Carve-out due diligence: separating a business and its documents

A carve-out is a sale of part of a business. A conglomerate sells a non-core division; a private equity owner splits a portfolio company; a listed group divests a product line to satisfy a competition authority. In each case the buyer acquires an operation that was built to rely on its parent, for finance, IT, HR, premises and often customers.

That dependency is what makes the diligence different. In a whole-company sale the perimeter is obvious: it is the legal entity. In a carve-out the perimeter has to be drawn, documented and defended, and the buyer will test every line of it.

How is carve-out due diligence different from a normal sale?

The core workstreams look familiar: financial, legal, tax, commercial, operational, HR and IT. What changes is the question each one asks.

Every row adds work. Most also add negotiation, because the seller and buyer often disagree on what “standalone” should cost.

Why do standalone financials matter so much?

A division inside a group rarely has its own audited accounts. Its revenue may be visible, but its costs are tangled with the parent: a share of head office, group insurance, central IT, shared procurement terms and intercompany trading at prices nobody negotiated at arm’s length.

The seller therefore prepares carve-out financial statements, sometimes called combined or standalone financials. They are built by taking the unit’s direct results and allocating a share of group costs on a stated basis, such as headcount or revenue. Buyers then ask two separate questions:

1. Are the historical allocations reasonable? They show how the unit has performed with the group’s support.
2. What will the unit cost on its own? The answer is usually higher, because the buyer must replace group services at its own scale. This is often called the standalone cost adjustment, and it moves the price.

If the buyer is an SEC registrant, the reporting rules for acquired businesses add another layer; the financial statement requirements sit in Regulation S-X, and a carve-out can need audited statements prepared specifically for the transaction. Start that work early: an audit of carve-out statements is not something an adviser can turn around in two weeks.

What goes in a carve-out data room, and what stays out?

This is where carve-out work differs most in practice. The group’s document systems contain everything about the unit and a great deal about businesses that are not for sale. Nothing should move into the deal room without being sorted first.

A useful working method is a three-bucket sort, applied document by document:

• Transfers with the business. Contracts, permits, employee records and asset registers that relate only to the unit. These go into the room in full.
• Shared with the parent. Master agreements that cover several divisions, group IT licenses, shared leases and group IP. These need a decision: a redacted copy showing only the unit’s part, a summary prepared by counsel, or a note that the item will be covered by a transitional or long-term agreement.
• Stays with the seller. Group tax returns, consolidated board papers, pricing for other divisions and the seller’s wider strategy. These stay out, or appear only as extracts where the buyer has a legitimate need.

Doing this sort before the room opens is far cheaper than redacting documents one by one after a bidder asks. It also produces a perimeter list that legal counsel can later attach to the sale agreement.

How do you handle shared contracts?

Shared contracts are the single largest source of carve-out friction. A group-wide supply agreement might give the division volume discounts it will lose on its own. A customer may buy from three divisions under one master contract. A software license may forbid transfer entirely.

For each shared contract, diligence should establish:

• whether the contract can be split, assigned in part or replicated with the counterparty;
• whether the counterparty’s consent is needed, and how cooperative it is likely to be;
• what the unit’s share of volume and value actually is;
• what happens to pricing once the unit stands alone.

Put the analysis into a contracts schedule that sits in the room next to the redacted contracts. Buyers find it far easier to review a schedule with clear references than to rebuild the picture from fifty partial documents.

What is a transitional services agreement?

A transitional services agreement (TSA) is the contract under which the seller keeps providing services to the sold unit for a limited period after closing. Typical services include payroll, IT hosting, email, accounting, procurement and sometimes warehousing or logistics.

Diligence on the TSA covers scope, duration, price and exit. The buyer wants enough time to build or buy replacements; the seller wants to stop as soon as possible. Six to eighteen months is a common range, with extension options for complex IT.

Reverse TSAs, where the sold unit provides services back to the seller, are less common but worth checking for. Both directions belong in the room as drafts once the second round starts.

What happens to the people?

Employees are usually split into three groups: those who work wholly for the unit, those who work wholly elsewhere, and those who split their time. The third group is where judgment comes in.

In the UK and EU, the employee transfer rules can decide the question by law. In the UK, the Transfer of Undertakings (Protection of Employment) Regulations 2006 move staff “assigned” to the transferring business automatically, on their existing terms, and require information and consultation. In the US there is generally no equivalent automatic transfer, so the buyer makes offers and the seller handles anyone who is not hired.

Diligence should produce an employee census for the unit, show the allocation basis for shared staff, list key people the buyer will want to retain, and set out any pension or benefits plans that cannot simply move across. Personal data in that census needs careful handling; our guide to secure document storage in data rooms covers the controls.

How should a carve-out data room be permissioned?

Permissions matter more here because the room is likely to contain at least some group material, and because different bidders may receive different levels of detail on shared items.

1. Sort before you upload

   Run the three-bucket sort on every document, and keep group-only material in the seller's own systems.

2. Build a separate folder for shared items

   Group redacted shared contracts, IT dependency maps and TSA drafts in one clearly labeled area, so reviewers know they are looking at partial material.

3. Create permission groups by workstream

   Give finance, legal, HR and IT advisers access to their areas only; restrict the employee census and the standalone cost model to a small group.

4. Stage the sensitive material

   Hold detailed customer data and the TSA pricing until the second round, and release it only to shortlisted bidders.

5. Route questions through Q&A

   Shared items generate questions the deal team cannot answer alone; assign each category an owner in the group's functions.

6. Keep the perimeter list current

   Every time a document moves between buckets, update the perimeter list that will later be attached to the sale agreement.

Most full data rooms handle this with folder-level permission groups, view-only access, watermarking and staged release. Compare those controls across vendors in our provider directory, and look at how the deal flow works more generally in our mergers and acquisitions guide.

Why do carve-outs take longer than whole-company sales?

Three reasons recur.

The perimeter is negotiated, not given. Every shared contract, person and system is a small negotiation. Even a well-prepared seller cannot settle all of them before bidders arrive.

The financials are new. Standalone statements, and any audit of them, take time to prepare and more time for buyers to test.

Separation planning runs in parallel. IT separation in particular can take longer than the deal itself, and buyers are reluctant to sign without a credible plan.

In practice, plan for a room that stays open well beyond the diligence phase, because TSA negotiations and separation planning continue up to signing. Our guide to how long a data room stays open covers duration and cost, and the VDR pricing page shows how monthly pricing behaves over a longer term.

Is a carve-out the same as a bolt-on from the buyer’s side?

Often the two meet. A buyer with an existing platform may acquire a carved-out unit as a bolt-on, folding it into its own systems instead of building standalone functions. That changes the TSA calculation: the buyer may need a shorter TSA because it already has payroll, IT and finance to plug the unit into. Our explainer on bolt-on acquisitions covers that buyer’s perspective, and the due diligence hub sets out the full review checklist.

What should sellers prepare before launching a carve-out?

A short list, roughly in order of lead time:

• Carve-out financial statements with a written allocation methodology, and an audit if a buyer will need one.
• A perimeter list of entities, assets, contracts, people and IP that are in scope.
• A shared contracts schedule with a proposed treatment for each item.
• An IT dependency map showing which systems the unit uses and who owns them.
• A draft TSA with a service schedule and indicative pricing.
• An employee census with an allocation basis for shared staff.

Sellers who arrive with these documents in good order tend to keep control of the timetable. Sellers who do not usually find that the buyer’s advisers draw the perimeter for them.