Episode 22 - Making carve-out deals a success

RJ

Today I'm speaking to Ben Fielding, Head of Sales for Global Entity Management at TMF Group, about the challenges facing organisations in carve-out situations. Evidence suggests there will be an increase in multinational carve-outs in 2024 and beyond. These cross-border deals are often complex with tight timelines and there is often limited in-house resource available to support their planning and execution. Ben will be giving us an insight into the challenges faced by governance professionals, general counsel, and finance directors to ensure entities are operationally ready for employees and to do business. It's great to be speaking to you today, Ben. Could you start by explaining what a carve-out is and the circumstances in which a company might undertake one?

BF

Thanks, Rachael; it's great to be speaking with you as well. When we talk about carve-outs, largely what we're talking about is when a business divests a part of itself. A phrase that you will hear a lot is ‘divesting non-core assets.’ It's taking a part of itself and selling it off, and that could be selling it off to another corporate; it could be selling it off to a private equity firm. Equally, it can range from selling off a book of business, maybe it's some client contracts that you're looking to separate out, or you're looking at a full service line, or you're looking at maybe a set of products or a set of brands. We see that common across a number of different corporates. They want to focus on the core of their business, what's making them the most profit, and then spin off something else and carve that out to really let someone else focus on growing it.

RJ

What are the safeguards or mitigating actions that could be put in place to minimise any potential damage or risks – like financial risks, or costs, or compliance – in the event that a carve-out falls through or the deal’s aborted?

BF

Generally, within the deal structure, you're going to have penalties or payments if the deal doesn't go through and if each party doesn't take particular actions. What you really want to do is a lot of planning upfront. The companies we work with will be planning this for months. They'll be talking to the parties, or both parties will be talking to each other, trying to work out what’s the best way to do it. It's in everybody's best interest at the end of the day to make sure that this deal goes through. To make sure that the deal goes through well, and to make sure that the employees that come across from it, and the business that comes across, really can take off when it starts. [Because success is] in everybody's best interest, generally everyone's working towards the same goals, which is fantastic. But a lot of it's upfront planning, really knowing what the issues are going to be as you move along the deal chain. What's going to hold you up? What are your risks and trying to identify those as much as possible.

RJ

I suppose the legal structure is something that will be really important there. I wondered if you could explain what the possible repercussions might be if the legal structure isn't prioritised during a carve-out and perhaps compliance is left as is something that's inconsequential?

BF

It's a funny situation because from our perspective, being in the field of corporate administration, the legal structure is very important. You can think of it as [being like] the foundations of a house, the better the foundation, the more secure the house. [The legal structure] really does lead into every decision that you're going to make going forward. But as you say, it's often taken for granted.

In these types of deals, they’re very fast paced, the deal team is looking at the best way to make a deal, you're looking at the timeframes and how to make them work. Often, it's not focused on what the legal structure needs to be, and exactly how it needs to work. For instance, if you're setting up the top entity, your headquarters, that needs to be done first, and then everything underneath it flows. That sort of sequential action really does need to be taken into account.

What's really important is you need to know what you need to have set up so that contracts can be signed by the legal entities, that really is important in the tax structure. Moving from step to step really does need to be planned out. Ultimately the consequences are, if the entity is set up wrong in the beginning, it can be either costly to the operations later on, perhaps maybe the entity wasn't set up right or the right registrations weren't done in the right way. And potentially it doesn't come to light until after, or until when you're trying to sell the business, and that can be quite an issue because it can impact the future value of [the business].

RJ

If you're working across borders, how are companies coping with some added complexity and timelines that might come about if you're setting up bank accounts locally?

BF

Oh, that's a very good question. The question about bank accounts is very important. As you can imagine, it's all nice to say that you've incorporated an entity and oftentimes we do get clients that come forward and say, well, we've incorporated everything, so we're ready to go. And we'll say, ‘well have you have you created the bank account?’ And they'll say, ‘no, we haven't yet, but that will be easy, right?’ It really is not.

Some countries are easier, but even if you're looking at the easiest countries, it's generally six to eight weeks to get a bank account open. It can range from that all the way up to ones where we've done it in nine to 12 months. That is simply [because of] compliance hurdles with the banks. Oftentimes, when you're dealing with private equity firms, the deal structure isn't always completely understood by the bank. So, trying to get the right compliance information to them is very important. Oftentimes that's not an easy process, there's a lot of different information you need. When you're acting in different countries, they have different requirements. Perhaps the firm is used to dealing with these requests but yet they need more information, or they need it done in a particular way, or notarised in a particular way. The local intricacies are very important to take into account.

RJ

Would you advise that companies start that process of setting up a bank account while they're still completing the deal?

BF

In most cases, you have to set up the entity first. Because of that, what you really want to do upfront is look for a banking partner. Somebody that is going to be able to take you from one country to the next and help in the process. We deal with carve-outs that are three, four countries, but all the way to 30, 40, 50 countries. When you have that banking partner, it makes it so much easier, because you can really rely on the bank's internal processes to help you along. Again, it's not always clear cut, and things have to be done in different languages and [there’s] all sorts of different requirements. But it does help to make sure that at least locally, the bank will pay attention to you, because oftentimes you have to be big enough for some banks to deal with you. That can be an issue if you're taking it one country at a time rather than the bank looking at you as a global business.

RJ

As we’re talking about local providers in different jurisdictions, is that a benefit of consolidating service providers in that banking context [you’ve just described]? And are there other contexts in which that can be helpful?

BF

Yeah, absolutely. I'm probably going to say that given TMF is the biggest out there and we're in in 86 countries around the world. But I think what really helps in these situations – and clients say this when they reflect to us [on] where we help them – is the fact that because of the global nature [of their business], we can provide a consistent approach globally, which is very important.

One of the key details about these types of deals is that you're generally dealing with a very lean management team at the top. At the beginning, it's maybe a chief financial officer (CFO), maybe a head of human resources (HR), maybe a head of legal, maybe a project management person, sometimes not even all four of those. You're dealing with a very small lean team that have a lot to do, and taking anything off them is really important.

Also streamlining those processes [is important]. So, when you have a consolidated approach [there’s] one person [the management team] can give something to and just say, ‘can you please take care of this?’ Rather than having to go to multiple different people and get these changes done, multiple different service providers. It does really provide that holistic approach and makes it a lot easier when you're dealing with a very difficult time.

RJ

Based on your recent experience, how can overruns, which can be costly, be minimised or even prevented?

BF

Again, it probably comes back to the planning upfront. You have to be realistic about what the timescale is. Generally, the overruns come [when you go] over your timescale. So, you agree to a nine-month timeframe and if you go over, if it's your action, you end up having to pay. What you really want to do is be realistic upfront. Know the sequential nature of what needs to happen, and map that out.

Also have a clear idea of who needs to do what. Because in these circumstances there's often something in that period between when you sign the deal, and when the deal actually closes, something called the transition service agreement. That covers what you need to do from a business point of view. So, [in terms of] IT infrastructure, finance infrastructure, these items. It's really important to be as clear as possible on who needs to do what and which party needs to do what. Because oftentimes things fall through the cracks, and there's so much going on, and so much that needs to happen, that if there's not that real clarity in the beginning, something will fall through the cracks. And what ends up happening then is that becomes important later on and ends up having an impact on the deal timeframe and penalties result.

RJ

What motivates a carve-out? What are the costs of it? And how do you measure success?

BF

Oh, that's an interesting one. The success of a carve-out, I suppose, in the short term, is getting the deal done. Which is very important.

Longer-term success, and that's really what you want to aim for, is obviously the business doing well and really thriving. These tend to be businesses that within a larger corporate, maybe they're a bit unloved or haven't had the right investment to really drive forward their growth. That's oftentimes why companies will approach these situations, or private equity firms will. It's about making sure you're giving consistency to the clients, giving consistency to the staff. That's really hard during these periods where there’s an immense amount of change. You might be going from a very large corporate, like a corporate enterprise, where there are 10,000 HR people to take care of things. And now, all of a sudden, you have a team of two. So, it's really important that you try to get that transition period over as soon as you can, as cleanly as you can. There's nothing more important than that first paycheck that they're going to get from this new entity, that that is completely right, and paid on time. It's these sorts of small things that really do have a long-term impact.

RJ

We've talked a little bit about the timeline [of a carve-out] and you've talked about doing things sequentially. Could you tell us a bit more about the timeline of a carve-out process?

BF

There'll be many months of negotiation, reaching a price at some point and reaching an agreement. Then it really enters into the phase where you have generally a very short period, something around nine to 12 months, where you sign the deal, and then you close that nine or 12 months later. What needs to happen in that interim period is setting up all the infrastructure. Setting up the registrations for the company. I mentioned [that] incorporation versus being operationally ready are two completely different concepts. When you think about incorporating a company, that's the first step, it's not the last step. You need bank accounts, you need local registrations, you need to be able to create invoices, collect that money, and then ultimately pay people. All those steps take time and each country is quite different.

RJ

Are there any IT challenges that organisations might face during that process?

BF

On the IT side, especially, you have to think of this [new entity] as coming out of the broader corporate business, and there's no infrastructure at the beginning. You might be buying a system maybe that comes with it, or maybe that's part of the intellectual property (IP). But generally, you have to set up finance systems, HR systems, your basic overall IT environment as well. Again, you have to do that in a very tight timeframe, that nine-month period. You're really looking at starting something from scratch, which is both a positive and negative. Because a lot of the times you have legacy systems in your old corporate, that actually, if you were to do it today, you'd take something completely different. And this is the opportunity to do that.

RJ

An interesting opportunity to innovate there with IT. Thinking about all these things that it's important to get right, I wonder, what might make a carve-out deal fail? And what can companies do to make sure they do get it right? Do you have any examples to give?

BF

In terms of what can fail, it really does depend. In the short term, it's meeting that timeline. That’s where that upfront planning is absolutely critical. If you're looking at the team, and what the team really has to do in these circumstances, it's having a really strong, capable management team, that can lead the business through these changes, because it's a massive change for a corporate. [They’re] coming out of that larger corporate environment, where there's a lot of safety nets, and moving to something that's maybe a lot more entrepreneurial.

I think one of the big things you're going to be dealing with is that transition period. Employees are going to be looking at that thinking, oh my, how do I deal with this? How is this going to impact my job? I think one of the biggest things that we've seen is really making sure that that change management is done very well with employees, that they're brought along on the journey, and that they stick with the business. Because there's nothing more valuable than your employees, than bringing your team along. [It’s then a matter of looking at] how they interact with your clients and keeping everything seeming business as usual, despite an immense amount of transition [having taken place].

RJ

What’s best practice to manage both known and ‘unknown’ risks

BF

It's knowing what you don't know or accepting that you don't know everything. Because you're never going to know all the risks when you go into these situations. Trying to find as many as possible is good. But at the same time, if you go into it thinking that I've identified everything, and nothing else is going to ruin my timeline, that's just not going to happen. It's just not true at all. Because ultimately, one month to the next month, your plan is going to change about ten times. Accepting that sort of uncertainty is crucial. Having people around you, other suppliers, other vendors, there's other consultants that can really help you lean through that process is really important.

I think you need an environment in which everybody's willing to put their hand up when something goes wrong, and say, ‘this isn't going right.’ Doesn't matter who's done it, who's done what, this isn't going right, and we need to fix it. Because ultimately, if you're going to spend a week pointing fingers at each other and trying to assess who's to blame, that's going to be very unproductive. The best way through it, part of that best practice, is really knowing that you don't know everything.

We're really looking at how do you get that whole support? That's one thing that we're really keen on is that we're connecting the decision-makers with our local teams to really talk through the issues. Because there's nothing better than getting it from the people that are on the ground, that can interpret the local languages and then say, this works or that doesn't work. Because a common misconception is, for instance, that all of Europe works the same, or all of Asia works the same, when country to country is so vastly different, such that you really need to make sure you're taking those items into account.

RJ

You talked a little bit about an organisation coming from one environment to another. In that process, how can companies ensure that best practice and knowledge remain after the completion of a carve-out?

BF

That can be very tricky. There's a lot of learning upfront to do in terms of how the business works. You're generally wanting to move the employees with the business. That would probably be the first start. I think [it’s worth considering] the uncertainty that people are going to go through during this time period. How do you engage with your employees to really make sure that you're bringing them on this journey? I think that's critical because so much knowledge, as much as we write everything down and we have processes that we develop, a lot sits in people's heads.

Equally [you should consider] your clients as well. If they know that the teams are staying, they feel more comfortable: engaging with your clients and walking them through it, how this is going to work. Bringing them along in the journey as well is really important because it can be very damaging [when] you're buying a business, buying a book of clients. When they leave, that's going to be damaging to the business. So you want to do everything you can to really make sure that you are making them comfortable with what's going to happen.

RJ

Yes. I suppose the corporate memory that comes with employees is central to the asset that you're buying, and so are the clients.

BF

Absolutely

RJ

What sorts of things do you think are motivating deals at the moment? What sorts of factors?

BF

It's a really interesting time out there, isn't it? We definitely have seen with inflation and interest rates and everything [that’s happened] over the past couple of years, we are in an environment where corporates are really looking at themselves and saying, ‘how do I keep pushing the margins? How do I keep pushing my returns?’ Or ‘where do I get some cash to reinvest into building this bigger?’ We have seen a lot more deal activity over the last few months. People are looking and saying, ‘we don't see this as part of our business going forward. So let's carve that out.’ From the seller point of view it's [about] really looking for some more investment, really trying to focus on their core operations.

From a buyer's point of view, there’s still a lot of private equity firms out there with mountains of cash that they've raised over the last few years. And those need to be deployed. And these are great investment opportunities when you can make them work. If you can put a really good management team in there, if you can really put some investment in there, perhaps it's getting some complementary products to bring with it, you're really starting to build up the business and create a lot of value. I think that's ultimately what drives a lot of this. I think it [seems] cynical to say it's all money, but I don't think it is. I think a lot of it's about [asking] how do I create value for our clients, but our people as well and the broader market.

RJ

[When] undertaking these cross-border M&A transactions, what are the key hurdles to overcome to make sure that things go as smoothly as possible?

BF

Cross-border [deals] are very difficult. I think the key here is knowing that every country is going to be different. And every country has different practices. Culturally as well, I think it's really important to recognise that each culture is very different.

If you're an American corporate versus a Japanese corporate, you have a lot of differences within your structures. We often find that Japanese clients, Japanese employees, they want to work with Japanese companies. So, it's much more important culturally to have something firm on the ground, a local Japanese entity you're dealing with, local management that is there. [Rather] than say, an American company, which is very happy to work overseas and be quite remote in terms of their working practices. It's very much [about] understanding that each country is very different. I threw out quite a broad example there with Japanese and American, but that's equally Japanese to Chinese or Chinese to Singapore. Even within the same region, it's very different. It's very important to really recognise those differences.

From an administration perspective, there's a variety of differences. We talked about different timelines and timelines for opening bank accounts. Those are going to be different. Equally, registrations [and] how fast government agencies react. Granting registrations is very different country to country. There's also different rules in terms of local requirements, so maybe I'll call it localisation rules. Whether you need a local director and have on-the-ground teams, or whether it can all be done from entry. These things need to be taken into account when you're setting these [entities] up. Because if you're not looking at them, ultimately, it's going to cause roadblocks for you later down the road.

RJ

How do you tackle cultural compliance risks? How can you look at that in detail?

BF

The compliance risk is what happens when it goes wrong? What happens when maybe there's some non-compliance within what you're doing? It's really important to know what happens then.

Sometimes you take for granted that in the UK, if you miss a filing, you end up with £100 fine and you pay that fine, you get the filing done and that's fine. In other countries, by not making that filing, it's a criminal offence. There’s a classic story of a local director getting off an aeroplane in Singapore and getting arrested for not making a filing. That's a terrible consequence of missing some paperwork. In each country, it's very different in [terms of] how they deal with non-compliance.

RJ

You mentioned earlier a transition services agreement, or a TSA. Would you be able to tell us a bit about the role of those in carve-outs? [Are there] any key considerations that people working on these deals should have in mind?

BF

In general terms [a TSA] will look at what services does the ‘old corporate’, for lack of a better phrase, need to provide to the ‘new corporate’ until everything can be transitioned into new infrastructure. It'll often focus on what that support is, what types of services, how long they’re going to be provided for.

I think the key here is really granular clarity on who does what. What we see often is little things that aren't picked up. So, who in this process is going to be responsible for incorporating a company? Who is going to be responsible for opening a bank account, for instance? They sound very small [areas], but if you haven't set up your bank account, you can't collect money from your customers, you can't pay your employees. It's these simple things that get taken for granted.

Also, it's important because in the old corporate context, these things were all there. That's what often gets missed is that you take for granted that there's a finance function that's just going to work: people get paid, expenses get paid. But in the new structure none of it’s there, and how do we set it up from scratch?

RJ

Yes, that does sound like quite a lot to take into account. And operational readiness that you've mentioned a few times, it sounds simple, but why is it important to understand local requirements?

BF

It's a really good question, and really very important. I talked slightly about the differences between incorporating a company and making it operationally ready. The real thing [to note] here is that each country is very different. It's very different in how they operate and what you need to do.

For instance, if you're going to issue an invoice in the UK, you really need to have your value added tax (VAT) number, you need to have bank account numbers on there. So, you need to set up your entity, you need to set up your VAT registration, you need to set up a bank account. That’s sort of simple.

Where you're looking though, at maybe a Brazil, where every invoice needs to be logged with a government office, and all of your IT needs to be able to interact with the government's IT, it becomes a lot more difficult. These are the sorts of things you need to think about ahead of time in terms of how long that's going to take. How do we make sure that we create milestones along the way and hit those milestones to our required timeline?

RJ

Looking back over the carve-outs you've been involved with, are there any that stand out, and why do they stand out?

BF

I'm very fortunate. I get the opportunity to work on ones where [there’s] two, three countries [involved], where there's 20 employees involved, [where there’s] up to 30, 50 countries [involved], where there's thousands of employees.

I suppose, probably, from my side, I really do like working on the larger ones, mainly because [of] the complexities they bring. How do you work with companies and really make sure that you're addressing the concerns, you're doing the timelines, all in the right order? When things go wrong, inevitably they do, something will pop up that doesn't go right. How do we deal with that? That's really interesting. You often find you're dealing in countries where it is different, and there are local intricacies.

I find I learn something every day as well, some new nuance that I just didn't really take into account before that now I know. Those sorts of ones are very interesting, but they're very difficult at the same time. They're ones where there's a lot of pressure and a lot to get done, of course.

RJ

I guess maybe the complexity is what makes it interesting.

BF

It is exactly. That's part of being at TMF is dealing with those local complexities. That's part of the job I absolutely love.

RJ

Well, thank you, Ben, it's been great to speak to you today about carve-out deals and understand what they are and why a company undertakes them and the nitty gritty of the deal process, from mitigating risks to working across jurisdictions to preventing costly overruns, and so much more that you've covered today. I'm sure our listeners will feel much better prepared to manage this kind of deal should it be on the horizon for them, or if they're currently in the midst of it. Many thanks for sharing your expertise with us today.

BF

Thanks, Rachael. Great to be here with you.