What Is an Equity Carve out?

Malcolm Tatum

Sometimes known as a carveout or a spinoff, an equity carve out is a situation in which an existing company chooses to launch a new subsidiary by offering minority interest in the new venture to outside investors as part of the financing for the venture. Typically, there is a low limit placed on the amount of ownership that is actually sold, allowing the business to retain a solid controlling interest in the new venture. It is not unusual for the company using an equity carve out strategy to offer more shares in the subsidiary at a later date, sometimes as part of an initial public offering (IPO).

Man climbing a rope
Man climbing a rope

With an equity carve out, the goal is to obtain some of the financing necessary to successfully launch the new venture, while still retaining control of the activity. To this end, companies will normally offer no more than 20% ownership in the new venture to outside investors. This amount can help to defray startup expenses while still allowing the parent company to maintain control of everything that has to do with the startup, including the day-to-day operations. Assuming the subsidiary is able to gain market share over time, the minority investors can experience significant returns for the investment, while the parent also enjoys the influx of profits.

Many companies have used this approach to create subsidiaries that help to supply materials needed to produce goods and services offered by parent companies. For example, a company that makes electronic appliances may create a subsidiary that makes proprietary circuit boards which can be used in those appliances. At the same time, the subsidiary may also produce components that are ideal for use by other businesses, allowing the venture to register a profit from more than one product and revenue stream. At other times, a brick and mortar company may use the concept of an equity carve out to fund the launch of an online business that serves as the means of selling the same goods and services provided by the more traditional retail locations.

Under the best of circumstances, an equity carve out can be beneficial for everyone concerned. Investors have the opportunity to secure interest in a venture that is likely to be successful and generate revenue for everyone involved. The parent company is able to launch the subsidiary without having to rely solely on its own resources, which means that cash reserves are not tied up during the startup phase. As the new venture begins to generate profits, the opportunity to take part in additional offerings of stock incentives makes the deal even more lucrative for investors while still allowing the parent to control the operation and future prospects of the subsidiary.

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