Definition
A carve-out is a corporate transaction in which a parent company sells part of a subsidiary or business unit to outside public investors through an initial public offering (IPO). The carved-out unit becomes a separate, publicly traded company with its own board and financial statements, while the parent usually keeps a minority or majority stake and continues to provide some strategic or operational support.
Why companies use carve-outs (short list)
– Raise cash without fully disposing of a business.
– Test the market value of a unit before a full sale or separation.
– Retain strategic influence while unlocking value for shareholders.
– Reduce complexity while preserving optionality for future restructuring.
How a carve-out works — step-by-step
1. Identify unit: Parent selects a business unit or subsidiary to separate.
2. Prepare standalone reporting: Management prepares separate financial statements and governance (board, management team).
3. Determine offering size: Parent decides what percentage of equity to sell in the IPO (often a minority stake).
4. Regulatory and tax review: Evaluate securities filings, regulatory approvals, and tax consequences (e.g., whether a later spin-off can be tax-free).
5. Roadshow and pricing: Underwriters market the shares, set price and number of shares to sell.
6. IPO execution: Shares are sold to public investors; proceeds flow to the seller (usually the parent).
7. Post-IPO relationship: Parent may continue to hold a controlling interest, provide transitional services, or gradually reduce ownership.
Key distinctions: carve-out vs spin-off
– Carve-out (equity carve-out): Parent sells shares of the subsidiary to outside investors in an IPO and receives cash proceeds. The parent typically retains some ownership.
– Spin-off: Parent distributes shares of the subsidiary to its existing shareholders pro rata; no immediate cash flows to the parent. To be tax-free under U.S. law, a spin-off usually must meet certain control requirements (see tax code references below).
Short checklist for evaluating a carve-out (for managers and investors)
– Strategic rationale: Why is this unit being separated? Is management aiming to unlock value, raise cash, or reduce complexity?
– Financial independence: Can the carved unit produce transparent, standalone financials?
– Ownership goal: What stake will the parent keep? Will control be retained?
– Market appetite: Is there investor demand for the unit’s sector and growth profile?
– Tax and regulatory issues: Will a subsequent spin-off be tax-free? What approvals are needed?
– Transitional arrangements: Are transitional service agreements (TSAs) in place for shared functions (IT, HR, supply chain)?
– Valuation and pricing: What valuation multiple is justified for the IPO?
– Timeline and contingencies: What are the milestones and fallback plans if market conditions deteriorate?
Worked numeric example
Assumptions:
– Parent owns 100% of SubsidiaryCo.
– Parent decides on an equity carve-out by selling 15% of SubsidiaryCo in an IPO.
– Underwriters price the IPO at $20 per share; 10 million new shares are sold.
Calculations:
– IPO proceeds to parent = number of shares × price = 10,000,000 × $20 = $200,000,000.
– Post-IPO ownership:
– Public ownership = 15%
– Parent ownership = 85% (assuming no other dilution)
– Implied market capitalization of SubsidiaryCo after IPO =
= 10,000,000 ÷ 0.15 = 66,666,667 total shares after the IPO
– Implied market capitalization = total shares × IPO price
= 66,666,667 × $20 = $1,333,333,333 (≈ $1.333 billion)
Further breakdown
– Parent’s remaining shares = total shares − new shares = 66,666,667 − 10,000,000 = 56,666,667 shares
– Value of parent’s retained 85% stake = 56,666,667 × $20 = $1,133,333,333 (≈ $1.133 billion)
– Parent’s aggregate economic position immediately after the IPO = IPO cash proceeds + retained stake value
= $200,000,000 + $1,133,333,333 = $1,333,333,333 (matches implied market cap)
Interpretation (numeric example)
– The parent monetized a 15% economic interest for $200 million while preserving control (85% ownership).
– The IPO set a public market implied enterprise value of about $1.333 billion for SubsidiaryCo.
– The parent still holds ~$1.133 billion of implied market value in the subsidiary, in addition to the $200 million cash.
Accounting and control consequences (brief)
– Because the parent retains more than 50% ownership (85%), SubsidiaryCo remains consolidated