The role of technology in a private equity carveout
NOV. 6, 2024
Technology can make or break a private equity carveout. Here's how to master the tech side of corporate separation.
Corporate carveouts are a true test of strategic execution in private equity (PE). You’re essentially performing surgery on a corporation, carefully separating a business unit from its parent company and giving it a new lease on life as an independent entity.
While financial maneuvering and operational restructuring are certainly important pieces of the puzzle, technology plays an increasingly critical role in every step of the carveout journey.
From unraveling a tangled web of IT systems to building a scalable infrastructure for the newly-formed business, technology can make or break a corporate carveout’s fate.
The critical role of data strategy in carveouts
Data informs every aspect of the carveout process. Without a clear data management strategy, you’re operating in the dark.
The benefits of a strong data strategy
- Accelerated setup: A clear understanding of the data landscape lets you hit the ground running, setting up the new company’s tech infrastructure quickly and efficiently. This minimizes disruption and gets you to market faster.
- Improved M&A integration: Aligning data and tech strategies early streamlines the integration process, avoiding costly delays and ensuring a seamless transition.
- Platform for future growth: A flexible data infrastructure is a launchpad for the future, enabling the new entity to adapt, grow, and even make its own acquisitions down the line.
- Reduced tech debt on exit: A well-maintained tech stack enhances the value of the business, attracting buyers and commanding a premium when it’s time to exit.
Key challenges and opportunities in carveouts
Carveouts are a high-stakes game with little room for error. Along with their challenges come opportunities—namely, a chance to innovate, expand, and gain a strategic advantage.
Data transfer and tech separation
One of the biggest hurdles in a carveout is the speed of separation. Quickly disentangling the new entity’s technology infrastructure from its parent company is critical. Still, conflicting interests, disagreements over data access, and the complexities of Transition Service Agreements (TSAs) can all create roadblocks that slow you down and drain resources.
Implementing efficient data transfer processes and leveraging cutting-edge technologies can accelerate the separation, minimize disruption, and give the young business a head start in the market.
Data quality and architecture
The quality of the data you inherit in a carveout can significantly impact its outcomes. Assessing data “cleanliness” during due diligence is crucial; ensuring it’s accurate, complete, and consistent.
But it’s not just about the data itself—it’s also about the underlying architecture. Conducting code-level diligence helps you understand the existing codebase's quality, authorship, and maintainability, identifying potential risks and dependencies.
Implementing a data warehouse or lakehouse architecture can help you centralize and manage your data effectively, providing a scalable platform for future growth.
Technology infrastructure
Building a technology infrastructure for a newly carved-out company is a delicate balancing act. It’s about meeting the immediate needs of the business while also facilitating scalability and potential acquisitions down the road.
Leveraging existing IT assets can be a cost-effective starting point, but it’s also crucial to have a roadmap for future upgrades and migrations. Sometimes, a custom-built architecture is the best long-term solution, offering greater flexibility and ease of migration as the company evolves. Ultimately, it’s about finding that sweet spot between short-term needs and long-term vision.
3 key areas of technology consideration
In a carveout, technology is the foundation upon which success is built. But with the complexities of separation and the need for rapid value creation, it’s crucial to focus your efforts on the areas that matter most.
Here are three key pillars of technological transformation that deserve your attention:
1. Data management
Data is the fuel that powers your business. During the carveout process, focus on a seamless and secure transfer of this valuable asset. This involves navigating data migration, ensuring data integrity and security, and establishing rigorous data quality governance.
2. Infrastructure
A newly carved-out entity needs an IT infrastructure that meets its current needs while having the ability to adapt to future upgrades and expansions. This often involves strategically blending existing IT assets from the parent company while also laying the groundwork for future upgrades and enhancements.
3. Application modernization
Legacy applications can be a drag on innovation and agility. Assessing and modernizing these systems, particularly crucial systems like ERP and CRM, is essential for ensuring the new entity can run efficiently and effectively.
Integration challenges can arise when adapting parent company systems to the new business’s scale and requirements. It’s an intricate process that requires careful planning and execution to ensure a smooth transition.
Technology solution pathways
There’s no one-size-fits-all technology solution for corporate carveouts. The optimal approach will depend on the unique circumstances and strategic goals of the new company.
Let’s explore three common technology solution pathways and their ideal use cases:
Data-first approach
- Advantages: Prioritizes building a robust data foundation, ensuring data is clean, accessible, and ready for insights. Lays the groundwork for future growth.
- Challenges: Convincing stakeholders of the upfront investment required, as the immediate benefits might not be obvious.
- Best suited for: Companies with their eyes on the long game, willing to invest now for bigger payoffs later.
Targeted modernization
- Advantages: Tackles critical pain points and bottlenecks within the existing technology infrastructure. A quick way to deliver immediate value and improve operational efficiency.
- Challenges: Balancing immediate needs with long-term scalability and flexibility can be tricky. It’s important to avoid creating new technical debt while addressing existing issues.
- Best suited for: Companies facing specific technology hangups that are hindering growth or efficiency, needing a quick fix without a complete overhaul.
Gradual transformation
- Advantages: Allows for a phased and iterative modernization process, minimizing operational disruptions and allowing the new entity to adapt to its changing needs over time.
- Challenges: Managing ongoing changes while ensuring business continuity can be complex.
- Best suited for: Companies with a clear long-term technology strategy but limited resources or a need to minimize disruption during the transition.
The importance of early technology and data assessment
Understanding the intricacies of a target company’s technology and data landscape early in the process can be the difference between a winning investment and a money pit.
Pre-acquisition diligence
A comprehensive technology and data assessment conducted during the pre-acquisition diligence phase provides a treasure trove of insights that can inform your investment strategy.
This deep dive, typically taking just a few days, helps you validate assumptions, uncover hidden risks like outdated systems or poor data-quality management, and even conduct code-level analysis to assess the health of the technology stack.
Benefits of early assessment
- Improved deal pricing and negotiation: Knowledge is power at the negotiating table. A clear understanding of the tech and data landscape can strengthen your position and potentially lead to a better deal.
- Faster post-close value realization: Identifying quick wins and potential risks early on can accelerate value creation.
- Early risk mitigation: Proactively addressing potential issues prevents them from escalating into major problems down the line.
- Informed technology investment decisions: A comprehensive assessment provides a roadmap for future tech investments, ensuring your resources are allocated effectively.
Overcoming obstacles to early investment
Convincing PE firms and CFOs of the value of a deeper dive into tech and data assessments can be challenging. However, getting into code-level analysis and running a confirmatory process on early assumptions on the technology is critical. Done right, you can uncover tangible benefits and realize ROI.
Highlight the potential for cost savings through a modernized tech stack, showcase how clean and reliable data leads to better decision-making and increased revenue, and leverage real-world case studies to illustrate the impact of early tech investment.
Long-term considerations and value creation
A successful carveout is ultimately about positioning the business for long-term growth and a lucrative exit.
Years 2-3: Adapting and evolving
As the company finds its footing, be sure to anticipate future tech needs. This means planning for upgrades and migrations that support growth while balancing costs with operational necessities.
Years 3-5: Preparing for a profitable exit
As the carveout matures, the focus shifts to maximizing its value for a potential sale. This means ensuring the tech infrastructure is robust, efficient, and aligned with industry trends. A clean codebase, modular infrastructure, and a track record of data-driven innovation can all boost valuation and streamline the exit process.
Demonstrating value: The case for early technology and data investment
Procrastinating technology and data investments in a carveout can be a costly mistake, hindering growth and eroding profitability.
Quantifying risks and downsides of delayed action
- Lost revenue: Operational inefficiencies, outdated systems, and a lack of data-driven insights can lead to missed opportunities and lost revenue.
- Increased costs: Relying on the parent company’s systems through TSAs can be a financial drain, adding unnecessary expenses and delaying the new entity’s independence.
- Missed growth opportunities: Inflexible or outdated systems can hinder your ability to adapt to market changes and capitalize on new opportunities.
Accelerating speed to value
- Rapid cost reduction: A modern tech stack can streamline operations, automate processes, and reduce reliance on expensive manual labor.
- Growth acceleration: Data-driven insights empower you to make informed decisions about marketing, sales, and operations, leading to faster growth and increased market share.
- Operational efficiency: A well-optimized technology infrastructure enables faster response times, improved service delivery, and increased customer satisfaction.
- ROI analysis: While upfront investment is required, the long-term gains in efficiency, productivity, and growth typically far outweigh the initial costs.
Building a future-proof digital and data foundation
Investing in scalable solutions creates a platform for sustainable growth and future acquisitions, enhancing attractiveness to potential buyers at exit.
Optimizing for exit in 3-5 years
When it’s time to sell, your technology story becomes a crucial part of your pitch to potential buyers. A strong technology foundation demonstrates your commitment to innovation, efficiency, and customer-centricity, all of which translate to higher valuations and a more compelling investment proposition.
Technology as the catalyst for carveout success
A data-centric technology strategy, implemented early in the carveout process, can accelerate value creation, mitigate risks, and pave the way for a profitable exit. And with a seasoned expert in your corner, you can smoothly navigate the complexities of the carveout process and make informed decisions that maximize your return on investment.
So, as you embark on your next carveout, don’t leave technology as an afterthought. Make it a central part of your strategy from day one, and watch as it unlocks the full potential of the new entity.
