Unlocking Value: The Strategic Role of Carve-Outs in Venture Capital Investing

A carve-out in private capital refers to the process whereby a parent company sells a subsidiary, division, or specific assets to another firm with the goal of focusing on core operations or raising capital.  

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.  ‍

What is a Carve-out?  

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.  ‍

Types of Carve-out Deals  

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.  

• ‍Spin-off: In a spin-off, the parent company distributes shares of the subsidiary to its existing shareholders, creating a new, independent company. The parent company is freed to focus on core operations, and the spun-off entity gains autonomy. Shareholders of the parent company receive shares in the new entity, but the effect is muted somewhat because the new entity is independent post-transaction.   ‍
• Asset Sale: In an asset sale, the parent company sells assets (e.g., intellectual property) rather than equity. The proceeds from the sale of assets can provide immediate capital to the parent company but they do not typically impact VC shareholders directly.  ‍
• Management Buyout (MBO): In an MBO, the company sells a subsidiary or division to its current management team – often with financing from its VC partner(s). As the name implies, the management team gains ownership and control of the business in this type of carve-out. The impact on shareholders can vary based on the terms of the buyout.    

How the Carve-out Process Works  

A successful private market company carve-out is a complex and multi-stage process. At a high level, the stages are as follows.  

• The parent company assesses long-term goals and then identifies a subsidiary, division, or asset that is not core to its principal business but holds value.  
• The company conducts a valuation process that considers financial performance, market potential, and synergies with potential buyers. That information is used to determine the appropriate type of carve-out and structure the deal and transaction terms.  
• The company goes to market to seek potential buyers or investors and begin negotiations.  
• After the carve-out deal is identified, the parties negotiate its terms to agree on price, terms, and conditions.  

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.   ‍

Carve-outs are Making a Comeback  

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.