Japan’s giant corporations are under pressure to shape up. Recent guidelines from the Japanese Ministry of Economy, Trade and Industry (METI) are putting pressure on boards to sell assets as a way of creating growth. Historically, Japan’s corporate leaders have tended to shy away from streamlining strategies. However, with many companies now facing liquidity challenges in the wake of the COVID-19 pandemic and increasing pressure from activist shareholders to streamline their portfolios, attitudes in the boardroom may be changing.
For directors considering carve-outs, there are a range of issues to think about – we have set out the most essential ones below. Carve-outs are complex and time-consuming, so any Japanese conglomerates considering such transactions are well advised to start developing their carve-out programmes as soon as possible.
Should you do a carve-out? Carve-outs tend to be complex, lengthy, cost-intensive and absorbent of management time. They can affect balance sheets and P&L adversely. They may require the consent of key customers or suppliers, of creditors, employees or their representatives. These are just some of the aspects that will need to be factored in when determining whether the merits of a carve-out outweigh its costs, risks and effort. In some cases, alternative options like a pure contractual cooperation might achieve the same effect in a more efficient manner.
The stages of a carve-out. Typically, a carve-out sale goes through six stages: (1) the carve-out perimeter (i.e., the scope of the business to be sold) must be defined; (2) the perimeter will inform the optimal structure of the carve-out; (3) the transaction documents will be prepared before or concurrently with (4) the auction process; (5) from the closing of the sale, the sold business will in most cases be run under a transitional operating model with various support from the seller; before finally (6) the target operating model is established fully.
Contractual protections. Any buyer will want to make sure it is getting the complete carve-out business capable of operating on a standalone basis, as well as value for money. The first aspect can be covered by wrong-pocket clauses, sufficiency of assets warranties, business continuity undertakings and the like. The bigger challenge is giving the buyer comfort that the business is indeed worth the money it is paying, particularly if no historical standalone financials are available to support the purchase price calculation.
Day one readiness: business continuity. Carving out a business will require a detailed separation plan. Ideally, the separation is completed before the sale process is started. However, in most cases it is still ongoing while the transaction is being negotiated and may even be a condition to closing the deal. In any event, it is highly unlikely that the carved-out business will be completely independent from the seller’s retained business in the initial period following closing of the sale. So the seller will need to determine, and agree with the buyer, the transitional operating model to bridge the time gap until the separation is complete. This phase of the separation is typically governed by a transitional services agreement and possibly other agreements, including real property lease agreements, IP licensing agreements, supply agreements, toll-manufacturing agreements, and distribution agreements. These agreements often require more time to draft and negotiate than the standard M&A documentation.
Auctions strategies. In addition to customary auction strategy considerations, sellers will need to determine whether to present the carve-out to bidders as a fait accompli or whether they are willing to work with bidders on the details of the separation and operating models. The latter approach may appear more cumbersome and riskier but may help to maximize proceeds by making the deal more attractive to the buyer.
In summary, carve-out sales require both more planning, more work and more time than the straightforward sale of a standalone business. The attached overview shows more details of carve-out transactions.