To understand the landscape of global M&A carve-out deals and the role of legal entity formation, we spoke with three experts with decades of combined experience providing guidance to private equity firms.
Tamara Sablic is Vistra's commercial sales director. With 14 years of industry experience, she works with global private equity funds and their portfolio companies to help them operate more efficiently. Maria Scofield is Vistra's relationship management director and has over 20 years’ experience helping companies in private equity, real estate and venture capital manage their operations. Anastasia Williams leads Vistra's commercial private equity practice in North America. For more than a decade, she's helped global private equity funds and their portfolio companies expand into new markets.
What’s a carve-out deal and why are they popular now in the private equity space?
Tamara: A carve-out is the sale of a specific business unit of a global multinational company. A large transaction often has many bidders from private equity, venture capital or corporate firms. Although carve-outs have been around for decades, they have been rising in popularity due to an excess of dry powder, or capital raised from investors not yet deployed into investment opportunities.
Carve-outs can be beneficial to both the seller and the buyer. The seller is able to sell a business unit that may not be core to their strategy or may not be performing at the level they want, and they can use the funds from the sale to reinvest in other parts of their business. For buyers like PE [private equity] firms, carve-outs present a great opportunity to strengthen their portfolio and raise funds. A PE firm will look for a business that fits into their investment strategy and areas of expertise, and one that has potential synergies with other companies in their portfolio.
What role does legal entity establishment play in an M&A carve-out deal, and why is the timing so critical for PE buyers?
Anastasia: Carve-outs are more complicated than a full acquisition because the entire corporate structure of the purchased business must effectively be re-established. Any services that stayed with the parent company — like HR, IT, finance and payroll — need to be set up for the carved-out business unit. To establish these processes, you need a legal entity first. Establishing a legal entity is not only critical to the success of the carve-out, but it requires a lot more time and resources that PE firms typically expect.
Maria: PE firms must do their due diligence to be adequately prepared for this stage of the process, because entity formation needs to be completed before the target close date. The transition services agreement, or TSA, states which services the seller will continue to provide — like payroll or accounting — while the buyer prepares to receive and operate the new business. The TSA outlines the close date, which is the point at which buyer must have an entity established so they can provide those services. If the PE firm is not on track to have entity establishment by that date, they will need to renegotiate the TSA or find another stopgap solution.
Tamara: Planning for entity establishment is essential in ensuring a strong start to the business. The best way to manage timing is to be realistic, be prepared and then get ahead of it. As soon as you have a transaction in the pipeline, line up a service provider to support with entity establishment.
Do most countries have similar legal entity structures and related budgets and timelines, or are there significant differences between jurisdictions?
Tamara: Carve-outs would be a whole lot simpler if every jurisdiction had the same process for legal entity formation! Each jurisdiction has its own timeline for entity establishment, so PE firms need to plan ahead and prepare for this. In my experience working across over 100 different jurisdictions, the United States is one of the fastest countries when it comes to entity formation. In the US, it may take only hours to establish a new entity; for a country like Brazil or Argentina, it could take six months. Most, if not all, countries take between a few weeks and a few months to establish and operationalise an entity.
Anastasia: In addition to the timing consideration, it’s also important to understand the exact requirements of establishing an entity across jurisdictions. For example, in France, you must have an open bank account before you can establish a legal entity — and opening a bank account in France can take one to two months. That pushes the entire timeline for entity formation back significantly. That’s why it’s so helpful to have a partner that understands the nuances of entity formation requirements and timing across different jurisdictions. Otherwise, it’s very difficult for PE firms to stay on time and on budget during the legal entity formation.
What stopgap solutions can be used in the interim while a legal entity is in the process of being set up?
Tamara: The first option is to extend or renegotiate the TSA to ensure that services continue to be provided by the parent company while the new legal entity is being set up. However, changing the TSA will typically increase the cost for the buyer and can increase tensions between parties. It places additional burdens on the seller, and they usually aren’t too happy about renegotiating.
Maria: If we see that an entity will not be established in time for the target transaction close date, we might recommend using an employer of record, or EOR, for three to six months rather than renegotiating the TSA. An EOR provider is a third-party organisation that hires and pays an employee on behalf of another company and takes responsibility for all formal employment tasks. An EOR allows companies to engage with workers in a new country without needing a local entity and without risking compliance violations. An EOR may sometimes be a good long-term solution, for instance if the company is operating in a jurisdiction with only one or two employees and if the business in that jurisdiction doesn’t trigger permanent establishment.
Is there anything in this area that clients and prospects routinely get wrong?
Maria: It comes down to having the right expectations. I often see clients underestimating the time it takes to set up a legal entity. It can sometimes take weeks just to collect documents! A lot of US-based PE firms are familiar with legal entity establishment in the US, so they assume that it’s a similar process everywhere. However, in many other countries — like ones in Asia and South America, for example — the process is often more difficult and time-consuming than expected. Furthermore, many workstreams are interconnected. There are contingencies in this process that must be accounted, for instance, needing a bank account in order to process payroll. Not preparing for this level of complexity may result in potentially serious consequences — anything from workers not being paid to missing deadlines for obtaining licences that allow the company to operate in the country.
Anastasia: Running a business in accordance with local laws can be difficult, and you need to know all of your compliance obligations — from HR to payroll to corporate taxes and more — before you close the deal. These compliance obligations can be very different from those in your home country or other countries of operation. Defining the new entity’s legal structure up front can help you line up the service providers and experts you’ll need to fulfil your obligations from the start. Otherwise, you may risk wasting time and money later, not to mention possible fines and penalties.
What considerations should be top of mind for buyers who are vetting service providers to support a cross-border carve-out deal?
Tamara: Finding the right service providers to support the deal and give you authoritative guidance is essential for success – from choosing the right law firm in the target country to the right fund administrator to the right firm to deliver local payroll and file corporate taxes. The most important thing is to find providers with expertise in the jurisdictions that matter to your acquisition. Each country has its own idiosyncrasies, so having partners that understand all the complexities and nuances, and can advise accordingly, is paramount. Project management expertise is also critical for providers to be able to stay on top of multiple interconnected workstreams.
Anastasia: It’s worth identifying service providers as early as possible in the bidding process. That way, once you win the deal, you can easily activate all your vendors to start working on the project — including legal entity establishment. That’s the best way to set yourself up for success and ensure you’re fully prepared for the acquisition closing date.
Is there a client or prospect story related to legal entity formation during a carve-out deal that you find particularly illuminating or interesting?
Maria: I had a client who was in the process of acquiring a business unit with global operations. We had to stand up over 30 legal entities within just three months in order to meet the scheduled closing. This was enormously complex because each jurisdiction has unique processes, contingencies and timelines for entity establishment. Although it was challenging, it was so fulfilling to see them operational by the close date.
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