Equity Carve Out

What is Equity Carve-Out?

Through an Equity Carve-Out, a company tactically separates a subsidiary from its parent as a standalone company. The new organisation is complete with its 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 organisation retain its hold over the subsidiary by keeping the majority equity for itself. The Equity Carve-Out allows a company to strategically diversify into other businesses that may not be its core operation.

Why perform an Equity Carve-Out?

This strategy may be used for various 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 entirely 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 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 and 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 deliver if they are given independence over a more extended period.

End Goal

The Equity Carve-outs are initially created to maintain indefinite corporate control over carve-outs. But it is found that only a few can continue doing so beyond 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 blocking takeovers or increased shareholding by rivals or competitors. This may hamper the very benefits the carve-out was intended to deliver.

Example of Carve-Out

Now, let us look into the spin-off of Lehman Brothers by American Express as an example of carve-out. In 1994, American Express announced the spin-off of its investment banking unit (Lehman Brothers) to form a new independent entity jointly owned by shareholders of American Express and employees of Lehman Brothers. The unit’s core business included corporate services, signature charge cards, travel, and financial planning

. They marketed the benefits under the brand name American Express. American Express also infused more than $1 billion into Lehman Brothers in the form of capital to financially support the newly formed company. Although the former parent had no directors on the board of Lehman Brothers, it continued to get a share of the entity’s future profits.

Researchers have concluded that Equity Carve-Outs raise share prices in the short term, but shareholders are at a loss over the long term. The possibility of shareholder value increases if the company follows a structured plan to separate the subsidiary fully.

Moving Forward

Conflicts between the parent companies and Carved-out entities intensify over a while because carve-outs grow at a higher rate starting with their initial IPO (Initial Public Offering).