A divestment is when a company sells off an asset.
Businesses large and small do this for a variety of reasons. It’s more common than one might think: Between 2010 and 2018, there were more than 5,500 divestment deals worldwide with a combined value of $3.9 trillion, according to research by insurance brokerage Willis Towers Watson.
Let’s delve into why businesses divest, the types of divestitures, what you should know before divesting and how to do it.
Business Divestment as a Strategy
Divesting assets are most typically used to increase cash for operations or other acquisitions. Divesting also can be used to shed underperforming business segments or assets that are unlikely to turn acceptable profits.
Unless there is severe financial pressure that forces divestiture, divesting can be a strategic move to help companies expand and prosper in the long term. The capital might be used to create new business and product lines or expand an existing one.
According to a study by advisory company EY, 87% of companies say they plan to divest some assets by 2020. They cite reasons such as changing technology, tax policy changes and changes in customer expectations as key drivers.
Business Divestiture Examples
Divestment often refers to the sale of noncore business units, although it can be used to describe the sale of any asset. It can include entire businesses, individual product lines, services or property.
Here are a few of the more common reasons business divest:
Selling physical property or intellectual property.
Other businesses under the holding company’s umbrella may be ripe for divestment if it doesn’t fit in well with the company’s strategy or isn’t profitable.
- Underperforming Assets
A product or service line that isn’t performing well and doesn’t show potential for turning around is a key target for divesting. Shedding these assets can generate cash while eliminating the need to focus on product lines that don’t have long-term potential.
- Location Shutdown
If you have multiple locations, you know that they don’t all perform equally. It can be a difficult decision, but closing an unprofitable location may be necessary.
- Sale of Your Business
A business divestiture can also refer to selling your entire business.
Bankruptcy also may force the divestiture of assets to pay off creditors.
Types of Divestment
Divestment typically will involve a direct sale of assets, but it can include spinoffs and equity carve-outs.
Direct sales are just what they sound like: Assets are sold outright. Sellers realize gains or losses and may be liable for taxes on any profits realized.
Spinoffs are noncash and tax-free transactions. A parent company might distribute shares of a subsidiary to shareholders. The subsidiary then becomes a stand-alone company. Shares of the subsidiary can be sold as a separate entity.
Under an equity carve-out, the parent company would sell a percentage of its equity in a subsidiary through a public offering. Equity carve-outs are tax-free because they trade cash for shares in the company.
What to Consider Before Divesting
- Weigh the Long-Term Potential: Selling an asset for cash to solve an immediate problem or shortfall might be necessary, but it’s crucial to consider the long-term potential of losing that asset forever. Take any divestment seriously and give it the attention it deserves.
- Choose What to Sell and When to Sell it Wisely: Getting rid of the wrong assets or divesting the right assets but at the wrong time can cause problems. Unless you are being forced into bankruptcy, take the time to decide what to divest and when is the right time to do it.
- Look for Liquid Assets: The easiest assets to divest are those that are most liquid. When you are examining your balance sheet, look for current assets. These include cash, cash equivalents, accounts receivable, and other items that can be converted to cash in short order.
- Know the ROI: Most businesses first divest assets that aren’t income-producing or are losing money. Analyze the return on investment (ROI) of each of your assets. If they’re losing money, you’re only going to go backward. If they are break-even or better, hold onto them if possible.
- Look at the Margins: Higher margin items are likely more valuable as they produce more income on smaller expenses. Measuring gross profit to sales volume (gross profit margin) can show you the better-performing assets.
- Review the Life Cycle of Your Product: This should play a role in your decision. Almost all products have a unique life cycle — from start to growth, to maturity to decline. When a product is in the mature phase, it may be ripe for divestment before the decline begins.
Companies need to look at the impact on key personnel and employees when looking at divestments. Employees may share duties across work units, which may be disrupted if one of the businesses is sold off. Also, key executives may be tied up handling divestment at the same time they are trying to run the rest of the business.
The Differences Between Divestment, Liquidation and Bankruptcy
Although the terms often are used interchangeably, each has its own definition and applies to specific situations:
In divestment, assets are sold to make strategic investments elsewhere or to pay off debt. In liquidation, a company sells off all of its assets and closes its doors.
Liquidation most frequently when companies are insolvent. In other words, they are unable to pay its obligations when they are due and may not be able to refinance or restructure their debt. Assets are sold, creditors and shareholders are paid based on priority and the company is dissolved.
There are several different types of bankruptcy filings, but the two most common are Chapter 7 (Liquidation Bankruptcy) and Chapter 11 (Reorganization)
In Chapter 7 bankruptcy, a company is liquidated. A trustee is appointed by a bankruptcy court. All the assets are sold, and the proceeds are distributed to creditors. The business is closed. Business owners are released from future debt obligations in most situations.
In Chapter 11 reorganization, the company will continue to operate under the guidance of a court-appointed trustee. Creditors must vote to accept the reorganization plan and may elect to defer payments over time. A business may have to divest some of its assets to stay in operation or satisfy creditor demands.
How to Divest a Business
There are 7 steps that businesses typically put in action as part of their analysis, planning, and sale of assets.
Step 1: Portfolio Assessment
The first step is to evaluate the current portfolio and identify candidates for divesting. It means making an honest assessment of business assets and their long-term potential.
Step 2: Divestiture Planning
Once assets have been identified, companies must get formal approval through their governance requirements. At this stage, a divestiture team is created, steps are taken to retain key employees and an action plan is developed.
Step 3: Preparation
Planning is undertaken to mobile the resources necessary to separate the business or assets from the company. Internal and external resources are engaged to handle the selling process.
Step 4: Buyer Identification
Identifying buyers is a crucial step to the divestiture process. Getting the requisite value associated with the asset you are selling needs to exceed the opportunity cost of keeping the asset.
Step 5: Execution
The company will make its intent to sell known to potential buyers, negotiate a sales agreement and close the transaction.
Step 6: Transition
The company will then transition the business or assets to its new owners. Depending on the type of transaction and the agreements made, companies may need to provide services to the acquiring company during this transition period.
Step 7: Post-Transition
After a successful divestment, the company will then decide what to do with the capital from the sale. Companies may decide to pay down debt, pursue new businesses or lines of business or expand existing businesses.
Downsizing and Divesting an Older Business
Weak businesses can take up a lot of management time and resources. As companies age, they often find that certain product lines, business assets, or even the business itself are no longer delivering the ROI that’s needed. Divesting is a strategic way to free up cash and resources for other uses, reduce debt, or to increase overall profit margins.