Text Version of the Interview
What Should be Divested?
First off, companies should be regularly evaluating whether any of their businesses could be divestiture candidates. Discussions around whether to divest the business can be quite sensitive internally; it's scary for people that are part of that business that is being talked about for potential divestiture.
But frankly, I believe that companies have a duty to their shareholders and to the employees and customers of a business that may not have a future under their ownership to at least consider whether divestiture would help extract greater value for them and result in a better owner for that business.
Another reason to engage in a regular divestiture analysis is that successful divestitures require rigorous planning, which could take many months.
Therefore, to accommodate all that plan, you need to identify the businesses that you may want to sell far in advance of when you may kick off an actual formal sale process. So you should avoid rushing into a sale process.
You should try to embark on a sale only after you've got your arms around: What exactly are you going to sell? What are the implications of the sale to the remaining businesses that you may have? And you need to identify all of the issues and risks that might pop up in a deal.
You should avoid the common trap of waiting to sell a business after the wheels have come off and it's traumatically underperforming. Because in both cases, if you rush to sell a business, it's going to significantly reduce the value of that business that you're going to be able to get for the company and it's going to limit your potential buyer pool.
They're going to be fewer people interested in a lower value business. And so, you may be left with a group of interested buyers that you may not want.
How regularly do you evaluate whether to divest? Annually seems like a good cadence. You've got a fresh set of financials and other operational metrics that you can look at the end of the year, going into the following year.
Companies should divest businesses that are no longer consistent with your strategic direction, no longer important to the core of what you do, your kind of your bread and butter. And often, that means underperforming businesses from a financial perspective.
Divestiture Process Without A Bank
Before you dive into the sale process itself, you have to remember that the ultimate key to success is the planning that goes in ahead of time.
- You have to plan what you are actually selling?
- What products are you going to sell?
- Is there intellectual property? You need to retain some license rights in that intellectual property after the deal.
- Who are the people that you're going to sell as part of that business?
- What contracts need to go?
- Customer contracts,
- Partnership agreements
- Office lease agreements
- And do you need to retain a part of those certain rights under these contracts?
- And what part assets are you going to sell?
So all of that needs to be defined upfront with specificity. And you need to clearly define what exactly you're offering to potential buyers. And you need to be able to exhibit to them that this is all they need to operate the business going forward effectively.
And, now with respect to the people you would propose to include, you need to plan not only who they are but also how you are going to keep them while you're running through a sale process.
Because at some point in the process, they are going to find out what's going on, and it may not feel good to them at that point that you're looking to sell the business that they're a part of and you can't lose them. They're part of the value for the buyer.
And so you may need to put some retention bonuses in place to keep them on board, and you should be open and transparent with them as they learn about what's going on. You're going to need at least the management of the business that you're looking at to be part of the sale process itself.
They'll be part of management meetings. They'll be giving their take on the business and their pitch for why it's an excellent business to the seller, so you need them on board.
Another thing that you need to plan is the right timing of the sale process. When you look at it, you might need time to clean up some of the business that you're thinking about selling. You may find messy contracts, or there are other terms that a buyer may not like. You may need time to renegotiate those and clean those up.
Or there might be a milestone coming up associated with the business, a new product introduction, or a new version of a product you're putting out; maybe you want to wait until that happens to increase value.
Another thing is the information that you are going to provide. It should be easy because the Corp Dev team should start with the due diligence request list that they would provide if they were the buyer.
The tricky part is, the business usually operates inside of a much larger organization. So you won't have things like financial statements because you probably are not reporting on that business separately from your broader business.
So you've got to create pro forma financials, and you've got to plan that out, and you need to involve your finance and accounting teams to help you generate those financial statements because that's what the buyer will look for.
There's a lot of things that you need to be thinking about before you even contact the first potential buyer. But all this planning in advance will benefit you down the road as part of the sale process.
It will enable you to better define and market what you include in the sale to potential buyers. You need to plan how to market the business, and doing all this planning will help you.
All of these planning happens before fundamentally starting a divestiture. And this could take a long time. We're talking months up to a year.
Is there a better time of the year to sell a business?
There is the year-end rush in M&A, just like in many businesses. Right now, where we are from a current environment perspective, it may cause a company to be tempted and rush a divestiture to market because it's such a seller market.
And you'd have to balance on how quickly you can get the asset out to market but having enough time to do all the planning that I talked about.
Another reason why year-end is a rush it's because of the change of administration. Everyone's worried that the tax law is going to change next year. So let's get this done and keep forward before tax laws change and the implications of the sale for us it might change.
What's Next After Planning?
The actual steps of the sale process look very much like what a typical banker auction process would look like. One of the top goals on your list is to maximize the value you're getting from the business by creating competition.
You start with defining the pool of potential bidders, pull together your VDR with all the information you've identified in the planning stage that you want to provide.
Now, you won't provide all of it to all the potential bidders on day one, you'll expose bidders to more and more information as they get more serious and as you run through your auction process.
But you'll populate the VDR as a starting point, prepare your CIM or your confidential information memorandum that provides the comprehensive overview of the business to be sold.
And CIM is one of the core things that bankers deliver. As a corporate development team or deal team, you can deliver something very similar to that, that lays out the assets, the employees, the contracts you're selling the financials, et cetera.
When you've got those steps in place, then start reaching out to your potential bidders. And I would begin by soft outreach to just describe the nature of the business that you're selling in generic terms without really sharing any confidential information because at this point, you don't have an NDA in place. So give them little bits of information.
They know your identity, and they know you're a public company. You don't want them out there telling people that you want to divest a business. So you have to be really discreet with what you're sharing initially with potential bidders. And if they're interested in hearing more, let them sign an NDA.
So once they sign the NDA, that's when you can send them your full CIM and your bid process letter. And so at that point, now you're ready to collect some offers from anyone who's still interested.
You should be narrowing the field down, at that point, to a small handful of parties that you could see yourself selling this business to.
And so with that group, you're now negotiating final agreements. After you know what they are offering, you select your buyers and sign the deal.
It's very much like a typical auction-type process.
Auction vs. Selecting Buyers
A part of that comes out of your assessment of the buyer pool. How many of these five potential buyers will be real buyers? And if that's the situation, you could shortcut the process, run a tighter process with just those five, and try to eliminate steps and just cut to the chase.
If it's less apparent where you're going to get the most value and find the best home for your business, then you want to go with the heavier process, start with a much larger pool, and run a complete auction process.
Steps in Creating Buyer's Pool
So I'd say the starting point if you are a large organization looking to carve out a piece of your business, who in your ecosystem or closest to that business could be interested? They need to be part of the buyer pool.
You can't just use money as the basis of your sale. It may not be the best overall strategic move for you as a company. You should also think about financial buyers. There's a whole industry of buyout firms out there that do nothing more than look to buy carve-outs.
You should think about who outside of those two groups, your ecosystem, financial buyers, what other potential strategic buyers might be interested. So you might have to do some research there.
You might need to think outside the box a little bit and consider buyers who may not be in your industry or your sector. There's this best owner principle.
There's not just one generic value for every business. The value of a business is kind of in the eye of the beholder or in the eye of the owner.
So a business could be a lot more valuable to a company that knows how to run that particular business and combine the synergies than to a company that plays in an adjacent space that doesn't understand the business.
And you want to think about what type of home you're going to provide for the employees because today they're your employees, and you want to give them a soft landing and a good home. And think about the record of these buyers and their ability to close deals.
But in all of this, resist the urge to target everyone under the sun. You're not going to make it easier on yourself by contacting a hundred potential buyers out there just because they're a software company, for example, when you're selling a software business.
So that's how you attack the bidder pool process.
Tools Best for Research
We do subscribe to a couple of databases. I would also tap into our banking contacts, even though they might be disappointed to hear that we're going to run this process and we're going to do it in house without them.
The point of having a strong banker network is that you can tap into them for things that don't involve you paying them a fee. And most of the banker contacts that I have are willing to share information.
Obviously, you're tapping into other public sources. And if you got to ask around at your own company, somebody in your sales organization may know quite a lot about the potential buyer because they work side-by-side with them and some sales cycles.
Asset sale vs. divestiture?
It's an asset purchase by definition, so it's very much akin to all the issues that you deal with in an asset deal are present in a divestiture and then some because you're not just packaging up all the assets. You're pulling out assets that are blended, in some cases, with other assets of your organization.
So just take a simple customer contract. Let's say you're selling some product as part of the business that you're selling. In a contract with your customer, you may have sold that product, but ten other products that you're going to keep.
It gets complicated on how you kind of divide the rights and stuff of a contract rather than assigning it as a whole, as you would if you were just selling all of your assets.
Switching to Stock Sale
That's something to think about as part of your planning before you actually start the divestiture.
If you are planning for a divestiture for a year, maybe throughout that period, you start pulling out those assets and house them in a separate subsidiary. And then when you actually go to market, you're going to sell that since the stock of that subsidiary.
And obviously, there's a lot of tax implications associated with that. HR, as you've mentioned, you're going to move people into a new entity, but there might be a good reason for doing that.
One thing to think about along these lines is, if you're a buyer of the business, and the business you acquire has a lot of different sub businesses. And one of those sub businesses is not really the reason you bought that larger business in the first place.
You might want to leave that sub-business in that subsidiary for a long period of time. Cause maybe that will be a good candidate down the road to divest.
And if you've kept it in that separate subsidiary, that does add at least that ability to think about selling the stock, as opposed to having to do a more complicated asset on our structure.
Why Divest Without a Bank?
First of all, even if you were inclined to ultimately hire a bank to run the actual sale process, the planning at a minimum really should be done internally. No one knows the interworking of your company, its business operations processes, systems employees better than your internal team.
Bringing a third party and getting them sufficiently up to speed and educated on all of these internal aspects would take more time, money, and human capital than it's worth and being compared to handling it internally handling them the planning and planning piece.
But on top of the planning, if you have an in-house deal team, then they'll likely have the expertise to run the auction-style divestiture process. They can collaborate much more easily and efficiently with all the internal people that you will continue to need to lean on throughout the sale process.
And you've got all the internal relationships. So you're going to be more effective at that than a bank would anyway.
So the bottom line is, it's cheaper and faster and the process will be more efficient. The outcomes are likely to be more effective for you strategically because you know the business better.
But that is all premised on; you need the horsepower to execute this cause it does take a lot of time, effort, and deal expertise, and you need to have that in-house, obviously.
Do all divestiture have TSAs?
90 plus percent of divestiture involves some sort of TSA, some services that need to be provided by the seller to the buyer for some period of time post-deal. And they run the gamut, but they're mostly in the category of back-office services, HR, IT, accounting, and finance.
A lot of it depends on who your buyer is. So if it's a strategic buyer that is fairly large, has a large back office of their own, and is already in the business that you're looking to sell, they can pick that up pretty quickly and absorb it within their structure.
But even then, they might need you to do a month-end closing or two of the books, or they might require you to do a couple of payroll runs until they can transfer the employee.
If it's a financial buyer, they don't have a group of accountants and HR professionals sitting around to sustain that business. So they may need your services for three months, six months, whatever it is, until they can hire those resources for that business specifically on their own watch.
You want to be as precise as you can on services you know you need to provide, what are the parameters? What are the service levels around those? The buyer might want you to catch-all.
But as a seller, you want to be careful about that because you want to know what your resources are going to be spending their time doing after you've sold this business to support it and what you should be charging for that.
And then, this is where I've seen a lot of parties on both sides get tripped up, is around the employees of these transition services. So this can't go on forever. You need to set an endpoint.
You need to set milestones for how you will get to that employee and fully transition the business to the buyer. You should establish regular management reporting, meetings to check in on the milestones to enforce some discipline.
You need a lot of discipline around your intent and actions towards moving the buyer off these services. And there's conflict internally because you don't want to do anything, as the seller, to disrupt this business, even after the buyer's taking it over.
Remember often the customers you've transitioned to this buyer; they're going to be your customers too, in other contexts. You don't want to do anything that damages the business that you've sold because it may end up impacting some of your continuing customers and partners.
So there is this internal conflict you want to support. You want to be helpful. You want to see that business stand up on its own with the new buyer, but you're not running a charity, and you need to do something with your own resources in the long term as well.
Buyer Refuses to Get Off TSA?
I've had that situation, but never to the point where it's become a problem. You might be back at the negotiating table, and you may need to renegotiate it to extend it, to have a tighter plan around the deadline.
The reason you define deadlines in the agreement is that you could have the right to end the contract on a schedule. So you want to set up your contract in that way. So you've got the worst-case scenario covered.
Are TSAs Profitable?
TSAs can be profitable. They can heavily be negotiated because the buyer is willing to cover your costs. But on the other hand, as a seller, you could be putting your resources to more productive use elsewhere. There is an opportunity cost associated with that.
So yes, if you could gain a little bit of profit from the TSA, at least for some time, why not do so. So there is some tension around economics, and I wouldn't count on them being wildly profitable. And, of course, they're going to have a fairly short time frame associated with them.
The biggest problem is you agree on transition services economics that don't even cover your costs to provide those services. And now your business that's left behind is less profitable.
Can You Stand Up the Entity On Its Own to Avoid TSA?
It's worth considering because if you're going to stand it up in a separate entity, the steps would be the same as you would do if you're just going to sell it directly to a buyer. You're not adding much more from a process step, and you may be saving yourself a lot of headaches with the TSA down the road.
Defining Value for the Buyer
One of the things that I found to be effective is marketing. So when you're pulling together a pitch for potential bidders, you need to define the market opportunity for the new owner. You've got to find a way to market this business.
Lean a little bit on that best owner principle. How would the best owner operate this business, and how can they achieve all the things they want to achieve if they get this business.
So pulling together that story is important when discussing your own historical financial performance of the business. There can be a disconnect between what you've dealt with in the business and the vision you're trying to sell.
Pitch it as how it could have performed better if it was with the best owner or a better owner and why there was a disconnect between the growth opportunity you see for the business and how you operate it.
It's like admitting you've been a bad parent, and that's why companies don't do it. There's an inherent admission of some failure at some level.
I go back to the strategic relationships that you have when you go into the process. And what strategic relationships do you want to maintain after?
For example, if you are selling software to a software business, you're selling it to a company that has better expertise in that software. But they only play in the US, and you do.
You can make it a part of the deal that you become their reseller for that software outside of the United States. So that way, you maintain some connection to those customers, the buyer and gain a continuing revenue stream. So it's much bigger than just the price.
Now, if it's a business that you want to get rid of, you never want to look back, and you will never have a tie to it ever again, then maybe just the headline price for the divestiture is most important.
And then, of course, you've got pricing, you've got the best home for the employees and the customers. And then finally, the certainty of closing and this is really important.
I throw it in at the end, but it is maybe in some regards the most important, because if you start a sale process, and you get very far down the road, and all your employees of this business know that you're looking to sell it, and then the buyer can't close or doesn't close, you're now that business is forever damaged.
You may lose all those employees. You got a big problem on your hands. So you want to make sure that you're dealing with a really serious buyer that can close and will close.