The Hidden Costs in Carve-Outs: What Private Equity Often Misses in Diligence and How To Find Them
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juin 25, 2025
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Carve-outs present a compelling investment opportunity for private equity. They provide access to non-core and often underinvested assets that, when separated, recapitalised and placed under new management, can become powerful growth engines. However, these deals also carry a unique set of risks that traditional diligence can easily overlook.
While headline metrics may appear attractive, it’s often the factors below the EBITDA line that create the most friction post-close. From underestimated stranded costs and vaguely defined transitional service agreements (“TSAs”) to unpriced IT disentanglement and hidden compliance exposures, these overlooked issues can erode value rapidly if not identified and addressed early.
The challenge? Much of this risk lies outside the scope of standard diligence. Even experienced deal teams can be caught off guard during the first 100 days.
So, what are the most common blind spots in carve-out diligence? With a practical framework, you can identify and mitigate these risks before they disrupt your value thesis.
Carve-Outs: The Risk Beneath the Reward
Carve-outs remain highly attractive for several reasons. They often involve motivated sellers seeking quick cash proceeds, giving buyers the opportunity to acquire businesses below their full potential value. Additionally, there tend to be fewer potential buyers, meaning less competitive tension.
But with that opportunity comes structural complexity. The business being sold is typically entangled with the parent company in areas such as corporate systems, people and business processes. The risks aren’t always visible on the surface, especially during competitive M&A processes. For private equity firms, success depends on knowing where those risks hide and how to price and plan for them.
Common Blind Spots in Carve-Out Diligence
IT Disentanglement
IT is often one of the most underestimated and complex aspects of carve-outs. Heavy reliance on the parent company, hidden licensing and contract separation costs, unsupported legacy systems and uncosted implementation timelines frequently lead to budget and timeline overruns. Post-close, the implementation of standalone systems or integration of new platforms can stall operational momentum.
Over-reliance on sell-side TSAs can create a false sense of security. The real priority should be day one stability, with an early and accelerated focus on TSA exit planning to minimise disruption and accelerate independence.
Under-Scoped TSAs
TSAs are meant to provide a bridge — facilitating the transition from the current state and operating model to day one operations and, ultimately, the target state. However, poorly defined agreements can disrupt day-to-day operations, create service gaps, lead to cost overruns or cause delays.
Key risks include incomplete scopes, unclear charging and exit mechanisms, and a lack of internal capabilities to replace TSA-provided functions in time.
Organisation and People Risks
Carved-out businesses often lack standalone capability, as many have never operated independently. The carved-out company’s organisation design is frequently a post-close afterthought, with this lack of focus pre-close ultimately increasing execution risk. “In a corporate setting, management teams benefit from established shared services (including IT, HR, treasury and tax), each of which have mature processes and well-written and implemented corporate policies,” explains Lewin Higgins-Green, who leads the Employment & Tax Reward offering at FTI Consulting. “Post-carve-out, these support structures disappear, and the carved-out company must scramble to build fit-for-purpose functions outside the parent’s shadow.”
Higgins-Green goes on to explain, “additional risks include hidden transfer of undertakings [“TUPE”] obligations and employment law exposures which require proactive and tailored solutions. Legacy pay arrangements and incentive plans misaligned with the new ownership model can result in disengaged management becoming easily frustrated and potentially resulting in high attrition. There may also be unforeseen tax consequences for those involved in a legacy incentive plan, and careful consideration of any plan documentation should be undertaken to minimise management potentially being out of pocket.”
Regulatory and Compliance Surprises
Cross-border deals can expose legacy operations to compliance obligations that were not apparent during diligence. Data transfer, licensing and legal entity restructuring can significantly delay operations or even halt them temporarily. The General Data Protection Regulation (“GDPR”) often needs to be carefully considered here.
One-Off Costs
Buyers frequently overlook the magnitude of the one-time costs involved in executing a carve-out. From lack of accountability for dual-running TSAs while implementing standalone capabilities and advisory costs (such as legal and financial) and underestimated IT carve-out costs (including applications, data, IT contracts separation and cybersecurity) to employee-related fees (such as TUPE, retention bonuses, or pension or benefit scheme setup). Underestimating one-off carve-out costs can lead to budget overruns, delayed separation and disrupted operations, undermining the deal’s financial returns and strategic objectives. It may also prolong reliance on expensive TSAs and erode stakeholder confidence.
Carve-Out Execution and Readiness
Private equity buyers increasingly require that carve-outs be fully ‘operationally ready’ at day one close, capable of functioning independently across people, processes, products, customer experience, contracts, assets and technology. No small ask. However, the term ‘operationally ready’ is often ambiguous, ranging from ‘business as usual’ to ‘minimal viable operations’. Clear alignment between buyer and seller on day one readiness criteria is essential to avoid misaligned expectations and execution risk.
While sellers may provide high-level separation blueprints, it is typically the buyer’s responsibility to validate that these theoretical exercises can translate into execution-ready plans. Success lies in the carve-out management team’s ability to execute the separation while simultaneously initiating a value creation plan. Private equity sponsors must ensure a well-resourced carve-out programme with strong governance is available to mitigate day one risks and enable a smooth transition to standalone operations.
Stranded Costs
For sellers, once the business separates, the costs absorbed by the parent, such as shared services, shared contracts, group insurance, corporate overhead or potential dis-synergies arising from loss of scale, must be rebuilt. These are often significantly underestimated, especially when allocations are overly simplistic or based on outdated cost drivers or when recharging mechanisms do not accurately reflect the reality of the business. Buyers may also experience stranded costs in situations where reverse TSAs that had to be provided from the carve-out back to the seller have ended — these can result in excess resources and potentially require rightsizing within those teams.
Why Standard Diligence Falls Short
Traditional diligence focuses on sell-side management’s plan, market, finance, tax and legal aspects. However, carve-outs demand operational and functional scrutiny. Deal teams often rely heavily on seller-provided cost bases or make assumptions about ‘business as usual’ that don’t hold true once the carve-out is executed.
Standard diligence often fails in carve-outs because it overlooks the true standalone costs, underestimates transitional needs, and lacks focus on operational and people-related complexities. Key risks like system dependencies, dis-synergies and talent retention are frequently hidden within the parent organisation.
Without a robust function-by-function exercise, many cost and capability gaps go undetected.
Best Practice: Function-by-Function Diligence
Leading private equity firms now apply a functional lens pre-signing, engaging experts across a variety of areas, including:
- Finance, Tax and Treasury: Can NewCo close books independently? Are controls and reporting robust? How will tax compliance be performed from day one? Will the standalone team have treasury capabilities to replace the parent company support (such as funding, allocation, hedging and interest rates)? Are financial planning and analysis capabilities ready for a private equity buyer? Are there any tax consequences for the legacy management incentive?
- IT: What systems are inherited, what must be replaced, and at what cost and on what timeline? Is the day one IT operating model and landscape fit for purpose for a standalone company?
- HR: What talent gaps or dependencies exist? What are the key day one and standalone hiring requirements? Is there a day one-ready HR function? What are the employee transfer requirements? Is there a clear HR transition plan? What are the critical roles that require a retention plan? How will payroll be run from day one? How will the new incentive plan be structured, and what impact could this have on management?
- Legal, Compliance and Regulatory: What are the entity-level obligations and risks by jurisdiction? Are there any regulatory requirements that must be met prior to day one? Have GDPR implications been assessed in detail? What are the intellectual property considerations?
- Operations: Can the business operate without group infrastructure? What dependencies exist? What are the plans to disentangle existing dependencies?
This cross-functional approach avoids post-close surprises and creates a clear, realistic road map for day one and beyond.
Pre-Signing Carve-Out Checklist
A pre-signing carve-out checklist is critical because it helps identify and mitigate major risks early on, ensuring the deal is structured for success before it becomes legally binding. In carve-out deals, there are complex, interdependent issues that can derail value if not addressed up front. Some questions that should be asked include:
- Is every TSA clearly scoped, timed and costed?
- Is the standalone operating model defined, including operations, sales and marketing, finance, HR, IT and legal?
- Have one-off and stranded costs been validated through a bottoms-up functional analysis? Have these costs been signed off by management, and are they therefore accountable for them? Is there a fully costed, execution-ready IT separation plan in place?
- Have key hires, especially a CFO and the Head of IT, been identified?
- Are there red flags on compliance, data handling or labour law in any jurisdiction?
- Has a holistic carve-out plan been prepared at the functional and activity levels, including estimated timelines to complete in preparation for execution?
Final Thoughts: Diligence Is the First Stage of the Carve-out Execution
Great carve-out execution begins in diligence. The firms that outperform the competition are those that treat diligence not just as an input to valuation but as a dry run for standing up the business. Complexity is where the value lies — but only if it’s surfaced early and addressed with deliberate planning.
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Date
juin 25, 2025
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