Carve-out transactions can take many different forms and involve unique considerations. A carve-out transaction is the sale of a subsidiary, business division, or other segment of a business. Careful preparation ahead of pursuing a carve-out transaction is critical, particularly with respect to issues such as tax structuring, how to unwind assets and liabilities, employee retention, and post-closing transition services.

One of the most important tasks that should be completed in advance is preparing financial statements for the business unit being carved-out. A company usually only has audited financial statements for the top-level company, not for individual subsidiaries or divisions. Carve-out financials take a long time and are costly to prepare. They must accurately reflect the assets and liabilities being divested. The buyer in an acquisition may make the preparation of carve-out financial statements a condition precedent to closing the acquisition. Thus, a lack of advanced preparation of the carve-out financials can result in transaction delays.

Employee issues can result in some of the biggest headaches in a carve-out transactions. The decision about which employees are transferred to the divested business and which employees remain with the seller requires painstaking thought. New employment or retention agreements may have to be entered into with key employees in order to ensure a smooth transition. The buyer will also want to diligence the new employees to make sure they are not being given unnecessary or low-performing employees.

The seller will also need to figure out logistics with respect to benefit plans. The existing benefit plans of employees being transferred to the divested business are often terminated, and such employees are instead integrated into the benefit plans of the buyer’s company. Transferred employees may have concerns about losing benefits under their current plans.

Software licensing issues are another hot topic in carve-out transactions. Software licenses generally apply at the top level of the company, allowing all divisions of the company access to use the software. Once a business unit is divested, the divested business unit will usually not be able to use these enterprise-level software licenses. The software replacement costs of the divested business may be higher because it cannot rely on economies of scale to negotiate better pricing.

Relatedly, the intellectual property rights of the divested business and the retained business must be carefully negotiated in a carve-out transaction. The parties may negotiate so that the divested business has the right to use certain IP in a limited manner following the closing of the acquisition. An alternative to licensing IP rights is simply selling the IP rights. However, this is not always feasible in situations where the IP is relevant to both the retained and divested businesses.

When tax planning for a carve-out transaction, it is important to consider the tax classification of the seller. If the seller is a C-corporation, it will be subject to two levels of federal income tax. It will first have to pay taxes at the corporate level when profits are earned, and then it will have to pay taxes at the stockholder level when profits are distributed.