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Carve-outs are gaining renewed attention in the private markets, particularly in the middle market (companies with revenues between $10 million and $1 billion). In Q1 2024, carve-outs accounted for 15.5% of buyout deals in the middle market—up from 7.6% in 2022.1 Within venture capital, the trend is worth noting because these deals can unlock value for founders and shareholders. Founders can use carve-outs to raise capital in a challenging environment or have an alternative to an acquisition—supporting the company's maturation. For VC investors, carve-outs can generate shareholder value and offer attractive opportunities to invest in established businesses with growth potential.
A carve-out is a transaction where a company sells a subsidiary, division, or specific assets to another firm. This process allows the parent company to focus on its core operations or raise capital. Carve-outs can take several forms, including equity carve-outs, spin-offs, asset sales, and management buyouts.
Carve-outs can be structured in four primary ways. Among them, equity carve-outs are most impactful for shareholders due to their potential for liquidity, valuation benefits, and strategic growth opportunities. They offer a direct way for VCs to capitalize on their investments and align with the typical VC strategy of seeking high returns through growth and public market exits.
In an equity carve-out, the parent company sells a portion of the subsidiary's equity to public investors through an initial public offering (IPO). The deal creates a new publicly traded entity while the parent company retains control over the subsidiary, benefiting from the raised capital while maintaining influence.
The IPO process itself can generate benefits for VC shareholders. The company can realize significant returns, improve liquidity, and potentially gain higher valuation multiples on their investment. An IPO can appreciate valuation because public markets often value companies more than private ones. Newly public entities also often benefit from the increased visibility and credibility the IPO brings, helping attract new investment and strategic partners. The progress can accelerate growth and operational improvements, indirectly benefiting VC shareholders who hold stakes in the parent company or the subsidiary.
The three other carve-out deal types are spin-offs, asset sales, and management buyouts. Each provides a distinct benefit for founders and shareholders.
A successful private market company carve-out is a complex and multi-stage process. At a high level, the stages are as follows.
Once the parties have reached an agreement, the carve-out deal is complete. At that point, integration efforts should begin immediately. How well the parties transition operations, employees, and systems will determine success for the parent company and the carved-out entity.
As Pitchbook reported, 2024 is seeing a resurgence of carve-outs in the private markets. Current factors contributing to the trend include the still-uncertain lending environment, which makes carve-outs viable fundraising options for growth-stage companies challenged by access to capital.
Some of the more enduring strategic reasons for carve-outs include the opportunity for a company to divest non-core assets, allowing them to refocus core operations and reallocate resources to improve efficiency. They can also raise a company's profile with private capital firms seeking attractive investment opportunities with established businesses pursuing rapid growth potential and strategic improvements.
These timely and strategic reasons are worth understanding and monitoring. Carve-outs are complex and can be time-consuming. But when done well, they are powerful ways for companies to capture the capital necessary to streamline and unlock new levels of growth and value.