October 26, 2026 | By: Mitch Kurylowicz, Director, Integration & Separation Advisory

In most carve-out acquisitions, investors begin with the essential diligence workstreams, including Quality of Earnings (QoE) and tax diligence. Each answers an important but different question. QoE helps investors understand the quality and sustainability of earnings and can inform valuation. Tax diligence identifies exposures and opportunities, and helps determine how the transaction should be structured.

But carve-outs introduce another question that is just as important: How will this business operate independently after the transaction?

That is the question carve-out diligence is designed to answer.

Unlike a standalone acquisition, a carved-out business is typically built to operate as part of a larger enterprise. Critical capabilities may sit outside the perimeter of the transaction. Finance may be centralized. HR and payroll may be shared. IT platforms may support multiple business units. Procurement, treasury, tax, legal, cybersecurity and compliance may all be provided by the parent.

The financials can be attractive, and the valuation can make sense. But the buyer also needs to understand what capabilities, systems, people and services must be replicated, replaced or transitioned for the business to operate independently.

That is where carve-out diligence becomes critical and complements the traditional diligence workstreams.

A QoE report helps validate historical earnings and identify adjustments to EBITDA. It is always essential for any transaction. In a carve-out, however, historical financials may not fully capture how dependent the business is on the parent, what it will cost to separate, what needs to be ready on Day 1, or what the business will cost to run in the future on a standalone basis.

In my experience, carve-out diligence should build on financial diligence by focusing on 4 practical areas:

    1. Functional entanglements: Identify and understand where the business relies on the parent across people, processes, systems, contracts, and services. A business may show strong EBITDA while relying on the parent for month-end close, payroll, vendor management, cybersecurity, ERP support, critical enterprise contracts, or cash management. These dependencies determine what needs to be replaced, transitioned, or supported by the seller through a TSA. 
    2. Separation and standalone costs: Distinguish between the one-time costs to separate and the ongoing costs to operate the business independently. Systems may need to be implemented, data migrated, vendors onboarded, and Finance, HR, IT, cybersecurity, reporting, and controls recreated. Buyers should also assess potential diseconomies of scale as the business loses access to enterprise-wide purchasing power, volume discounts, shared contracts, and other benefits negotiated by the parent. Additionally, management costs are often understated. Parent allocations rarely reflect the full cost of the leadership roles, such as a CFO, controller, or HR lead, that the standalone business will need to hire. Many of these costs will not appear in the historical cost base but can directly affect standalone EBITDA, capital requirements, and ultimately the investment thesis. 
    3. TSAs and Day 1 readiness: Identify which services require seller support after close, how long they will be needed, what they will cost, and what is required to exit them. At the same time, ensure the Day 1 basics are in place so employees can be paid, customers can be served, vendors can be managed, cash can be controlled, systems can be accessed, and the business can operate without disruption. 
    4. Standalone operating model: Define how the business should operate after separation. Determine which capabilities should be built internally, outsourced, or temporarily supported by the seller, and define the people, systems, controls, reporting, and vendor relationships required to support the independent operating model. 

I have seen firsthand why this matters.

In one carve-out, our client appeared relatively standalone from a financial perspective. But when we went function by function, we found that several critical systems used by the business were licensed at the parent level and could not simply transfer with the transaction.

That meant the buyer was not just inheriting an IT cost. It needed to determine whether the seller could continue providing system access under a TSA, whether new licenses or replacement systems were required, how data would be separated and migrated, and whether all of that could be completed before the TSA expired.

In another carve-out, the target business reported positive adjusted EBITDA following the financial Quality of Earnings (QoE) analysis. However, when we conducted our function-by-function carve-out diligence, we uncovered significant costs associated with standalone software licensing, shared services, and other operational entanglements with the parent that had not been reflected in the financials. Once the full cost of operating on a standalone basis was factored in, EBITDA turned negative, fundamentally undermining the original investment thesis.

These are not questions historical financials are designed to answer. The historical P&L may show the allocated functional costs, but it does not necessarily tell you whether the business has the systems, licenses, data access, and infrastructure required to operate independently after close.

This is a very common challenge in carve-outs. A business can look standalone financially while remaining deeply dependent on its parent operationally.

Going through these analyses help the buyer gain a much better understanding of what it would actually take to own and operate a business. More importantly, it surfaces requirements early enough to address them through TSA negotiations, separation planning, the standalone cost base, and the broader investment case.

Carve-out diligence is often the missing lens in a transaction because many of the most consequential issues do not become obvious until the business is viewed as a standalone company rather than as part of its parent. Bringing that perspective into diligence allows buyers to identify those issues while there is still time to address them in the deal, rather than discovering them after close.

At Leo Berwick, our Integration & Separation Advisory team helps private equity investors and corporate clients identify operational dependencies, quantify separation and standalone costs, develop TSAs and Day 1 plans, and define the operating model required for a carved-out business to stand on its own.

We also provide training for private equity investors, corporate development teams, transaction professionals, and operating executives looking to strengthen their capabilities across carve-out diligence and separation execution. No two carve-outs are alike, but the ones that go smoothly tend to have one thing in common: the buyer understood how the business would stand on its own before close, not after. If that’s a question you’re working through, we’d be glad to connect.