Carving out a new company, aka “Just Add Water”

Earlier this month, our Google Alerts picked up a press release praising our role in a recent carve-out project. It was a nice surprise for us, and has generated some inquiries about our role. In this post, I’ll quickly scope out the project, and our role, for you.

Edgewater Technology was approached by one of our existing clients to assist with defining technology strategy for a “carve-out” that they were bidding on. Both parties sought a way to minimize or eliminate the need for a transition services agreement (TSA) and close the deal as quickly as possible. Our client, the buyer, intended to integrate the carve-out into one of their existing portfolio companies. This portfolio company was running well with a lean organizational model and homegrown ERP platform, but it was clear that it could not absorb the new acquisition with its existing enterprise technology architecture. Senior consultants from Edgewater Technology’s M&A and Infrastructure Services practices, with our colleagues from Edgewater Fullscope, our sister company with expertise in implementing Microsoft Dynamics AX, quickly put together a strategy based on:

  • Migration of the acquisition onto Microsoft Dynamics AX
  • A new corporate network  to link the parent company with 1 US and two international sites, providing for remote access for employees and contractors as well
  • Hosted MS Exchange based email
  • Hosted MS Sharepoint
  • Virtualized application deployment in Edgewater’s Data Center

In addition to implementing the technologies described above, Edgewater rehosted a smaller ERP system in use at one of the international sites, to avoid having to take on two ERP application migrations at once. This business unit will eventually migrate onto AX after the initial  stabilization of the US business is completed.

Because of Edgewater’s 10+ years of experience with M&A integration, program management, business process definition and organizational change management, our team provided these wraparound services as well, spearheading a Program Management Office that embraced all US and International acquisition sites and members of both the Buyer’s and Seller’s transition teams.

In an intense 120 day transition, Edgewater successfully completed the implementation of all the technology described above, as well as definition of key business processes for a global organization that relies on international suppliers and domestic third party logistics providers.  Some of the challenges we addressed along the way included: 

  • Bringing up a short-term web-based EDI solution to meet the aggressive timeline, while beginning to rollout integrated EDI processing in time for Day 1
  • Reconciling numerous issues data migration issues
  • Replanning exercises to address unforeseen obstacles without jeopardizing the timeline
  • Scaling down our implementation methodology to minimize the resource requirements on a lean core team that was still running the platform company’s business with no backfill
  • Training a workforce that included a significant number of new hires

Keys to Successful Divestitures

There’s no doubt about it. A well-crafted TSA (Transition Services Agreement) can make or break a divestiture. In a recent review, Deloitte describes some of the key elements of making a fast break. Shrinking the interval between Day 1 (Financial Close) and Day 2 (Full Separation) is a priority goal of a successful transition. To achieve a short timeline, it’s crucial that IT decisions be made as soon as possible, even before Day Zero (the day the deal is publically announced).

While the Deloitte approach provides a reasonable framework, I think we can add some additional perspective based on our own experience in this area.

1. The acquiring company or PE firm should recognize the fact that the IT resources within the business unit to be carved out are not likely to possess the strategic vision and leadership to create a target architecture and craft an accelerated transition plan.

2. The internal transition team needs skilled coaching and leadership to effectively “turn the tables” on the former parent organization. Think  about it: the IT resources you are bringing over with the divestiture have been taking orders from corporate IT. During the transition they must quickly change the dynamic of power and manage their former bosses as service providers.

3. SLAs are important. The Deloitte article minimizes the need for formal SLAs, but it only stands to reason that service requests from divested assets will fall to the bottom of the priority list when there are more pressing internal service requests.

4. Make sure that the agreement specifies the level of involvement from the parent organization’s resources and access to data and information that you can expect during the transition.

5. Don’t pay for what you don’t need, and scrutinize TSA cost drivers diligently. For example, if the parent organization is making an allocation to maintain a highly customized, automated environment that you will not fully use during the transition period, you should negotiate for discounted fees for that particular TSA area.

6. Manage expectations within the carved out business appropriately. Sometimes a little more chaos and pain in the short term is worth it to achieve full separation and transition to a more efficient operating platform.

Experience, negotiation, coaching, strategic vision are all key elements of a successful transition team leader. If you can’t find the right combination of skills within the acquired asset, it’s well worth it to bring in an expert to lead the team during the short but intense transition team.

Reducing IT Costs for New Acquisitions

Over at CIO magazine, Bernard Golden recently published an update on Cloud Computing. In his list of the types of companies that can benefit substantially from computing in the cloud, he left off one situation that can reap tremendous benefits from this approach: newly acquired private equity portfolio companies that are being carved out from larger businesses.

For these companies, cloud computing offers the following benefits:

  • Accelerated implementation timeline that dramatically reduces implementation costs
  • Significant savings on support costs, which typically represent 60% of the IT budget
  • Eliminates the dependency on staffing and retaining IT support staff
  • Costs scale with number of users
  • Repeatable implementation playbook
  • Easily extensible for tuck-in acquisition

One of our senior architects, Martin Sizemore, has laid out the broad strokes of this approach in a short slide show.

It’s an especially attractive M&A technology approach in the middle market, where it can help drive annual IT budgets down under 4% of revenue. While it is most advantageous for creating a new operating platform to accelerate transition services (TSA) migrations, the transition to cloud computing makes sense as a value driver at any point in the asset lifecycle.

M&A Transition Services: Pitfalls and Opportunities

Deals that involve Transition Services Agreements (TSAs) turn into our most challenging and satisfying M&A projects. Over the years, we’ve seen (and helped our clients avoid) many pitfalls unique to the TSA situation. Right now, we’re also really excited about the opportunities for creating a lean IT organization and architecture when planning out the strategy for getting acquisitions off of their TSAs.

TSAs: The Dangers

It’s important to begin vetting out the hidden risks of the TSA during the M&A IT due diligence phase.

1. Assuming that the IT staff of the carved out business unit can evaluate, negotiate and manage the relationship with the former owner during the transition period. Think about this: these are the people who used to take their orders from the parent company. They are good at executing to orders, and they are rarely quick enough to realize that they must now relate to their former bosses as service providers during the transition period. We have seldom seen the right mindset and leadership skills in an acquired company to radically and rapidly turn the tables on working relationships that may go back for decades. If a TSA is on the table, it’s an important component of our IT management evaluation during IT due diligence.

2. Failure to insist on the following key components of a comprehensive M&A TSA  during the evaluation and negotiation phases:

  • Service Level Agreements (SLAs) – treat the seller as an outsourced service provider, and demand adequate performance. Ask yourself about the quality of service you have received as a PART of the parent company, and assume that they will deprioritize your needs over their own once the deal has closed. You need SLAs and performance monitoring to safeguard against that. 
  • Definition of Termination Notice windows on a service by service basis.
  • Appropriate cost basis for each service offered under the TSA. Caveat emptor – I can’t tell you how many times we’ve seen cost allocations that made no sense in terms of the going-forward business model of the acquired company.

3. Failure to fully plan out Day 1 (day of close) operations. For each business functional area (including core IT services like email and help desk support) make sure there is either an included TSA service offering or a viable internal process and technology component that will be ready on Day 1.

TSAs: The Opportunity

Because a carve-out and the subsequent TSA migration offer the opportunity to create a new operating platform (process+technology+organization) for the stand-alone business, leveraging new technology approaches can result in significant run-time IT cost savings. By relying heavily on Software as a Service (SaaS) solution providers, outsourced hosting and support, and interim strategic IT advisory services, the run-time IT department can be kept quite small, and there is often a reduced need for big-ticket IT leadership resources as the helm.  Outside of IT itself, we can design the technology platform to support significant business process outsourcing of non-strategic, non-customer facing transaction processing to reduce other operating costs as well.

We’re excited about this approach because it provides a viable path for driving IT spending down below the current industry average of about 7% of revenue. In addition, it represents the quickest approach to getting off of the TSA. We’ll be laying out the broad strokes of a generalized virtual operating platform in future posts.