Divestment is a form of retrenchment strategy used by businesses when they downsize the scope of their business activities. Divestment usually involves eliminating a portion of a business. Firms may elect to sell, close, or spin-off a strategic business unit, major operating division, or product line.
What is Divesting Strategy?
Divesting is a word that originates from the Latin word divesting meaning ‘to take away’. In a business context, divestment is the process of selling off companies that are not part of the companies core business.
Divestment Strategy is best employed when an organization or a business firm decides to pull out from a particular business activity or market. It is a way of reducing the company’s business scope.
The decision to divest should be taken by weighing all the pros and cons of staying in the business.
However, organization has to take extra caution while implementing the strategy of divesting. The potential risks involved while divesting are-
- A reduction in profitability.
- Decline in company’s value.
- Loss of reputation.
- Loss of customer base.
- Loss of skilled or professional employees.
- Exposure to legal challenges due to bad or wrong method.
- Companies may also hold equity in each other or in a parent company.
Next to divest and selling, spin-off is another form of divesting process. In this process, company spin-off an operating division and make it into a separate business entity, which is independent to the original business firm.
Under divestment strategy, a company can either spin off or merge a business activity or division with a strategic business partner.
Merging of two related businesses into a single entity is known as acquisition. In this process, both businesses are merged together and operate under the same management.
Difference Between Spin-Off, Divestment and Acquisition
Divestment, spin-off and acquisition are the three popular forms of corporate restructuring.They are used by many firms for a variety of reasons. The main difference between these three corporate restructuring tools is the intent.
In case of divestment, the firm does not view the asset or business in a long-term perspective. The primary focus is to take the strategic asset off the firm’s balance sheet. The asset or the business may be sold and rebranded or given to another company to manage.
Once the asset is sold, divesting firm has no intention or desire to use the business in future. It is completely unimportant for the divesting firm if the business is sold at a profit or loss.
A spin-off is a process involving separation of a business from its parent firm. The focus of the spin-off is to run the business independently, not to sell.
Usually, a parent firm creates a new business entity, which operates with its own management. This new entity is called a spin-off company. Sometimes, existing managers of the company serve the new spin-off company.
Spin-off offers the parent firm a way of raising funds. They raise funds by selling part of their firm, rather than selling the entire company as whole.
The parent firm views a target firm as an essential part of their business. The firm uses this tool to acquire a smaller and more successful company.
The acquiring firm is looking for growth by doing complementary business. A firm acquires another firm to gain a new technology, develop new markets or produce a new product.
Divestment Strategy Procedure
The decision to divest or to sell a business activity or division involves several steps.
Step 1: Prepare a divestment strategy document
Prepare a document which details the different reasons for major business changes as part of the divestment strategy. This document must explain the factors which prompted the decision to divest.
The document must include background information related to the decision to divest. It should include reasons for divesting from the market. It must indicate the advantages which will be achieved by divesting from the market.
Step 2: Consider the market
After the business has decided to divest, the firm should estimate the demand of key customers, suppliers, and employees.
The firm should also estimate the market share and the financial assets and liabilities. If the business is divesting a specific business unit, the firm should consider the market position of the business unit.
Step 3: Identify potential buyers
Once the firm is ready to divest a business activity, it is time to choose a potential buyer.
The parent firm should compile a list of potential buyers with the help of investment bankers. The list must contain the names of companies, which have the resources to buy the business unit.
The list should also include companies, which would be interested to purchase the business. Potential buyers may include competitors, foreign firms, or private equity firms.
Step 4: Make an offer
Once the potential buyers are identified, the parent firm should contact each of them to determine their interest in the business.
Firms usually come up with a selling price, which reflects the true value of the business unit. The parent firm should then call a meeting of the potential buyers to make them an offer.
The parent firm must determine the process and system by which changes will occur. The parent firm should decide whether the business unit will remain under the control of the parent.
The firm should also decide whether the former business unit will continue to operate under its original name. The parent firm should determine the conditions under which the buyer will take over the asset.
The parent firm should decide the length and duration of the time between the offer and the final date for the transfer of assets. The parent firm should decide whether the business unit will continue to operate until the transfer of assets.
The parent firm must decide the impact on the legal responsibilities and liabilities of the business.
Step 5: Construct a divestment contract
The parent firm should construct a divestment contract, which contains the main terms and conditions for the sale. The contract should contain the following terms and conditions.
The business firm’s name, which is to be divested. The product or service offered by the divested business.
The identity of the buyer and the parent firm. The selling price and the amount for which the business is being sold. The marketing and sales plan for the business.
Obligations of the parent company and the buyer. Conditions of the merger. Redevelopment plan for the business unit.
The time at which the asset is transferred.
Step 6: Conclusion
By the end of step 6, the parent firm must decide the conditions, which need to be fulfilled, in order to proceed with the divestment. When these conditions are fulfilled, the process of divestment can take place.
What is an Acquisition Strategy?
Acquisitions strategy is a tool of corporate finance which refers to the process of acquiring one company by another for the purpose of achieving synergies and economies of scale.Acquisitions strategy involves purchasing ownership of an entire firm or a portion of it.
Why Acquire Companies
Acquisition strategy is significant for firms which want to gain more market share, grow in size to compete in a saturated market, increase their market power or prevent firms from gaining market power.
Firms will use acquisition strategy to enter into a new market or buy from a new supplier. Acquisition strategy can be used to reduce their costs by merging existing operations that do not produce at optimal levels.
Firms may also use acquisition strategy to gain advanced technology in order to enhance their competitive advantage.
Example of an Acquisition Strategy
Salesforce.com uses acquisition strategy to buy firms or business units which have the potential to add to Salesforce.com’s existing businesses.
Acquisitions Strategy Elements
When using an acquisition strategy, the targeted firm will consider three main elements.
The target firm must answer the following questions. Why and when to acquire other firms? What will the firm buy? What will the firm sell?
Selection of Market
The firm must choose which firms or business units to acquire in order to gain greater market share.
There is a three-fold process of picking the right target firms.
The firm identifies firms which have the potential to be bought out or merged in order to achieve synergies. The firm must assess whether the target firm fits into the firm’s portfolio strategy. The firm must determine whether the target firm is underpriced or undervalued.
The firm must weigh out the risks of the merger, such as whether the target firm’s business will be compatible with the firm.
How to Identify Targets
The firm must choose how to identify targets. The firm will need to consider some or all of the following methods.
The firm may use trade associations. The firm may use the internet. The firm may use investment bankers or financial advisors. The acquisition strategy can be successful if the appropriate target is found.
Selection of Buyer
The firm must determine the buyer, who has the best resources and skills to buy the target firm.
The firm will consider the following factors.
The financial resources of the firm to buy the firm. The firm’s experience in buying firms in the same industry. The management’s experience with acquisitions of the same size and scope. The management’s reputation for successful mergers and acquisitions.
The firm must make sure that the firm and the target are a good match, such as whether they had a history of successful mergers and acquisitions.
Step 1: Introduction
In the introduction stage of the process, the firm should introduce themselves to the target firm. The firm must identify the type of merger which they wish to achieve.
The firm must state their acquisition strategy clearly in the introductory letter. This will allow the buyer and the target to decide whether the merger would benefit both parties.
Some key concerns of target firm managers would be how the merger will affect the firm. Will the merger make the firm and the target firm stronger or weaker?
Step 2: Negotiation
In the next stage, the firm will attempt to negotiate the components of the deal, while keeping up a business-like relationship. The negotiations will be conducted by a member of the firm’s senior management team.
The potential buyer may offer or withdraw the deal during this stage. The purchase price for the target firm is subject to negotiation.
Step 3: Evaluation
During the evaluation stage, the target firm can review the terms and conditions of the acquisition.
The target firm can make the decision to acquire or decline the offer. If the firm who made the offer, accepts the target firm’s decision, the stage ends.
If the target firm wishes to extend the negotiations, the stage will proceed to the next step. If the target firm accepts the firm’s offer and both parties sign the contract, the acquisition strategy is completed.
If the target firm wishes to continue to negotiate, the firm must make several decisions. Will the firm offer another form of compensation to sweeten the deal and acquire the target firm?
Will the firm wait a longer time, before counter-offering on price again? If the negotiations continue, the original proposal will be on the table.
Step 4: Implementation
If all the terms and conditions have been agreed upon, the deal can proceed to the next stage. The target firm may merge with the buying firm or the firm may buy a portion of the target firm.
The firm must decide whether the target firm will continue to operate under its current name or acquire another name. The firm must also decide whether the target firm will retain both its staff and its management.
Step 5: Conclusion
The final stage of an acquisition strategy is the conclusion of the deal. The firm must decide the conditions under which the deal will go through. The value of the deal and the date on which the deal will go through.
Problems Which May and Will Occur
There are several problems which may and will occur during the deal. The firm may run out of money to complete the deal. The firm may run out of cash flow and liquid assets.
The firm might be over-committed at the negotiation stage and fail to make the acquisition. The firm may lose the prospective target during due diligence.
The firm may fail to find a buyer for a key component of the target firm. The firm must decide how to proceed if the deal is found to be non-viable.
The firm must decide how to proceed if financial markets change in between the negotiating stage and the final stage. Is the firm still interested in the deal?
How to Minimize Failure of the Acquisition Strategy
The firm can minimize the potential of failure by following several steps.
The firm can request a letter for approval from the target firm’s Board of Directors. The firm can request the approval of the target firm’s shareholders.
The firm can do due diligence to check the target firm’s financial position, balance sheet and profit and loss account. The firm can also request a letter from the target firm’s existing bankers. If the firm has a history of making acquisitions, other firms in the same industry may recommend the firm to their contacts.
The firm can provide incentives for the target firm to acquire their own firm. The target firm is likely to approve the deal, if management feels that the offer is attractive.