• Private equity investors use corporate carve-outs as a strategy to obtain greater returns on investment.
  • The carve-out segment is often “spun-off” into a public company and the shares are distributed to the shareholders of the parent company.

What Is a Carve-Out? 

A carve-out refers to the sale of a business unit. A parent company will sell a minority interest of a business unit to outside investors, often through a minority initial public offering or IPO. A public offering also creates a new class of investors. There are two primary contexts for the sale: an equity carve-out and a spin-off.

In an equity carve-out, the parent company sells an equity stake in the unit. This is either because a single buyer could not be found, or because the firm wants to maintain some control of the business. The ultimate goal of such a move might be divesting completely, but there are a plethora of reasons why a firm may need to gradually restructure its assets. One common reason for the restructuring is that the smaller unit no longer represents the parent company’s core operations, but the parent still wants to benefit from its equity and potential new investors.

In a spin-off, the business unit becomes a standalone company. In some cases, a carve-out will precede a full spin-off. A key difference from the carve-out is that shares are instead transferred to current investors of the parent unit. The original parent company may also choose to retain an equity stake within the new firm. To retain a tax-free spin-off, the company needs to retain at least 80% of the stock, limiting the initial stock available in an IPO.

Reasons to separate a segment vary. Common motives include targeting activist shareholders, streamlining business, requiring an injection of cash to de-lever or invest, or believing the separated segment will have a better valuation as a standalone business. 

Carve-Outs and Private Equity

Within the private equity universe, a carve-out is most valuable when it opens a channel for the firm to profit...