In the course of a carve-out, valuation questions regularly have to be answered on several levels. These are partly dependent on the specific motivation of the project, and in all cases, GAAP and tax requirements must be met. Here, the company often has valuation options with potentially far-reaching consequences. Early planning of these aspects is therefore essential for a successful carve-out.
Every carve-out must be reflected in the Generally Accepted Accounting Principal (GAAP) accounting of the companies involved in accordance with the legal and economic structure of the transaction:
- Is a split-off, split-up or spin-off (or something else) preferable and how do they differ in accounting?
- What does the divesting entity have to record as compensation for the net assets being divested and how does this affect the balance sheet structure, also with regard to financial covenants?
- At what total value (business value) and at what individual values (asset values) does the acquiring entity record the transferred items? Does goodwill arise that can be used by the acquirer for tax purposes?
- Are there any options to account for the divesture or the acquisition either at fair values (realising hidden reserves) or at current book values (without realising hidden reserves)?
- Does the carve-out have any effects on future impairment tests that should be thought through in advance?
Furthermore, every carve-out has tax consequences (or is part of tax planning), for the determination of which valuations must be carried out:
- Does the disposal of net assets trigger a tax-relevant gain (or loss)? How high is this?
- Are there options to account for fair values or book values also in tax accounting? Can these options be exercised independently of the options under GAAP?
- Does my decision today bind (or influence) me for the future?
If the carve-out serves to optimise business activities in the current ownership structure, these questions are at the heart of the valuation tasks. In these cases, the valuation methods and assumptions being applied to the carve-out operations, as well as to individual assets, must meet the GAAP and tax law requirements for ‘fair values’ (in several manifestations). In general, the ‘objectified values’ of the relevant professional valuation standards meet this requirement.
However, if the primary purpose of the carve-out is to facilitate a sale or other type of exit for the carve-out business, the question of the transaction price often comes to the fore:
- What is the minimum price I need to ask? What is a fair price? What is the maximum price?
- What will change if the carve-out operations are separated from the existing group of companies? Will synergies be lost? What does a stand-alone cost structure look like? And how do all these points affect a company’s valuation?
Assessing the value
Company valuations are then the central basis for bringing these considerations to a satisfactory conclusion. In this environment, however, the objectified view of a company's value is only one element in the decision-making process. Instead, individual, subjective ideas of the seller and, if necessary, an anticipation of corresponding considerations of the potential buyer now also play an essential role. As a result, the requirements for the company valuation become more complex, require more extensive information or assumptions, and can be met, for example, by scenario models.
In addition, the acting management may also have a need for an external opinion regarding the purchase price, for example vis-à-vis the owners or the supervisory board. This need can regularly be addressed by valuations in the form of fairness opinions. A valuation that takes appropriate account of the relevant future economic scenarios and defines appropriate valuation assumptions is therefore a prerequisite for an economically successful transaction.
The detail is in the data
Regardless of the specific valuation requirement from GAAP, tax law or transaction-related drive, in the case of carve-out valuations there is often a major challenge in practical implementation: the availability of historical and forecast financial figures for the carve-out operations. As a result of the interconnectedness with other business units, carve-out financials often have to be recreated for the past, since the ‘tailoring’ of the carve-out operations is often not done along established financial reporting structures.
In this context, significant allocation issues can arise if intercompany transactions exist between the carve-out operations and the rest of the corporate group, but also when resources of the corporate group are shared by different business units. However, a reliable valuation can only be made once this information is available. This is why timely initiation of the carve-out process for the financial reporting is of crucial importance. This is not only essential for the company's own valuation considerations, but is also regularly the focus of due diligence exercises performed by potential buyers. A non-transparent set of figures then leads to increased uncertainty on the buyers’ side and, as a consequence, can also lead to value discounts.
Naturally, the Covid-19 pandemic also has a significant impact on the key factors influencing company valuations. In particular, the preparation and plausibility check of forecasts regularly poses major challenges for companies and valuers. At the same time, forecast figures are a key driver of company values. And in this context, each company valuation must, against the background of the macroeconomic Covid-19 consequences, properly reflect the concrete individual subject of valuation. This can only be achieved if, in addition to the preparation of historical carve-out financials, the planning topic is also addressed in good time in the carve-out process.
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This article is part of a series of short articles about managing a successful carve-out. Other articles include:
- Could carve-outs be a strategy for success in the automotive industry?
- The people factor – inform, involve, empower
- IT infrastructure – plan, do, act, check