The sale of a business unit or division is often looked on as a last attempt to access capital when times are hard. With a solid divestment strategy, however, the disposal of assets can present an opportunity rather than a hasty solution.
A well planned divestment can, among other things, allow the parent business to focus on its core capabilities and free up capital for investment in other areas. It also allows the business to be ‘divestment ready’ should an unexpected opportunity present itself.
An effective divestment strategy in many ways mirrors an acquisition strategy. It involves looking at the core capabilities of the business and working towards strengthening these areas or removing areas that are not core to the primary business.
There are a number of key steps to consider when planning a successful divestment strategy as follows:
Step 1 – Establish the rationale
The divestment of a business unit is most often reactive. It occurs as a consequence of changing market conditions or a downturn in the business lifecycle. Consequently, the process is seldom systematic. Proactive divestments on the other hand tend to be more closely tied to the business’ long-term strategy.
There are many reasons why a business may choose to divest a business unit including:
- To allow the business to focus on its core capabilities or assets
- To obtain funding
- To access new opportunities
- To unleash a specific business unit and allow it the freedom to grow outside the parent business
- Because the business unit was a poor strategic fit
- Attracting and retaining staff in a more focussed business
The rationale for the business divestment will determine the nature of the divestment. For example, if the business wishes to obtain more funding, a trade sale or private equity sale may be most appropriate.
It is important to put a dedicated team in place to manage the divestment process and ensure that attention is not taken away from the core business.
Step 2 – Determine what is being sold and who your buyers are
Fit and value
Although it may seem to be common sense, determining which business units should be divested can often be a challenge. In tough economic times it can be tempting to off-load those business units that are underperforming. Business units should be tested for both fit and value.
To determine fit, management should ask if a unit contributes to the core capabilities of the business and if it is essential to the business’ long-term growth. To determine value, management should assess the unit’s performance and ask if the unit is worth more within the business than it would be outside the business. For a unit to be considered for divestment it should fail both of these tests.
Valuation as a stand-alone business
It’s important to determine which assets are included in a business unit, which may include products, services, systems (in particular IT systems), facilities and support services.
To attract serious buyers, the business unit must then be valued as a stand-alone business. This may require financial statements to be adjusted to account for costs shared by the parent company such as administration, finance and marketing costs.
It’s also important to consider if you are selling the business or shares in the company as this may have tax implications for the parent.
Appeal to buyers
When a business unit is underperforming or has been identified as a divestment candidate, it can be tempting to ‘milk’ the business unit by extracting the remaining value. This is a common mistake.
Buyers want to purchase assets that still have value. It is important to know the market including who the potential purchasers are. They may be competitors, suppliers, employees and/or private equity firms. Having identified your potential purchaser it is then possible to make a compelling case for buying the business unit.
Conducting vendor due diligence at this stage is advantageous as it provides verified, credible information on the business unit as a stand-alone business. It can also provide objective forecasts on when the purchaser is likely to realise value on the investment.
Be honest about the business unit’s weaknesses and outline steps that the purchaser should take to enhance its value. Providing the information upfront will save the purchaser a lot of hassle and can help close the deal.
Step 3 – Plan for the separation
A successful divestment lies in the planning. The complexity of the plan will depend largely on the level of integration of the business unit. Some of the key issues that an effective plan will take into account include:
- Forecasted costs – it is important to accurately forecast the costs associated with the divestment upfront and add some fat into the budget for unexpected costs
- Brands and patents – consider brands and patents early. The upfront cost of obtaining legal advice on how to deal with shared brands and patents can pale in comparison with the associated costs of legal action later down the track
- Shared services – carefully consider shared services between the unit and parent business. Both the seller and the purchaser must have a plan in place for providing these support services. It is not uncommon for the buyer to provide a Transitional Service Arrangement (TSA) for 6-12 months. This allows the purchaser time to set up the facilities and services required to support the acquisition
As a vendor, it is important to carefully assess the business’ ability to provide these services before entering into the agreement.
Stranded costs include people costs and property that are no longer required by the vendor following the divestment process. Planning for this may involve reassigning them to other parts of the business, disposing of further assets or implementing redundancies.
In developing a divestment function the human resources function will be key. A significant challenge lies in motivating employees to see the divestment through to completion when there will no longer be a role for them at the end of the exercise. An effective incentive plan based on completion targets can help keep staff motivated.
A divestment involves a number of moving parts which if not managed correctly can distract the management team from the core business. For assistance in developing a divestment strategy please contact your local William Buck advisor.