Investors are increasingly pursuing more and more carve-out transactions as competition in private equity (PE) ramps up and multiples come under greater pressure. PE asset and business unit acquisitions totaled about $24 billion across 145 deals between January and June 2025, compared with about $19 billion across 127 deals during the same period in 2024.1
Carve-out transactions typically entail a buyer purchasing a segment, asset, or division of an existing company—some part that is effectively getting “carved out” from the parent company’s operational structure (see sidebar, “What do we mean by carve-outs?”). Generally, carve-outs allow acquirers to develop fit-for-purpose operating models for divested assets while refocusing their leadership and shareholders on these changes, which is critical for quickly realizing growth and profitability.
Acquirers get an opportunity to buy an at-scale platform with lots of upside—such as improved agility and focus, lower structural overhead compared with the larger company, and greater leadership attention. Previous McKinsey analysis also suggests that companies that actively manage their portfolios, including through mergers and divestitures, can yield returns that are between 1.5 and 4.7 percent higher than their less active peers.
Recently, however, both PE buyers and sellers have struggled to create value from carve-out transactions. In fact, according to some studies, about one-third of carve-out deals do not create the value initially ascribed.2 This is partly because of the complexity of such deals, as well as buyers’ and sellers’ inadequate focus on their operational aspects. For instance, sellers often need to go through a protracted process (from a few months to more than a year) to operationally separate people, processes, systems, facilities, contracts, and intellectual property (IP) so that the carved-out part can operate as a stand-alone company.
In the toughest type of carve-outs (our focus for this article), the buyer needs to spend time and resources to stand up all the missing support functions in the divested asset (for example, technology and human resources) while avoiding business disruption at deal close and ensuring that the asset does not start underperforming or losing key talent. To put this complexity in context, many companies take decades to develop their infrastructure, whereas the new owner of a carve-out is often required to build a stand-alone company around the acquired asset within six to 18 months.
How can PE investors improve their odds of success?
They can start by building reviews of operational risk and opportunity into their deal negotiations. Buyers (and sellers) usually have a robust commercial due diligence process to assess the merits of a carve-out transaction—but less sophisticated buyers often downplay or omit the need to perform a comprehensive assessment of the operational risk. In many cases, these buyers simply do not fully understand the complexities of standing up a carve-out or fail to recognize the potential ramp-up of complexity during negotiations.
Based on our field work and research, we’ve identified five operational levers that buyers and sellers can use during the negotiation process to ensure a more thoughtful allocation of value between parties—whether captured in the form of cash, service agreements, liabilities, or other exposures. Some facility with these operational levers can significantly affect the final purchase price of the transaction and, subsequently, the return on investment for the buyer.
Five operational levers for creating value from carve-outs
After identifying a carve-out deal, buyers can use five levers to assess the potential to create value from various aspects of operations: structure, stand-up costs, agreements, working capital, and purchase price and economics. Buyers should be prepared to explain how they will position these levers to create maximum impact when they go to their investment committees to get interim and, eventually, final approvals for the deal.
Foundational structure of the deal
Carve-out transactions can be structured in two ways: A buyer can purchase the legal entity or entities that hold the carved-out asset or just the asset. The buyer and seller should determine their preference before entering into negotiations.
Some buyers prefer to buy the legal entity, since it often comes with an established infrastructure and full financial history, such as a balance sheet; employee, supplier, and customer contracts; and bank accounts. Others may want to buy only the operating asset if they have elevated concerns about certain liabilities transferring with the full entity. This may be the case for businesses more prone to potential legacy liabilities, such as environmental cleanup concerns; these issues are often difficult for the buyer to fully estimate even after using diligence measures such as an environmental survey. In the case of asset-only deals, buyers also need time between signing and closing—and prior to asset transfer—to ensure that the deal perimeter includes everything required to monetize the asset. During this time, they should also prepare to establish their own entity or proxies in the core jurisdictions of the business, set up a banking solution and credit facility, and address staffing concerns.
Sellers are also expected to lead with the deal structure most beneficial to them. For example, if a seller is aware of a higher likelihood of a “hidden” and yet-to-be-quantified underlying risk, doing an entity sale may allow them to transfer more of that risk to the buyer. For others, an asset-only approach may be cleaner, as they can retain the full historical balance sheet and P&L while building out the carve-out financials—helping them avoid disclosing performance elements that may be comingled with the rest of their operations. The latter approach is also preferred in situations where legal, contractual, or operational concerns are too deeply intertwined with the parent company. This could be true during bankruptcies, for example, when the estate has remaining liability or there is significant comingled dependency with the remaining business.
Cost of divestiture and subsequent stand-up
The negotiating parties should establish their own perspectives on the costs associated with the carve-out, including the one-time cost of divesting the asset and then turning it into a stand-alone entity. Both sides should understand how one-time costs—such as initial outlays, establishing a new IT system, addressing legal expenses, or reallocating IP to the new entity—will be split between them during the transition in ownership.
That split can vary. In proprietary deals where a PE fund or investor approaches a seller, the division may be 75/25 percent or even 100 percent borne by the buyer. By contrast, in deals where the seller is separating from an asset for its own benefit, the costs are usually split equally. And in cases where the seller is looking to move quickly, it may be willing to bear substantially more of the full cost of separation. Ultimately, whether it is a process or proprietary deal, getting to an equitable cost split is critical.
It’s also important to account for the fact that the asset may require improvements before it’s ready for sale—repairs that sellers may be unwilling to pay for after the keys are handed over. Buyers will need to do extensive due diligence and communicate with sellers early and clearly if their diligence process reveals prior efforts by sellers to dress up the asset. Extensive asset dressing by the seller can result in the buyer paying more than historical maintenance fees, which could in turn decrease valuation—and that could be a deal killer.
Buyers and sellers should also be mutually clear about the cost envelope associated with establishing the new entity. By nature, sellers may be less inclined to engage in comprehensive and detailed communication about financials. For example, they may not fully understand the variances in accounting standards or the way costs have been historically allocated to the business unit. Additionally, sellers may not have a full view of third-party spending on an asset being carved out; this is typically handled at headquarters. Sellers may also want to avoid disclosing details that communicate too much about their remaining lines of business.
Agreements
Several contracting mechanisms allow buyers and sellers to specify the services that each party will provide after a deal closes. Among the most common are the transition service agreement (TSA) and the long-term service agreement.
Transition service agreements. In a typical carve-out, the buyer and seller may establish a TSA to ensure that the seller continues to support the operations of the acquired asset while the buyer is still standing up the required capabilities in the new company. By carefully thinking through and negotiating a full set of TSAs, buyers and sellers can reduce the business continuity risks associated with the transition and address the critical interdependencies between the asset being carved out and the parent company—for example, shared back-office services or IT, finance, or payroll functions. Three items, in particular, are worth deep discussion: cost structure and exit, the likely duration of the TSA, and how the agreement will be enforced:
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Cost structure and exit. The process of determining the costs associated with TSAs often favors sellers, since they hold most of the relevant information required. The negotiations typically start with a discussion about the allocations that the seller currently charges to the asset, including base operating and overhead costs for services. Initially, buyers may assume such allocations are coming at an “overcharge.” It is the seller’s job to prove that these charges are justified to maintain operations—or to correct course as needed. For instance, in one large aerospace deal, the seller used historical allocations as a basis for TSA costs in its offering documents, only to discover later that its actual costs were much higher. The PE acquirer ultimately secured undermarket pricing and then pushed to have the longest TSA possible.
To maximize its return on the sale and limit risk, the seller should attempt to have the buyer assume full responsibility for various capabilities as quickly as possible. Let’s say a buyer is allowed to exit a TSA for accounts payable services but still maintains access to the enterprise resource planning (ERP) system for accounts receivable services and general ledger reporting. In this case, the seller will continue to maintain the cost of helping the new entity manage its financials while not receiving the full reimbursement through the TSA.
Pricing for TSAs is typically negotiated around delivery costs and usually does not have an explicit profit component; however, in certain situations, sellers may choose to insert a profit component in the agreement asserting that they are providing certain operational services to the buyer from which the buyer would profit.
The buyer, in some cases, may need greater flexibility to stand up portions of the business. The ideal scenario lies somewhere between a fully functional exit from the TSA and a subfunctional exit. Negotiating an escalation in pricing for TSA extensions can also help buyers demonstrate greater urgency in cutting the umbilical cord with the seller a bit faster.
When it comes to TSA billing, some buyers and sellers initially consider using models that focus on costs per transaction or costs per purchase order. However, such models may require additional overhead to administer. Instead, they could consider a model that emphasizes a fixed charge per month for the various services being provided if the service volume stays within historical norms and service levels are anticipated to remain the same. Depending on the size or complexity of the functional support required, this approach can simplify the billing process.
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Duration. When it comes to the duration of the TSA, the seller is often in the driver’s seat: The seller determines exit conditions and tenures. We have often observed that the seller wants to be liable for the least number of services, with the shortest base tenures and an earlier notice period for exits, whereas the buyer prefers long base tenures and a short notice for an early exit.
In general, TSAs are terminated on the date within the base tenure when the buyer no longer needs the service. Many TSAs do not allow the seller to terminate the agreement within the base tenure—but they also limit any extensions that may impinge on the seller’s future.
In one carve-out transaction, for instance, the seller was about to undertake a full ERP rollout across its global footprint. The buyer wanted to maintain a finance TSA that would have overlapped with the beginning of the ERP rollout, thereby delaying the rollout and increasing the cost for the seller. To make the transaction happen, the buyer had to identify a method to accelerate its transition to stand-alone operations to ensure that it was no longer reliant on the seller’s system by the time the entity was ready to officially launch.
If an agreed exit date is not honored, and a seller approves the buyer’s requests for extensions beyond what should have been operationally possible, fees for the same services may be doubled or tripled. Failure to exit on time should be punitive to the buyer. And discussions about whether a seller needs to approve the first, but perhaps not subsequent, extensions of TSAs should be a core part of initial TSA negotiations.
- Enforcement. The goal for both parties should always be to exit the TSA as rapidly as possible. As such, buyers and sellers should negotiate service-level agreements for specific elements of the broader TSA. Penalties can be made into service-level agreements to account for any shortfalls by the provider—as much as two months’ cost of the TSA when service levels are not met. To ensure that both parties have a full view of performance against service-level agreements, buyers and sellers should jointly develop and review performance dashboards and reconcile any findings.
Long-term service agreements. In certain situations, a buyer and seller may envision ongoing service or supply relationships that would continue well past an interim transition period. The seller can also use such agreements to maintain a longer-term profit stream from the divested entity.
Long-term agreements—for example, a manufacturing service agreement, supply agreement, or shared service agreement—can flow in either direction and must be negotiated at arm’s length with market-based pricing. Anticompetition and other authorities will usually expect to see a profit component embedded in these agreements.
In one case, a PE fund that was planning to divest a portion of its business was keen to maintain some long-term profit from the exiting business segment. Some important components needed for the new entity had to be manufactured by the remaining business, which the PE fund would continue to own. So, a long-term manufacturing services agreement was put into place. The contract allowed the seller to continue to profit from the sales and growth of the product being divested. The buyer also benefited because they had a guaranteed supply of the needed components.
Working capital
During a carve-out, buyers should evaluate how much it will cost to fund operating accounts as well as the overall balance sheet of the new asset or entity. They may need to provide capital at the start of deal close to ensure that funds continue to flow or rapidly add money to the asset’s balance sheet once in operation.
If a large seller with a heavy corporate model is divesting a part of its business, the leadership involved in the deal may have limited experience across working capital funding cycles. In one case, a new business being acquired by a PE firm was requesting cash infusions, so the PE firm had to make efforts to upskill the transitioning management in cash management techniques before deal close.
It is not uncommon for buyers and sellers to negotiate on certain components of the balance sheet. For example, a buyer may be unwilling to take on debt that a seller pushed down into the asset in a manner that is not operationally justified.
A buyer or seller can also agree and negotiate on a “working capital peg,” which is a benchmark or baseline of net working capital that will transfer with the business at the time of deal close. By doing so, both parties would have a clear idea of how to manage various components of working capital, including inventory, accounts receivable, and accounts payable. It is important to develop this peg: A buyer’s valuation will typically make certain assumptions about the level of accounts receivable present on the balance sheet at the time of deal close, and how much of that will be fully recoverable. But if either of these amounts deviates materially from the peg, the buyer can adjust the purchase price after deal close. In most cases, the parties agree to put a portion of the purchase price into an escrow to accommodate adjustments in either direction and to release any remaining balance to the seller once the peg period has ended.
For its part, the seller should strive to deliver the carve-out asset at the established working capital peg—for instance, replacing the balance sheet’s cash components dollar for dollar and replacing the asset’s inventory at a wholesale cost versus the cost of goods. In this way, the seller cannot sell down inventory without an offsetting penalty.
Purchase price and economics
The long-term economics and impact of the near-term costs for the carved-out entity or asset should be handled in the valuation and, ultimately, the purchase consideration. Experienced sellers and buyers take a holistic approach to reaching their expected valuation. For example, if a buyer insists on decreasing TSA pricing below the actual cost to deliver, then the seller can recoup the gap by increasing its sales price. Conversely, if the seller does not agree to an unencumbered transfer of IP needed to fully monetize the asset, then the buyer can seek to decrease its purchase price.
There may also be instances where the carved-out asset requires significant capital expenditure. Buyers should discuss these costs and factor them into the final economic consideration for the assets.
Although private capital buyers can create significant value and establish platforms through a carve-out transaction, they need to be mindful that some of that value risks getting lost in the operations of the asset. To avoid these pitfalls, the structure of the deal needs to incorporate the consideration paid, the transitional “one time” costs, and the near-term and long-term run rate costs that will need to be managed, among other negotiation levers. If not managed effectively, these elements could deteriorate buyers’ and sellers’ returns prior to the deal being signed.
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