What Is a Corporate Carve-Out? How They Work & Why They Happen

Companies “carve out” business units all the time, for all sorts of reasons. The parent company might think the business unit is undervalued as part of a bigger company, or no longer be interested in operating it, or simply need to raise cash by selling it.

A carve-out is an important first step for companies facing these (and many other related) scenarios. But people who don’t do this stuff every day often misunderstand exactly what they are, how they work, and why they happen.

What Is a Corporate Carve-Out?

A corporate carve-out happens when a company gives up some control over an internal business unit. It often involves a partial sale of equity in the unit to an outside investor or group of investors, like a private equity firm.

A corporate carve-out usually happens as part of the divestment process, which is when a company decides it no longer wants to own or be actively involved in a particular part of its operation. The parent company (the bigger company carving out the smaller unit) might retain an equity stake in the carved-out company but probably won’t play a big role in day-to-day management.

Is a Corporate Carve-Out a Spinoff?

A corporate carve-out isn’t a spinoff, exactly. A spinoff results in the creation of an entirely new, independently managed entity in which the former parent company may or may not retain a minority stake.

In other words, a spinoff is more “final” or “complete” than a carve-out. However, it’s a common endgame for companies considering carve-outs with the ultimate goal of divesting.

A spinoff isn’t the only divestment option for carve-outs. McKinsey describes the most common, including spinoffs:

• Cash sale to a strategic buyer, often a competitor in the same industry (this is known as a “trade sale”)
• Sale to a private equity firm, which may own similar companies or be in a unique position to achieve synergies within the carved-out unit
• Initial public offering (IPO) of the carved-out business, in which the former parent company retains a passive equity stake
• Public spinoff or “splitoff,” another type of stock transaction where all parent company shareholders receive equity in the carved-out business
• Merger with strategic partner, often a competitor, in which the former parent company retains some equity
• Joint venture with a strategic partner, with the former parent company taking a more active role in strategy/management

Why Do Corporate Carve-Outs Happen?

Corporate carve-outs happen for all sorts of reasons. While every situation is different, many carve-outs fall into one of these categories.

They Help Businesses Streamline Operations

Carve-outs can help bigger companies streamline their operations by separating less important (non-core) business units from the larger whole.

Maybe the unit is responsible for just 5% of overall revenue and has little in common with the rest of the business because it’s left over from a previous acquisition, or other business units grew much faster. Management is more focused on the rest of the business and maybe doesn’t understand the non-core unit at all. Maybe activist shareholders are pressuring management to do something about the oddball unit.

Whatever the case, management decides the unit is better off on its own. They might even think it’s more valuable that way.

They Often Create More Aggregate Value

Although they have a lot of upfront costs that can reduce profitability, corporate carve-outs often unlock aggregate value because:

• New management/ownership could understand the business better than the former parent company’s team
• New management/ownership has more resources to devote to the business
• The business was previously undervalued by the market and has more room to “shine” as its own entity
• The former parent company no longer has to devote resources to the carved-out entity (but may still benefit from its performance if an equity stake is retained)

They May Help With Broader Restructuring

Sometimes, management doesn’t much care what happens to the carved-out unit. They execute the carve-out as an early step in a broader restructuring process that improves the parent company’s performance. If divested quickly, the carve-out can help raise cash to fund the restructuring, which often takes several years.

They Can Be More Profitable in the Long Run

A corporate carve-out not only has the potential to create more market value. It can also increase profits and improve profit margins in the long run, which is good for the overall health of the business.

The carve-out can improve profitability at both the former parent company and the carved-out company. This is an important goal for many carve-outs regardless of the eventual divestment strategy. In fact, in cases where the former parent company retains some ownership of an IPO’d or privately sold business unit, they can earn income from the business without spending time worrying about how it’s run.