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Achieving Effective IT Separation in Carve-Out Transactions (Article)
Date: Mar-2009 Sector: News
A business unit which is being divested from a parent company is likely to have many existing dependencies upon the parent for the provision of its IT systems and services. These dependencies will have to be identified and removed as quickly and cost-effectively as possible, and alternative supply arrangements may have to be put in place, if the business unit (or NewCo) is to operate as a standalone entity.
Investors in a carve-out will often be faced with the problem that there is little IT expertise within the business unit being divested. In addition, the parent company itself may have little prior experience of making a carve-out happen. This lack of expertise can result in dependencies not being identified and in the investment, amount of work and resources required to achieve separation not being fully quantified or understood. In order to mitigate these risks, achieve a smooth transition process and avoid any costly surprises post-deal, the business unit being divested must accept ownership of these issues and, in collaboration with the parent, adopt a structured approach to the IT separation planning process that results in the production of five essential deliverables prior to deal completion (i.e. Day 1 for NewCo):
It is in the interests of both parties that these deliverables (their importance is further explained below) be formally approved as part of the deal process. NewCo, in particular, should assume that any opportunity for re-negotiation with the parent post-completion is likely to be limited or non-existent.
The complexity of the IT separation planning process depends on how tightly integrated the business unit is with the rest of the corporate entity.
Where the IT links are relatively loose the business unit will probably have its own IT staff who can provide much of the information required to plan and effect IT separation. Since, in this scenario, the systems and IT resources will already be relatively separate from those of the parent, it is less likely that significant additional expenditure will be required to enable the business unit to operate as a standalone entity. This is because most of the required personnel, hardware and software assets will be transferred as part of the divestment process. In such situations the IT separation analysis and planning is likely to be largely confirmatory in nature and there will be less need for additional expertise to be sourced.
At the other end of the spectrum are those businesses that have no IT systems of their own and that utilise exclusively systems and resources provided by a corporate IT function. In these cases, the task of planning for and effecting IT separation can be complex and time-consuming and should be started as early as possible in the transaction process. Since there is likely to be little or no expertise within the business unit, external assistance will probably be required to help plan and prepare for separation. There may also be significant costs associated with establishing an independent set of systems for the standalone business. It is often the case that simply replicating the systems used by the parent would be inappropriate as they would be far larger, more complex and more expensive to run than would be suitable for or affordable by the new, smaller business entity. In such situations the procurement and implementation of new systems will be dependent on a requirements capture and system selection process that may take several months to accomplish.
Intuitus’ approach to the IT Separation Planning Process is illustrated below and a brief description of the key elements of each stage (referenced by box numbers in the diagram) follows.
Stage 1
The first stage is to detail in an IT Service Catalogue or equivalent all of the IS/IT services that NewCo will require in order for the business to be fully operational from Day 1. This includes but may not be limited to:
Where such a list has already been prepared, the business unit must review and confirm its completeness. Unfortunately, even in relatively large organisations with sizeable IT departments, it can be the case that there is no complete list of all of the IT services and facilities that are used by the business unit. In these circumstances the business unit must prioritise the collation of this information. Intuitus has developed a series of structured tools and templates that can assist with this process.
Stage 2
Having established an agreed, complete list of all IS/IT services, the second stage in the process is to identify who currently owns these services - not only the physical assets but also any support agreements associated with the assets. This stage of analysis will confirm the degree of dependence and therefore indicate the complexity or otherwise of the separation project.
Assuming that there is at least some degree of dependence on the parent company, it is likely that it will be impractical to achieve complete separation by the desired date of deal completion, with the result that:
In this case, subsequent stages of the IT Separation Planning Process are as follows:
Stage 3
Confirm and detail in the Asset Purchase Agreement which of the IT assets from stage 2 will be transferred into NewCo’s ownership on deal completion (Day 1). It should not be assumed that ownership of all required IT assets can simply be transferred, at no additional cost, particularly with business-critical software systems. The software vendor’s licence terms may preclude this, with the result that NewCo may have to re-license the software, which may result in substantial cost.
Stage 4
Define and plan those activities that must be achieved by Day 1. Any such activities will be influenced by business need and the amount of time available but might include, for example, business-critical services such as the creation of new email and Internet services, a new payroll service, etc. The most pragmatic approach to achieving an early deal completion is likely to be to defer as much activity as possible into the transition period. The Day 1 Plan should be acted upon as soon as it is agreed.
Stages 5 and 6
Produce and agree the IT Transition Plan and agree the transition timetable. The IT Transition Plan will detail all IT-related activities that must be undertaken for NewCo leading up to and during the transition period (which starts at Day 1) and until such time as NewCo’s IT operations are independent from the parent. There are specific issues related to IT that require specialist understanding, such as software licence transfers, network separation issues, ownership of IP, service contract novation, etc. These can involve significant cost and may involve services with substantial lead times. A failure to understand the requirements fully or to put in place robust plans to deliver them may result in additional cost or disruption to the business at a time when it has many other challenges to face.
The Plan should be constructed as a Gantt chart, supported by a project definition document that includes the capex and opex costs, key activities and dependencies, the timescales, resources and effort that will be required to deliver the project, a risks register and all relevant assumptions. It should be realistic and clearly indicate the critical path to achieving separation. The IT Transition Plan is an essential pre-requisite to agreeing a realistic, achievable transition timetable.
Stage 7
Agree the IT Schedule to the TSA. This will define the scope of the services to be provided by the parent to NewCo (and vice-versa if appropriate) during the transition period, service levels (hours of support, response times etc.), the costs of service provision, remedies for poor service performance, reporting and escalation procedures, termination arrangements etc. For NewCo in particular the IT Schedule to the TSA is an essential deliverable. Together with the IT Transition Plan it will provide the mechanism by which NewCo will be able to see, implement and control the “big picture” and through which leverage could be exerted on the parent, if required, should service performance during transition drop below the agreed levels.
Stage 8
As with any business-critical project, an appropriate governance structure should be agreed to oversee the Plan’s successful and timely implementation. This should be in the form of a Steering Committee, comprising Executive sponsorship, project manager(s) and decision makers from both parties. It should meet on a regular basis to review progress, resolve issues, manage change and risks, etc. Day to day responsibility for delivering the transition project should be delegated to a suitably qualified Project Manager from within each party, each of whom should report to the Steering Committee. Ideally, terms of reference for the Steering Committee and a schedule of Steering Committee meeting dates will be set out in the IT Schedule to the TSA.
The above stages 4 – 8 in the IT Separation Planning Process focus on the necessary preparations for Day 1 and the period of transition. Typically, both the business unit and its parent company will participate in these activities.
Stages 9 and 10
In addition, the business unit being divested will need to give early consideration to any additional work and associated costs that will be required to enable NewCo to operate as a stand-alone entity. For example, NewCo may need to procure and implement a new business system or Wide Area Network. These are significant, potentially costly, projects that will take time to deliver and could impact the transition timetable. The business unit should create a Plan that schedules realistically for requirements definition, a selection and procurement process, product delivery lead time, testing and implementation etc. There are no excuses for this process to be rushed and the risks of doing so can be costly. Importantly, this plan should be validated against the IT Transition Plan to ensure that there will be no gaps in service provision. If separation is not achieved within the period agreed for transitional services it is possible that the former parent will require significantly higher recompense for extending the period and NewCo will probably have a very poor negotiating position.
Summary
The best practice approach outlined in this article will be impacted by the real world demands of a carve-out transaction: resource availability and the time constraints of the transaction may hinder the production of some necessary detail. Moreover, future strategies (the choice for NewCo between an in-house or outsourced IT operation, for example) may only be determined post-completion and therefore will not be reflected in the initial IT Transition Plan. However, if the aforementioned approach is followed, NewCo should be able to obtain the precise level of commitment required from the parent during the transition, determine its resource requirements and the project’s critical path etc. with much greater certainty and, importantly, identify with confidence its capex and opex requirements for the transition process and thereafter. NewCo must take responsibility for driving these activities and remember that, no matter how good the historic relationship with the parent, that relationship and the parent’s priorities will inevitably change once the deal has completed.