A tool is only ever as powerful as the person using it. That same logic can be applied to companies, their business units, product and service lines. Right now, business owners across the United States are failing to exploit millions of dollars of value from some aspect of their companies because they haven’t woken up to the potential of divestitures to help them do so.
This is a story that M&A Science sees repeated over and over: Outstanding executives so focused on growth, be that organic or through acquisition, that they fail to look at the inherent value in divesting a division, a line, or even underused intellectual property. This is our guide to divestitures and how they should be considered as tools to fuel corporate growth.
A divestiture occurs any time that a company divests one of its assets with the express intention of generating value.
The most common form of a divestiture are the many variants of M&A transaction, including but not limited to:
- Spin offs: Spin-off is the process through which companies create a new company from a business unit, distributing its stock among existing stockholders on a pro-rata basis.
- Carve outs: A carve out occurs when some shares in a company’s subsidiary are listed on a public exchange with the intention of later divesting of the subsidiary entirely.
- Split offs: The process through which companies divest business units and create new companies in which current shareholders are offered to participate.
- Liquidation: The process through which the component assets of a company are sold separately to generate cash.
- Trade sale: The sale of a business unit or company to a third party company operating in the same industry.
Invariably, divestitures occur because a company’s management decides that the company would generate more value with the asset being divested.
Reasons Companies Divest
Businesses get rid of assets all the time for various reasons. The most straightforward explanation is bankruptcy, where the company needs to liquidate all its assets to receive some cash in return.
But aside from this worst-case scenario, there are a lot of other reasons why companies go about a divestiture:
1. Non-core Assets
As a company grows and acquires more assets, some of the existing businesses might no longer be part of their core strategy. Corporate strategy changes depending on technology developments, consumer demands, and other external factors. If so, divesting the said business might be the best route.
Because the business is no longer part of its core strategy, it will stop getting the attention or resources required to reach its full potential. At this point, this business might be better off with a new owner. This approach is typically seen from proactive buyers who acquire multiple companies annually and eventually need to dispose of some of the assets.
The perfect example of this is Roche Diagnostics. Back in 2007, Roche divested three pharmaceutical products to Actavis - Bezalip, Rapilysin and Neotigason, with the purpose of focusing on therapy and diagnostics.
2. Raise Cash
Some companies might sell their business simply because they need to raise cash for better opportunities. They might need cash for another acquisition or to license an intellectual property of some sort.
3. Underperforming Assets
The most common type of a divestiture is when a company sells assets or products that are not performing to their potential. The owner can sell this asset in the hopes that it may be worth more to someone else than it is to them.
In 2013, the world’s biggest food group, Nestle, sold its weight management business, Jenny Craig. The Jenny Craig business in France was not part of the deal, as they only sold businesses in North America and Oceania to a private equity firm North Castle Partners. This was part of their project to divest underperforming brands so they could focus more on their leading brands including Nescafe Coffee and KitKat Chocolate.
Sometimes, divestitures are required and mandated by the Federal Trade Commission as part of the antitrust law. This law prevents monopolies from controlling a specific market sector and ensuring healthy competition in the market after a deal is closed.
One of the largest court-ordered divestiture was back in 2015, when supermarket operators, Albertsons and Safeway Inc, merged with one another. According to the FTC, these two companies competed heavily on product variety, price, and services. The merger would have lessened the supermarket competition and negatively impacted consumer experience. The FTC forced them to sell 168 supermarkets before they would
5. Few synergies
Even if an asset is cash generative, it may not be synergistic with other assets held by the company, meaning its value is not being exploited to its fullest and many companies find that certain assets (such as business units) would be worth more as standalone businesses.
6. Balance sheet improvement
Closely related to cash generation is the ability to ‘clean up’ the company balance sheet with extra cash.
When a company enters a bankruptcy procedure (say, chapter 11), divesting assets is a central part of the process.
To acquire some assets, anti-monopoly regulators may stipulate that the companies should divest others.
The business unit or division may have been underperforming (perhaps as a result of being non-core), thereby making a divestiture attractive.
Advantages and Disadvantages of Divestitures
Examples of Divestiture
The 2014 of Motorola Mobility by parent company Google is a prime example of a divestiture. Google sold Motorola’s handset division to Chinese company Lenovo, while retaining other assets, including its patent portfolio in a deal worth nearly $3 billion. Lenovo had itself previously divested several divisions before being acquired by Google for $12.5 billion in 2011.
In 2022, Kellogg’s announced that it saw its future in healthy snacks - a remove from its traditional core area of high-sugar breakfast cereals. As part of this strategic shift, it announced that it would be divesting three North American cereal divisions through spin offs, which together accounted for 20% of Kellogg’s sales in 2021.
For any company undertaking a divestiture, there a number of issues which merit consideration.
M&A Science has conducted a deep dive into these issues, which include everything involved in the process including how to assess the readiness of a company for divestiture and the work roadmapping and planning that should underpin the process, outlined down below.
When Should You Consider Divestiture?
There’s a good chance that right now, your company holds assets that are worth more to you outside the company than inside. There may be a string of these assets. When the difference between what the company is worth outside your company and inside it becomes significant because of strategy, market conditions or anything else, it’s time to divest that asset.
What Makes Executing Divestitures Hard
As mentioned before, executing divestitures is not as easy as buying and selling a company. The biggest difference lies within the fact that in divestitures, you are selling an asset that has never stood independently apart from the parent company. More often than not, this business will have shared services with the parent company that will no longer be part of the sale process.
Most business units are more integrated into a company than owners initially consider. The more integrated they are, the more difficult divestitures become. An obvious example is the shared workforce that operate between units - who gets to keep these workers? And for those workers that the divesting company loses, what value are they losing by their exit?
The best example of this would be infrastructure. The business that you are selling is probably housed inside your company building. If a buyer suddenly decides to buy your business, they will have to have a ready infrastructure to take in their newly acquired asset. If not, that's when things can get complicated as the transaction will need a transitional service agreement (TSA).
This also includes a shared workforce as there will be people working for the parent company but that are also touching the divested business. The most common example of this is human resources. It is highly unlikely that a business will have multiple HR departments, especially a dedicated one to a particular business segment. In some cases, this can also apply to production and operations management.
Lastly, a company will rarely have a complete standalone set of financial statements for the same business being sold, but buyers will want to see how the business is doing to assess viability and profitability from a financial standpoint. This can be highly complex because of the shared services and the dependence of the business to the parent company.
What are TSAs?
A transitional service agreement (TSA) is an agreement or contract entered into by the buyer and seller of a business. The purpose of this agreement is to bind the seller to provide certain services necessary to operate the company that has just been purchased. These services can include HR, accounting, IT, or even just leasing the infrastructure. In exchange, the buyer then agrees to pay the seller for said services, for an agreed price, for a certain period of time.
As mentioned before, TSAs are necessary for divestitures if the buyer cannot operate the business post-close. The TSA outlines all the essential services that the buyer will need from the seller, with a predetermined end date, price to be paid, and other limitations and conditions.
M&A Science offers an outstanding overview of how a divestiture strategy should be put together here.
The playbook, developed by Toby Tester, Senior Consultant and Project Manager at BTD, is just one of the multiple resources dedicated to value generating divestitures available on the M&A Science platform. There are certain traits which we can observe across successful divestitures, regardless of the industry:
- Timing (the ‘when’): Knowing when to divest is as important as knowing the right time to invest. And the two are often closely linked, with companies opting to sell in the expectation that the funds achieved will be used for investment.
- Focus (the ‘why’): Companies’ strategies change according to changes on balance sheets, CEOs, market and industry shifts, and the overall economy. As they do, they acquire assets that are soon deemed unnecessary. Value is usually generated by the companies that have less of their cash tied up in these assets.
- Well defined (‘the what’): What is being sold? Is it the asset or the asset with people? Is it an asset sale or an equity sale? And of course, consider the impacts of selling (see next section).
If the introduction to divestiture strategies in the last sub-bullet attracted your interest, Toby Tester has also collaborated with M&A Science to put together a divestiture framework based on extensive experience in the field.
Having worked on hundreds of divestitures over the past decade, we believe the course provided by Tester is the best way to reduce complexity in these processes. This can be summarized as follows:
Assess the relative importance of transaction speed
Some deals generate more value by being sold faster than others. An example is a company with an urgent need of liquidity. In alternative scenarios, it may pay to take time and find a suitable buyer. Finding this balance is the divestiture team’s first task.
Create a divestiture roadmap
Establishing the transaction speed determines the speed of the various steps in the divesitture roadmap. In short, these are:
- Initiation: Outlining the divestiture strategy and goals.
- Setup: Formal establishment of team, governance, and resources required.
- Information memorandum: Marketing document for the asset being divested.
- Due diligence: On request of buyer(s).
- Negotiation: With suitable buyer(s).
- Closing and transition: Where the company adapts to the period without the divested asset.
Adjust Approach Based on Likely Impacts
The nature of dependencies that exist within a company usually makes it nearly impossible to measure the impact of a sale of an asset. However, good practice is to estimate and minimize these impacts as much as possible. Impacts which need to be considered include:
- Data management and migration
- Data centers
- Technology contracts
- Transition service agreements (TSA)
- Regulatory impact
- HR impact
- Finance impact
- Tax impact
Revise the Deal Roadmap Timeline
Ensure that the framework fits with the time restrictions set at the outset.
The process of divestiture is much more complicated than a typical M&A process. It has complexities that will be detailed as you go through execution.
The process starts by clearly defining the asset that you want to dispose. It might sound simple, but this could get complicated very quickly because of the shared resources with the parent company. You need to decide what equipment, furniture, office supplies, computer, and other essential materials will come with the sale. Without the deal perimeter, you won't be able to continue to the following steps properly.
The next step in a divestiture is to identify which employees will go with the business for sale. There will be a core group of people dedicated to running the company that is being sold and who will have to be included in the transaction. However, It gets blurry and complicated for the people that are in the role of the shared service.
People sharing is widespread in any business, like an HR department that runs the entire organization with multiple business segments. If you are selling a software product, the people who developed it in the IT department might be included in the sale. It's primarily subjective on who you want to include in the deal, but the general rule of thumb is that if more than 50% of an employee's time is dedicated to the business being sold, they will most likely be included in the sale.
Typically, the seller needs to communicate the intention to sell with the people within the ring fence. This conversation is usually accompanied by a retention plan to let people know they are locked in once the deal goes public. It means that they will not be eligible to apply for roles outside of that ring-fence within your company.
Due to the dependency of the business to the parent company, such as the shared services of some of the employees and equipment, the business for sale will most likely not have a standalone financial statement. If you are selling this business separately, then you have to come up with financials that will tell the story of how it looks like as a standalone business.
Financial statements are documents that show the financial activities of a business or a person. It also shows the assets and liabilities of the business, as well as the cash flow periodically. These are extremely important because this will be the baseline of the buyer’s due diligence. You need to have these ready before you even consider talking to buyers.
Before you can actually come up with standalone financials, you need to have identified the scope and the extent of the sale process, and who will go with the business. Identify and remove shared services from the financial statements to get a clear picture of what the business looks like independently. The structure of what you're selling will drive the structure of your financial data.
You will also need to come up with several years worth of standalone financials to show stability, consistency, and profitability. This will need to be audited by a third-party auditor.
Due diligence is an excellent way for buyers to fully understand the business value and risks of acquiring the target company.
It is also in the seller's best interest to conduct due diligence on their own business. This will reduce surprises that the buyers might see during their diligence, and if detected early, it will give the seller a chance to fix the problem before engaging with the buyer.
Furthermore, it will allow the seller to better understand the value of their business and bridge the gap between expectations and reality. This is often the number one cause of prolonged negotiations as buyers and sellers can't agree on the purchase price.
One of the essential parts of understanding the value of the business is a quality of earnings report (Q of E). This is usually done by an outside party to ensure parity and objectivity. The Q of E report concept is to understand the business's regular, average run rate without any one-time costs or events. It's usually derived using earnings before interest, taxes, depreciation, and amortization (EBITDA) before adjusting and removing the one-time events.
Looking for a Buyer
After all the preparation is complete, the seller will be ready to sell the business, and it's time to look for buyers. If the seller already has a buyer in mind, then they should be pretty straightforward. If not, there are a couple of ways to find buyers.
The first and the most common approach is to hire an investment bank. Bankers will help you find buyers for a certain fee. The good thing about bankers is that they have many connections that will allow them to find multiple buyers, which will most likely end up in an auction process. The more potential buyers you have, the higher the price.
However, if you have adequate manpower in your corporate development team and don’t want to pay to use an investment bank, you can always find buyers yourself. You can start by contacting competitors, suppliers, or anyone else within your ecosystem.
How M&A Science Can Help
M&A Science's experience over hundreds of deals across practically every industry vertical gives it unique insights into how to extract value from divestitures. Some of the services that we can provide include:
M&A Science was founded by Kison Patel, the father of Agile M&A and lead advisor on several hundred value-creating transactions. Users can call on Patel’s advisory for complex divestitures to avoid the pitfalls that befall even seasoned M&A practitioners.
- Free eBook: How to Create Long Lasting Value from Divestitures
- Podcast: M&A Science Podcast (Divestiture Category)
- Courses: 50+ M&A Courses by M&A Practitioners (certification included)
- M&A Science M&A Play: Determining a Divestiture Approach
- M&A Science M&A Plays: Overview of M&A Plays
- Get in touch: Contact us for a free assessment of your needs!