By Mike Thorne
When a business splits from its parent company, the move can be exhilarating, with fast timelines, massive challenges, and big opportunities. But the complexities and the risks of planning and executing such a “corporate carve-out”—a corporate reorganization method in which a parent company divests a business unit—can be tremendous, and nobody wants to destroy value in the process.
Not surprisingly, in a carve-out, the overwhelming focus for the management team is on execution and achieving Day One readiness. While execution is certainly key, “not destroying value” is very different from “creating value.”
One way CFOs can create more value for their businesses during a carve-out is by intentionally working with tax and finance leaders to design Day Two from the start.
More than the sum of their parts
There can be massive tax implications of a carve-out, not just in how the new company (NewCo) is structured but also in how it will operate. New service agreements, supplier contracts, facilities, and business models have tax impacts. Even for a carve-out as simple as cleaving a company in two, the tax implications are significant.
Splitting a company very often changes the realities of the business. An organization might find that the allocation of its taxable profits shifts as a result of changes to the centers of activity or where the decision makers for NewCo sit. (They often aren’t hired until just before the transaction closes.) Any taxable profits can also change according to where NewCo’s assets are, where its employees are working, or where capital is invested.
The same goes for the remaining part of the company (RemainCo). If your tax calculations were based on certain research and development (R&D) incentives and you are now carving out your R&D division, your tax assumptions will clearly change. Or perhaps you are splitting out your contract manufacturing division to focus on core services; that, too, will have a significant impact on RemainCo’s tax status as you shed physical assets from the books and pivot toward services revenue.
Tax and finance leaders must have a good grasp of the carve-out’s implications for operations and business models to develop the most effective business structure. They cannot assume previous models will hold true. From the very start of the execution process, they must understand what Day Two will look like.
The benefits of a Day Two focus
Planning for business after the carve-out allows tax leaders to provide better advice to the CFO on how the future businesses should be structured. And that can improve both financial value and business flexibility.
In part, Day Two planning is about aligning the business structure and profit profile to ensure NewCo is maximizing its potential tax benefit. Virtually every market offers a range of tax incentives or rebates for anything from R&D investments to environmental impact. But availing yourself of those tax opportunities depends on generating profits in the same market. Maximizing tax value requires carve-out teams to plan for the future.
Day Two planning is also about creating greater flexibility for both NewCo and RemainCo. The business environment will continue to change after the carve-out. NewCo will grow into new markets and segments; supply chains and investment flows will evolve; profit centers and employee locations may shift. By focusing too much on Day One readiness, businesses might miss an opportunity to create the right environment for both organizations’ success.
Tomorrow’s opportunities, today
There are many reasons why CFOs and tax leaders should not delay thinking about Day Two. Perhaps the biggest is that planning for Day Two directly influences the financing that the deal can attract. Private equity investors often look for debt structures that provide tax relief by matching interest costs to profits, thereby lowering the cost of capital. The sources of financing will have a direct effect on how the deal gets financed.
At the same time, CFOs need their tax leaders to consider the wider matrix of opportunities. They can put a great structure in place to claim relief on interest costs in one market, but once in operation, they may find it changes where their organization’s profits are located, which changes the effective global tax rate and cost of capital.
A modernization moment
Thinking about Day Two also means thinking about your tax operating models, as they will need to shift. Carve-outs can provide a blank sheet on which to design the optimal tax operating model for NewCo. The fresh start allows planners to think holistically about their strategy and the type of skills and capabilities they need. New tools, outsourcing, co-sourcing, and operating models offer unprecedented opportunity to start NewCo off with a modernized and efficient tax function. The same can apply to RemainCo.
Smart outsourcing is key to enhancing your tax operating model. Taking into account all available options for NewCo and RemainCo can reduce the disruption of transformation, help you manage costs, and create a more flexible and effective tax operating model.
Tax professionals are usually the first to admit that preparing a company to execute a carve-out is difficult work. But in most carve-out situations, tax and finance leaders may be missing out on opportunities—not just to protect value but also to create it.
Deloitte is a recognized global leader in mergers and acquisitions, with an established network of experienced professionals around the world. To learn more about how Deloitte M&A can help your organization, please visit deloitte.com.
Mike Thorne is partner at Deloitte UK.
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