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A Complete Guide to Divestiture Strategy

Companies may pursue a divestment strategy to refocus on their core business, in response to the operating environment in their industry or to release underperforming assets. Companies typically pursue a liquidation strategy when their core business, business line or subsidiary has failed or no longer serves the owners’ purpose. Divestitures involve a sale, spinoff or liquidation of a business unit, line or subsidiary. Liquidation involves shutting down a business and selling off or distributing its assets.

What is Divestiture Strategy?

According to Investopedia and FTSE Williams Divestiture strategy is

“A strategy that takes advantage of the opportunity to exit a business unit, business line or subsidiary that is not part of the company’s core business or strategic goals.”

“Divestiture is the process of selling or spinning off an asset from a larger company. It can be a way for a business to exit a business line or unit that is not part of the core business, such as a media company exiting its book publishing division. It can also be a means of selling off an asset, such as a liquidating a business with a view to improving profitability by eliminating overhead (“fix and sell”). Often, the value of the subsidiary business justifies a price that is higher than the price to be received for the corresponding assets in a liquidation.”

Top reasons to pursue a divestiture strategy

  1. Time for a Re-Focus

Some companies have gone through an extensive period of growth and acquisition, with no well-defined vision or strategy. These companies are often burdened with an unnecessarily complex organizational structure, business processes and a heavy debt burden. To regain focus on their core competencies and better position themselves for profitable growth, companies often choose to divest of non-core products, services and businesses and better manage their debt payments and cash flows.

  1. How do you divest of a business?

To set up a divestiture strategy, the company must be clear about its strategy: why, what, when, the target buyers and the strategy to maximize shareholder value (including the price to be paid for the assets). The company’s board of directors must take a clear decision to divest the business unit before approaching potential buyers.

A board of directors with clear objectives and process will make sure that all interested buyers have some key information about the divestiture. Having this information in place also makes the bidding process fair for all interested parties willing to buy the business unit.

There are many alternatives to help you implement your divestiture strategy, including:

  • Sale
  • Leaseback
  • Management buyout
  • Asset sale

Lease-back, spin-off and spin-out are strategies in which a company creates a new business entity and leases or lends the business’s assets to the new entity, which then takes control of the business and its assets. The company’s existing business processes and operations can be separated into two parts – the core business and the non-core business or assets being unbundled or divested. Finally, the company may spin off or spin out the non-core business as a new independent company or corporation. The steps in any of these strategies may be combined to create a hybrid approach that gives the company the right mix of divestiture options.

Sale

In a merger or acquisition, the company is bought by another company or business. If the other party offers a fair price for the assets or operations, then the sale is favorable for the company.

Leaseback

In a leaseback, the company leases back to the business the leased assets that it owns and then enters into a new lease with the business for those assets. The assets then become the responsibility of the business, while the parent company keeps the cash flows from the assets. Under the leaseback, the parent company could also continue using the business operations or assets in exchange for a fee.

Management Buyout

In a management buyout, the company’s existing management, or an outside firm, or current and former managers, buy the company. The management buys the assets of the company through loans or generally with their own funds or funds they solicit from third-party investors. These funds could include both equity and debt.

Asset Sale

An asset sale involves the transfer of assets, a piece of business or a subsidiary to a third party. An asset sale can also be a part of a larger divestiture strategy.

These are more complex compared to other strategies and if you want to learn more about this strategy you can check the FTSE Williams website.

Benefits of Divestiture

For the company:

Currency: By divesting the company will be able to focus its energies and resources on its core business.

Cash flow: The company will be able to improve the cash flow.

Efficiency: The company will need to manage fewer business processes, assets and employees.

For the shareholders:

Enhances shareholder value: Divestiture maximizes the value of assets by enabling the company to remove the non-core business or asset from its balance sheet.

Makes funds available: The company gains freedom of cash flow and funds to finance growth, reinvest in itself or pay off its debt.

Negative aspects

There are a number of issues to address before you decide to take the plunge into divestiture:

Internal support. The directors and shareholders must fully support a divestiture strategy.

Uncertain future. Divestitures often involve a change in business direction; as a result, there may be uncertainty fit the sale of an asset or a transfer of operations.

Compete head-to-head. Sometimes, the company must compete with other interested parties, each of which is eager to acquire the business unit or asset.

Hidden costs. The company may incur costs in moving personnel, realigning or revitalizing the company and its leadership team, rewriting business processes, restructuring its debt, selling or leasing premises, and shedding or outsourcing equipment and other assets.

Inflammatory issue. An internal or external factor could create an inflammatory situation that critics could use to attack the board’s decisions or even its integrity.

Startup cost. The company may have to invest funds or incur expenses in setting up a new business unit to house the divested business.

Non-core business. The company may not want to keep the non-core business in its portfolio or it may not be able to find a buyer for the business, which could lead to a loss of shareholder value.

If you have read this far you are probably quite serious about going down the divested road. But let me tell you that it is not for the faint hearted. To successfully divest you need a clear strategy, time, patience, financial resources and good advisers. Most of all you need to be patient as this is not a decision to be rushed.

Good instincts and a solid business plan is going to be the key to your success or failure. If you do not have the patience then trust someone who does. If you can’t, then it may be prudent to hire a professional to guide you through the process.

The biggest hurdle facing a company is often their own directors and the shareholders. They can roadblock the process, so make sure you have a plan of action and address their concerns.

Once you believe your company is ready to consider divestiture, you should start the process by developing a comprehensive strategy and work plan. This strategy includes the guiding principles and objectives for the divestiture process, along with the key decisions, critical milestones, main risks, and the key elements for success.

In addition to developing a strategy, you should have a clear set of objectives for your divestiture.

In the final analysis remember that you can’t do it yourself! So don’t attempt this procedure without the appropriate experience. In the past few years the international financial markets have seen numerous asset sales where a clear strategy has been missing. You will never make mistakes if you simplify your business.

Guiding Principles

  • The Leaders of the Corporate Divestiture Should Have a Plan and a Clear Objectives for the Divestiture
  • They Should be Objective in Deciding whether the Divestiture solves a Problem or Solves a Problem in a Favourable Way
  • They Should Have a Clear Picture of the Strategy to be Pursued in the Deal
  • They should have a successful track record of having worked on a divestiture of a similar nature
  • They Should be Highly Motivated and Committed to the Deal being successful
  • They Should Have the Ability to Explain the Problems which led the Company to Divestiture
  • They Should have the Ability to Present a Solution to the Current Problem
  • They Should be Able to Present an Explanation of the Benefits of the Divestiture
  • They Should Work Closely with the Legal Advisers Involved in the Deal
  • They Should Ensure that there Is a Mutual Understanding between The Selling and Buying Companies

Corporate Divestitures can Accomplish the Following Goals

  • Protect the Company’s Revenues
  • Allow the Company to Focus more Effectively on its Core Businesses
  • Result in the Company Having Greater Valuation of its Stock
  • They Can Improve the Cash Flow and per share Profits of the Company.
  • Allow for a More Flexible Structure of the Company
  • Divestiture can Solve the Following Problems.
  • Problem of Too Many Products and Services
  • Problem of Bloated Shareholder Equity
  • Problem of Insufficient Management Talent
  • Problem of Excessive Debt
  • Problem of Expanding Into a New Business or Area that is Not Supported by the Company’s Core Strength
  • Sell Assets That Are Mismanaged, Under Management, or Assets Which are Not Profitable or Assets Which are Not in the Company’s Best Interest
  • Sell Assets That Are Not in the Company’s Line of Business or are Not of Interest of the Company’s Core Business Activity

Asset Divestitures Can be Done for the Following Reasons.

  • To Protect Company’s Revenues
  • Close Underperforming Businesses
  • Sell Off Assets Which are not Profitable or Not of Interest to the Company’s Operations or to its Core Business Activity
  • Devote Resources and Energy to Their Core Business
  • Sell the Assets that are Not in their Line or Business
  • Sell Assets Which are the Result of a Merger or Acquisition.

In summary, Divestitures are crucial to a company’s growth and development. They are a case of choose the past or invest in the future. The sale of divested business assets provides the company with cash. Some companies go on to create new businesses that have higher barriers to entry making it difficult for new competitors to enter the market and the company gets new products and or services to escape commoditization of its old business.

The benefit of divestiture increases as the new business has higher barriers to entry and has early mover advantage. This advantage retards entry of competitors by making it expensive for them to do so. In the long run, the acquisition of new businesses and products can better ward off the competitors who want to capture your existing market.

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