Presenting a live 90-minute webinar with interactive Q&A

Carve-Out Transactions: Strategies for

Due Diligence and Structuring the Deal
WEDNESDAY, JUNE 28, 2017

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Today’s faculty features:

Jason C. Breen, Partner, Goodwin, Los Angeles

Charles J. Morton, Jr., Partner, Venable, Baltimore

Rita-Anne O'Neill, Partner, Sullivan & Cromwell, Los Angeles

The audio portion of the conference may be accessed via the telephone or by using your computer's
speakers. Please refer to the instructions emailed to registrants for additional information. If you
have any questions, please contact Customer Service at 1-800-926-7926 ext. 10.
Tips for Optimal Quality FOR LIVE EVENT ONLY

Sound Quality
If you are listening via your computer speakers, please note that the quality
of your sound will vary depending on the speed and quality of your internet
connection.

If the sound quality is not satisfactory, you may listen via the phone: dial
1-888-450-9970 and enter your PIN when prompted. Otherwise, please
send us a chat or e-mail sound@straffordpub.com immediately so we can
address the problem.

If you dialed in and have any difficulties during the call, press *0 for assistance.

Viewing Quality
To maximize your screen, press the F11 key on your keyboard. To exit full screen,
press the F11 key again.
Continuing Education Credits FOR LIVE EVENT ONLY

In order for us to process your continuing education credit, you must confirm your
participation in this webinar by completing and submitting the Attendance
Affirmation/Evaluation after the webinar.

A link to the Attendance Affirmation/Evaluation will be in the thank you email

that you will receive immediately following the program.

For additional information about continuing education, call us at 1-800-926-7926

ext. 35.
Program Materials FOR LIVE EVENT ONLY

If you have not printed the conference materials for this program, please
complete the following steps:
• Click on the ^ symbol next to “Conference Materials” in the middle of the left-
hand column on your screen.
• Click on the tab labeled “Handouts” that appears, and there you will see a
PDF of the slides for today's program.
• Double click on the PDF and a separate page will open.
• Print the slides by clicking on the printer icon.
Carve-Out Transactions:
Strategies for Due Diligence
and Structuring the Deal

June 28, 2017

Strafford Web Seminar
Rita-Anne O’Neill
Charles Morton
Jason Breen
Carve-Out Transactions –
Latest Trends

6
What Is a Carve-Out Transaction?

 A carve-out transaction is a sale of a business line, division or

portion of a larger company. By their nature, carve-out
transactions combine many aspects of public company and
private company M&A and also raise their own set of unique
issues.
 Key Attribute of Carve-out Transactions:
 Seller remains an operating business once the transaction has been
completed.

7
ABA Carve-Out Transaction Deal
Points Study
 The M&A Market Trends Subcommittee of the Mergers & Acquisitions Committee of
the American Bar Association’s Business Law Section is in the process of a new Deal
Points Study on carve-out transactions expected to be released by the end of 2017.
 The Deal Points Study includes analysis of approximately 120 carve-out sale
transactions that were announced from January 1, 2015 through December 31, 2016.
 The carve-out transactions included in the Deal Points Study are public deals with
transaction values in excess of $10 million where the ultimate parent of the Seller is a
U.S. public company, the Seller was not in apparent financial distress at the time of the
announcement of the transaction and the Seller did not retain any equity interest in the
carved out business sold.
 The Deal Points Study excludes agreements that expressly contemplate that the Seller
will obtain stockholder approval prior to consummation of the transaction.
 Note that the data from the Deal Points Study referenced throughout this presentation
is preliminary.
 Also note that the data from the Deal Points Study only covers public deals and the
data may be different for private deals.

8
Carve-out Transactions – Structure
 Carve-out transactions can take the form of asset purchases in which the
Seller identifies and sells or “carves out” specific assets; or the form of an
equity purchase in which the Seller sells equity in one or more of its
subsidiaries.
 Carve-out transactions can also combine the two structures, for example,
when the Seller sells both assets and equity in subsidiaries, or when the
Seller transfers assets in a pre-closing restructuring to a subsidiary and
then sells that subsidiary to a Buyer.
 Even with a transaction structured as an equity purchase, it still may
involve an asset sale in connection with a restructuring.
 Practitioners advising a Seller should discuss very early on in the process
whether a pre-signing or a pre-closing restructuring, if any, is desirable.
 Structure should also take into account input from tax advisors.

9
Carve-Out Transactions –
Unique Legal and
Business Considerations

10
Consideration
 Issue of valuation gaps may be amplified in a carve-out transaction.
 There may not be stand-alone financials relating to the carved out
business.
 To bridge the valuation gap, the parties may agree to staged payments
and/or earnouts.
 Earnouts often address specific concerns and risks of Buyer in assuming
the carved out business. For example, milestones based on satisfying
integration metrics, sales targets and/or regulatory approvals.
 Deal consideration may include mix of stock and cash, which should
be considered in the structuring of the transaction.
 Parties should consider the scope of the retained liabilities by Seller
and post-closing recourse of Buyer against Seller in determining the
deal value and the triggers for payment of the consideration.

11
Transferred Assets/Liabilities
 A key aspect of structuring a carve-out as an asset purchase or with
an asset purchase component is identifying the specific assets to be
transferred and the liabilities to be assumed.
 Describe specifically?
 List and/or describe specific assets for purchase in an attached schedule.
 This may be tedious and creates the risk that an asset related to the
carved out business will be omitted.
 Describe generally?
 Describe the assets to be purchased conceptually.
 Flexible definitions ensure the intended assets will be included in the
purchase agreement. However, the added flexibility leaves room for
debate as to whether a specific asset is included in the conceptual
definition or should rightfully remain with the Seller.
 Pair conceptual description of assets with non-exclusive lists of
particularly important classes of assets to be purchased.
12
Transferred Assets/Liabilities (con’t)

 Example standards used to define conceptually described

transferred assets:
 Related to another transferred asset or the carved out business.
 Exclusively used in the carved out business.
 Primarily used in the operation of the carved out business.
 Necessary to the carved out business.
 Used in the operation of the carved out business.
 Primarily related to or associated with the carved out business.

13
Transferred Assets/Liabilities (con’t)

 Example standards used to define conceptually described

excluded assets:
 Liquid assets such as cash, tax refunds, accounts receivable, funds
owed under outstanding hedging arrangements, etc.
 Equity of subsidiaries.
 Corporate records of Seller and Seller parent.
 Insurance policies.
 Assets, rights and interests in employee benefits plans.
 Rights under Seller and Seller parent trademarks.
 Assets unrelated to the carved out business.
 Commingled contracts.

14
Transferred Assets/Liabilities (con’t)
 Assumed liabilities by Buyer specifically articulated, with all other
liabilities retained by Seller.
 Liabilities listed on a schedule.

 Liabilities relating to transferred assets following the closing.

 Liabilities arising from the sale of products following the closing

by Buyer.
 Assumption of executory liabilities arising following the closing
under the transferred agreements (excluding liabilities relating
to breaches or events that occurred prior to or at the closing).
 If there is a working capital adjustment, current liabilities.

 Retained liabilities specifically articulated, with all other liabilities

assumed by Buyer.

15
Transferred Assets/Liabilities (con’t)
 Example standards used to define conceptually described retained liabilities:
 Liabilities relating to pre-closing and transaction-related taxes.
 Liabilities relating to present or former employees of Seller.
 Liabilities arising under employee benefit plans of Seller.
 Liabilities arising pre-closing or relating to an event occurring pre-closing.
 Liabilities relating to excluded assets.
 Liabilities associated with Seller indebtedness.
 Liabilities arising from Seller's breach of representations, improper performance or
defective products/services.
 Liabilities arising from litigation for pre-closing actions.
 Seller accounts payable.
 Liabilities unrelated to the carved out business.
 Liabilities arising from Seller's failure to comply with contracts or applicable law.
 Liabilities for environmental claims.
 Liabilities owed to Seller’s directors and officers.

16
Commingled Contracts
 Commingled contracts are contracts that cover the carved out business
and all or part of the business to be retained by the Seller.
 Unwinding refers to the situation in which the carved out business is
released from the commingled contract, or the commingled contract is
split into separate contracts (whether by novation, partial assignment or
amendment, or some combination thereof).
 The obligation to unwind or allocate a commingled contract can be
reflected in the purchase agreement as a pre-closing or post-closing
covenant, or both.
 A pre-transaction reorganization can also be an opportunity to unwind
commingled contracts.

17
Commingled Books and Records
 In carve-out transactions, you may also need to address commingled
books and records other than contracts.
 The Seller should expect to deliver to the Buyer copies of all such
commingled records that are primarily related to the carved out business.
 Those records typically would contain a mix of information – Seller
information that is not related to the carve-out business, Buyer
information that is exclusively related to the carve-out business, and
shared information. All of this information is often mixed in commingled
records that will be transferred to the Buyer.
 Consider confidentiality restrictions and mechanisms for both parties to
share and use shared commingled information.

18
Carve-Out Financial Statements
 Carve-out financial statements are financial statements covering the carve-out business on a
standalone basis.
 Preparing carve-out financial statements may require significant time and resources.
Accordingly, if carve-out financial statements will be required as part of a transaction, the
parties should discuss this as early in the process as possible.
 By preparing carve-out financial statements early, it will help the parties identify the assets
to be transferred as well as any commingled contracts.
 A Buyer may, for various reasons, require carve-out financial statements with respect to the
business it is acquiring. For instance, carve-out financial statements may form a significant
portion of the Buyer’s due diligence and impact the Buyer’s valuation of the carved out
business, and the carve-out financials may also be necessary for the Buyer to obtain the
financing it needs to fund its acquisition of the carved out business.
 Carve-out financials may be required if the Buyer is a public company and the transaction is
significant.
 Rule 3-05 of Regulation S-X requires a Buyer to file audited financial statements with the
SEC on the carved out business for up to the three most recent fiscal years, depending
on how significant the transaction is; there are various tests to determine significance.
 Even if carve-out financials are not required, they may be advisable to provide certainty for
the valuation of the carve-out business.

19
Carve-Out Financial Statements (con’t)

 If carve-out financials are not prepared or audited before a

transaction agreement is signed up, the purchase agreement
should specifically address the timing of completion.
 Include a Seller representation with respect to carve-out financial
statements that have been made available to the Buyer at signing.
 Include a covenant that provides that the Seller will prepare and
deliver additional audited or unaudited financial statements.
 Even if not currently needed, consider adding a covenant for Seller to
assist in the preparation of financials if a private company may go public
in the near term.
 Condition the closing on the delivery of carve-out financial
statements that are reasonably satisfactory to the Buyer.
20
Scope of Representations, Warranties
& Covenants
 Parties typically will be sensitive to the scope of the
representations and warranties.
 Categories of representations and warranties.
 How broad is the coverage of the representations and warranties?
 Seller generally.

 Business.

 Specific assets.

 Scope of restrictions on the Seller generally between signing and

closing.
 Seller generally.
 Business.
 Specific assets.

21
Sufficiency of Assets Representation
 In a carve-out transaction, the Buyer is acquiring some but not all of
the Seller’s assets. Accordingly, a sufficiency of assets
representation gives assurance to the Buyer that, upon
consummation of the transaction, it will obtain all of the necessary
assets to operate the carved out business without the excluded
assets that are retained by the Seller.
 Agreements structured with an asset purchase component and
agreements structured without an asset purchase component both
often contain a sufficiency of assets representation.
 Because of the importance of sufficiency of the assets
representation to carve-out transactions, the specifics of drafting
the representation can be critical.

22
Third Party Consents
 All carve-out transactions, but particularly those structured as asset
purchases, can raise significant third party consent issues. This is
because a company may not have structured its contractual
arrangements in a manner that would have contemplated a partial
sale of the Seller.
 Buyers should consider including provisions in the acquisition
agreement that address the following:
 outlining the efforts that the parties must undertake in order to
obtain consents;
 expressly providing for the consequences in the event that certain
contracts cannot be assigned; and/or
 conditioning closing on obtaining certain consents.
 If the acquisition agreement is conditioned on obtaining certain
consents, parties should have a clear understanding of the threshold
of consents required to facilitate closing.
23
Third Party Consents (con’t)
 When drafting a third party consent covenant, parties need to think
about:
 Who will bear the responsibility to obtain third party consents (Seller, Buyer or
both).
 Most agreements have both parties responsible.
 Who participates in the discussions with third parties.
 Important to have a consistent message regarding the transaction.
 What level of efforts such party should use to obtain third party consents.
 Level of efforts commonly used include:
 Commercially reasonable efforts; and
 Reasonable best efforts.
 Whether there will be any limits on the obligation to obtain third party consents.
 Limiting consideration paid, commencing litigation, modifying the underlying contract, etc.
 The time needed for obtaining third party consents.
 Parties often underestimate the time needed to obtain third party consents.
 Who will bear the costs of obtaining third party consents.

24
Non-Competition/
Non-Solicitation Covenants
 Unlike in a typical M&A deal, in a carve-out transaction the Seller
remains an operating business once the transaction has been
completed, and therefore non-competes and non-solicitation
provisions are probably one of the most interesting negotiations in
a carve-out transaction.
 The typical non-compete, if any, will restrict Seller’s ability to
compete with the business being sold for some period of time,
typically between two to five years.
 The typical non-solicit will restrict Seller’s, or sometimes Buyer’s,
ability to solicit employees of the other party, or sometimes
customers and vendors of the carved out business.
 Beware of confidentiality obligations creating back-door non-
competes.

25
Indemnification –
Deductibles, Baskets and Caps
 Virtually all carve-out deals have indemnification based on breaches of
representations and warranties, similar to any sort of private deal
transaction.
 Most provide an indemnification of Buyer for retained liabilities, while
others provide an indemnification of Seller for assumed liabilities.
 As reflected in the preliminary data from the Deal Points Study, caps,
baskets and survival periods, as well as other indemnification provisions
such as treatments and components of fundamental representations and
materiality scrapes tend to be similar to those in typical private company
transaction agreements.
 One departure is that indemnification for retained liabilities may be
uncapped.
 For indemnification provisions generally, customary private transaction
agreements for entire companies are often good starting points for
drafting carve-out transaction agreements.

26
Indemnification –
Use of Escrows and Holdbacks
 One key way in which carve-out transactions differ substantially
from private transactions is the source of the recourse for Buyer
indemnity claims, that is, whether such recourse is supported by an
escrow, a holdback or general recourse to the Seller.
 The low frequency of escrows and holdbacks in public carve-out
transactions is consistent with expectations where there is a Seller
that remains to answer for any potential future indemnity claims.
 Use of escrows and holdbacks tends to be more common in private
carve-out transactions.
 Set-off against future payments (staged payments and/or earnouts)
may be another source of recovery.

27
Retention of Key Employees
 From a Buyer’s perspective, it’s often critical to make sure that key employees
come along with the carved out business.
 Even though key employees can be very important to a deal, the Seller won’t
want the entire deal to be at risk over a couple of employees who may refuse
to go along.
 Could include a closing condition that a certain percentage of the employees receiving
offers agree to Buyer’s employment documents.
 Require that Seller terminate any offered employees that do not accept Buyer’s
employment terms.
 Parties often address this issue outside of the agreement, such as by
negotiating employment agreements prior to signing or by requiring the Seller
to make various representations and warranties about the key employees of
the carved out business.
 Negotiating the employment agreements prior to signing reduces the leverage that key
employees may have on the transaction after the agreement is signed and announced.
 Another option is to have the key employee provide services under a
transitional services agreement or a reverse service agreement after closing.
28
Other Employee Considerations
 Condition offers of employment on closing of
transaction.
 Allocate pre-closing (and closing) obligations to offered
employees between Buyer and Seller.
 Consider integration matters and what is required to
occur by closing.
 If offered employees are employed outside of the United
States, engage local counsel as employees may
automatically transfer with the carved out business,
while in other jurisdictions certain procedural
requirements may be required that could impact the
timing of the closing.
29
Ancillary Agreements
 In a carve-out transaction, there are a number of ancillary agreements. These ancillary agreements
tend to be more substantive than you might see in a whole company transaction.
 Some example ancillary agreements include:
 IP licenses, if you have IP that’s shared in a business, the Seller may need a license back to the IP that was
transferred so it can continue to run the retained business, and Buyer may need a license to shared IP of
Seller that was not transferred.
 Leases or a sub-leases for the facilities of the carved out business.
 Supply agreements.
 Transition services agreements.
 The most common, and the most negotiated, ancillary agreement in a carve-out transaction is a
transition services agreement where the Seller provides services to Buyer for some period of time
post-closing so that Buyer can fully transition and integrate the carved out business into its own
business.
 Sometimes you have transition services going back from Buyer to the Seller if there were assets
transferred that the Seller needs to replace or come up with other services to replicate.
 Key issues in a transition services agreement are scope of services, the period of time for the
services and what the cost will be for those services, if any.
 Careful attention should also be paid to the indemnities in the TSA and in the other ancillaries.

30
Carve-Out Transactions –
Due Diligence Best
Practices

31
Identifying Key Assets
 It is really important to determine early on in diligence which assets
will be transferred in a carve-out transaction.
 Parties need to identify the key assets (including the type and
location) in order to:
 Structure the transaction.
 Determine tax ramifications.
 Describe the assets to be transferred or retained in the transaction.
 As discussed earlier, will these be described specifically or conceptually or both?
 Determine which contracts will need to be unwound.
 If so, how will such contracts be unwound? Is the carved out business released from the
commingled contract, or is the commingled contract is split into separate contracts?
 Whether a transitional services agreement, license agreement or other
ancillary agreement is necessary.
 Whether third party consents are necessary for transfer.
32
Assignment and Third Party Consent
 As discussed earlier, a carve-out transaction is likely to require a number of third party
consents.
 In order to inform the parties’ negotiations and drafting, it is important to identify
critical contracts early in the transaction, and if any are identified, to understand the
consequences if the transaction is consummated without the receipt of such consent,
for example:
 whether the assignment would be void;
 whether it would constitute a breach of the contract;
 whether that would give rise to a claim for damages; and
 what the parties would do if the contract cannot be assigned.
 If a contract states that it may not be transferred without consent, then any transfer in
violation of such provision would result in a breach of that agreement and entitle the
counterparty to any damages incurred as a result of the transfer.
 However, if the contract to be transferred expressly states that any transfer without
consent shall be void, then the contract cannot effectively be transferred without such
consent and the parties should consider methods for ensuring that the Buyer gets the
benefit of that contract.

33
Other Due Diligence Matters

 Release of liens.
 Intercompany arrangements (documented, required post-
closing, arm’s length terms).
 Diligence on Buyer.
 Required consents.
 Impacts on legacy business.
 Integration matters.
 Engage local legal advisors early.

34
Contact Info
Rita-Anne O’Neill, partner at Sullivan & Cromwell LLP
1888 Century Park East, Los Angeles, CA 90067
(310) 712-6698
oneillr@sullcrom.com

Charles Morton, partner at Venable LLP

750 East Pratt Street, Suite 900, Baltimore, MD 21202
(410) 244-7716
cjmorton@venable.com

Jason Breen, partner at Goodwin Procter LLP

601 S. Figueroa Street, Los Angeles, CA 90068
(213) 426-2574
jbreen@goodwinlaw.com

35
Bios
Rita-Anne O'Neill, Partner
Sullivan & Cromwell LLP, Los Angeles
Ms. O’Neill has a broad-based practice that includes advising clients on mergers
and acquisitions and securities offerings, and providing general corporate advice
on disclosure and governance. She has advised clients in a wide range of
industries, including apparel, financial institutions, healthcare and life sciences,
semiconductors, telecommunications, and transportation. Ms. O’Neill is currently
chairing the new ABA Deal Points Study on Carve-Out Transactions.

Charles J. Morton, Jr., Partner

Venable LLP, Baltimore
Mr. Morton Co-Chairs the firm’s nationally prominent Corporate Practice Group.
His practice focuses on the healthcare, technology, and consumer products
industries. Mr. Morton assists lenders, investors, and entrepreneurs as they
create, build, and buy or sell businesses. He regularly acts on behalf of private
equity groups and banks. Mr. Morton is the past Chairman of the Global Board of
Directors of the Association for Corporate Growth.

Jason C. Breen, Partner

Goodwin Procter LLP, Los Angeles
Mr. Breen represents startup and later-stage companies in the software,
technology and life sciences industries throughout their corporate life cycle,
with a particular focus on mergers, acquisitions, divestitures, financings and
other strategic transactions. He also represents venture capital, growth
equity and private equity funds focusing on technology and life sciences
companies.

36