Standalone cost base

A division inside a group does not have its own cost base. It has its own direct costs plus an allocation of central overhead, usually driven by revenue or headcount, chosen because the group has to charge its central cost somewhere. That allocation is a bookkeeping convention, not a bill the business will receive once it stands alone.

The standalone cost base is the real figure: its own finance function, its own accounting system, its own audit, its own insurance programme, its own treasury and its own board. It is usually higher than the allocation, because the parent bought all of those services with the purchasing power of the whole group and the division inherits none of it.

The correct adjustment is therefore two sided. Add the allocation back, because it is not a real cost of the standalone business, then deduct the standalone cost base, because it is. Doing only the first flatters the business and doing only the second charges it twice.

This is where carve out valuation goes wrong most often, and the reason it is tempting is structural: the allocated figure is the one in the information memorandum, and every comparable multiple in the market is quoted against a reported number. A bidder that prices off the presented figure pays a full turn more than it thinks.

Lenders apply the same discipline. Debt is normally sized off the standalone figure, sometimes with further conservatism, because a business whose true cost structure has never been observed in operation carries more uncertainty than a clean company's audited history.