The buyer takes the EBITDA. The seller keeps the people, systems and floor space the overhead charge paid for, and the multiple it really sold at falls.
Stranded costs are the central costs once allocated to a business that stay with the seller after the business is sold: allocated overhead minus the costs that transfer with it, net of any TSA income, until the seller cuts them. On an illustrative carve-out sold for 180.0 at 9.0x EBITDA, 10.0 of overhead stays behind, 2.5 of it for good, and the stranded costs are worth 35.5 in present value, 19.7 per cent of the price, so the seller is really selling at 7.2x.
Worked in full in Mergers and Acquisitions by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A division's reported EBITDA is struck after a charge for group services: IT, finance, HR, the head office. When the division is sold, the buyer takes the EBITDA and the seller keeps the people, contracts and floor space that the charge paid for. Those costs do not leave because the allocation stops. They are the reason a disposal that looks accretive on the multiple can leave the remaining group with lower margins for years.
| Function | Allocated | Transfers to buyer | Stays with seller |
|---|---|---|---|
| IT | 5.0 | 1.0 | 4.0 |
| Finance | 3.0 | 0.5 | 2.5 |
| HR | 2.0 | 0.5 | 1.5 |
| Property | 2.0 | 0.0 | 2.0 |
| Total | 12.0 | 2.0 | 10.0 |
Other inputs: division EBITDA after allocations of 20.0, a price of 180.0 (9.0x), a transitional services agreement (TSA) for 12 months under which the seller keeps serving the buyer at cost of 6.0 plus a 5 per cent mark-up, a cost reduction plan that removes 40 per cent of the stranded base by the end of year 1, a permanent residue of 25 per cent, one-off severance and exit costs of 4.0, and a 9 per cent discount rate. How the 12.0 was allocated in the first place matters; the methods are compared in how to allocate corporate overhead to segments.
Stranded base = allocated overhead − costs that transfer with the business
12.0 − 2.0 = 10.0 a year. Only costs that move with people or contracts transferring to the buyer leave. Property transfers nothing here: the division's staff sat in the group's head office, and the lease does not shrink when they go.
| Year | Driver | Stranded |
|---|---|---|
| 1 | 10.0 base less 6.3 TSA income | 3.7 |
| 1 | One-off severance and exit costs | 4.0 |
| 2 | TSA ended, 40% of base removed | 6.0 |
| 3 onwards | Permanent residue, 25% of base | 2.5 |
Year 2 is the worst year, not year 1. The TSA income of 6.0 × 1.05 = 6.3 masks most of the problem while it lasts; when it ends, the costs that served the buyer are still on the books until the cuts land. A seller that budgets from the year 1 figure plans for 3.7 a year and meets 6.0.
PV = (3.7 + 4.0) ÷ 1.09 + 6.0 ÷ 1.09² + (2.5 ÷ 0.09) ÷ 1.09²
= 7.06 + 5.05 + 23.38 = 35.5. The permanent residue, capitalised at 27.78 at the end of year 2, is two thirds of the total. In Excel: =NPV(9%,7.7,6.0+2.5/9%).
| Headline | After stranded costs | |
|---|---|---|
| Price | 180.0 | 180.0 |
| PV of stranded costs | 0.0 | −35.5 |
| Net value to the seller | 180.0 | 144.5 |
| Multiple of division EBITDA | 9.0x | 7.2x |
The group also loses more EBITDA than the division earned: 23.7 in year 1, 26.0 in year 2 and 22.5 a year after that, against the 20.0 in the sale memorandum. If the group trades at more than 7.2x, the disposal destroys value on these numbers even though 9.0x looks like a full price.
| Permanent share | Annual residue | PV of stranded | Net to seller | Effective multiple |
|---|---|---|---|---|
| 0% | 0.0 | 12.1 | 167.9 | 8.4x |
| 10% | 1.0 | 21.5 | 158.5 | 7.9x |
| 25% | 2.5 | 35.5 | 144.5 | 7.2x |
| 40% | 4.0 | 49.5 | 130.5 | 6.5x |
Each 1.0 of permanent residue costs about 9.4 of value, because it is capitalised like EBITDA. Even a seller that eventually removes every stranded cost loses 12.1 to the transition. Without a TSA at all the PV rises to 41.3 and the effective multiple falls to 6.9x, which is why a well-priced TSA is a seller's tool, not a favour to the buyer.
Stranded cost is the allocated overhead that does not transfer, less TSA income, run year by year until the cuts land, with the permanent residue capitalised. Here it takes 35.5 off a 180.0 price. Mergers and Acquisitions is built on the idea that one deal has several prices and only one is true, and the free workbooks for the book carry the models with their inputs emptied for your own deal.
Central costs once charged to the business being sold that remain with the seller after closing: shared IT, finance, HR and head office space. In the illustrative case 12.0 of overhead was allocated, 2.0 transfers with the business and 10.0 stays. They persist until the seller cuts them, and some never go.
It defers them. Income under the transitional services agreement offsets the costs while the seller serves the buyer, here 6.3 a year against a 10.0 base. When it ends, year 2 stranded cost rises to 6.0. Without a TSA the present value of stranded costs rises from 35.5 to 41.3.
Deduct their present value from the price and divide by the division's EBITDA. A 180.0 price on 20.0 of EBITDA is 9.0x; after 35.5 of stranded cost the seller nets 144.5, or 7.2x. If the remaining group trades above that multiple, the disposal dilutes value.
This article is one calculation from Mergers and Acquisitions. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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