clear-eyed understanding of the challenges and a well-structured approach to addressing them, PE sponsors can transform these once “too hairy” deals into significant sources of value creation and competitive advantage.