International Carve-Outs: Understanding Your Obligations, Part 1 of 2
The following is part one of a two-part Radius series on the subject of M&A carve-outs. Read part two.
By Chris Stone, Chief Executive Officer, Radius
Mergers and acquisitions are on the rise and most authorities agree that the trend will continue. Not surprisingly, many if not most U.S. companies seeking to merge with or acquire another business are looking beyond their own shores. A 2014 Deloitte M&A trends report notes that of the more than 2,000 executives they surveyed, fifty-nine percent indicated “their M&A investments will involve an acquisition in a foreign market” and that “almost three-quarters of private equity firms are expecting to acquire a target in another country.”
An increasing number of these international deals are so-called “carve-outs,” in which one company’s M&A investments will have operations in a foreign market (or markets) that are supported by the parent company. To take a hypothetical example, let’s say a private equity firm buys the assets of a technology group that is owned by a U.S. parent company. The technology group is registered in the U.S. and has employees there. However, it also has employees in France and China. These employees based outside the U.S. work for the technology group, but they are registered as employees of foreign subsidiaries (in France and China) of the parent company, not the technology group whose assets are being acquired. Therefore, after the assets transfer takes place, the private equity firm — or representatives from the technology group itself — must arrange to support the non-U.S.-based employees in the way that the parent company had supported them; that is, by having a registered legal entity in each host country, making payroll, providing benefits, remitting income and social taxes to local authorities, etc.
This has always been a complicated area, and buyers in the international carve-out market are becoming increasingly sophisticated. They are no longer laser focused on getting a good purchase price, but on obtaining long-term value after the deal is closed. If you’re a prospective buyer, one of the primary means of ensuring that you achieve that lasting value is to understand all the obligations you’ll inherit from the parent company if and when you do close the deal. These costs include not only the obvious expenses like those related to procurement and information technology, but also expenses that are sometimes overlooked, such as those employee benefits I mentioned, which in our example will be dictated not by U.S. laws but by target-country laws.
Perhaps needless to say, obtaining a complete, accurate assessment of all the support services you’ll inherit from the parent company may not be easy or in some cases even possible. As early as you can in the due-diligence process, you should request a list of services provided by the parent company and related costs, along with documentation. Beware that the costs the parent company pays for a particular service may not be what you’ll pay. For example, the parent company may have greater purchasing power than your organization, resulting in lower purchasing costs for them than you. In addition, the information you receive from the parent company may not necessarily reflect all the services you’ll inherit, so you’ll have to be careful to research commonly provided target-country services and assess the information for gaps so you can create a reasonably accurate cost model.
Many carve-out deals involve a transition services agreement (TSA), which sets terms for the parent company to continue providing certain support services (such as IT and payroll) for a stated term after the transfer is complete. If your company isn’t prepared to assume all obligations immediately after the transfer and needs a TSA, you should carefully review the terms prior to negotiations. The TSA will give you an idea of the types and costs of services you’ll need to provide going forward. Keep in mind, however, that the parent company may not include all the services you’ll need to assume, and it may charge a hefty premium for continuing to provide certain services. Not only will the high fees provide the parent company with revenue, they will act as a disincentive for your company to continue using the parent company as a service provider.