Why Does a Company Divest?
There are many reasons why a company may choose to divest its assets. It can be the case that the asset is no longer a core business, or the seller may be facing new regulatory compliance requirements and needs to divest the asset.
The other reasons may involve cases where the seller may be looking to raise capital and reduce debt, or situations where the seller needs to stop cutting the lost.
How Does a Company Decide to Divest?
The most common divestiture challenges that I have encountered are to identify and agree on divestiture candidates. It could be assets, liabilities or both and there should be an agreement between the corporate business and a divestiture candidate.
There needs to be a clear expectation of what I call the guiding principle - What are we selling and what is our seller’s post-close commitment?
Another challenge a seller should consider are buyer dependencies, especially financial and operation enablement capabilities and capacities. For a large, strategic seller, a challenge can also be their lack of flexibility and open-mindedness regarding divestiture.
Divestiture can be new territory for them and while they may have a very robust integration M&A process in place, divestiture can be a challenge simply because it is a different breed and needs to be dealt with accordingly.
The original methodology regarding pre and post activities are very important to consider. The key to divestiture is to be flexible and agile. Finally, it is important to know how to handle the buyer’s demands before, during and after the close.
The seller needs to know when to say no, whether to post-close activities, such as restructuring the business, which is affecting their capability to divest their assets quickly and according to an agreed schedule, or the customer reaction or impact.
Benefits of Divestitures
The benefits are cutting the loss, raising the capital or reducing the debt and reducing the risk of regulatory compliance, focusing on the core, strategic business.
Advice for Companies Considering to Divest Assets
My main advice is to be prepared to answer questions such as
- What am I selling?
- How and I planning to sell it?
- How am I going to package a deal?
- Who is my target buyer?
There needs to be a roadmap set going forward with the divestiture journey. When thinking about the potential acquirers of the company, there is a mixture of working with outside counsel and making inside decisions. There are the outside counsel and the investment banker, but you also get to do your own homework in order to see which one is the best fit.
When a Bank Comes Into the Divestiture Process
There is necessary homework that needs to be done within internal company to identify assets, package them the way you would like to put them in front of the buyer and the adviser is there to help you with all aspects of this process, whether there is a legal aspect, a regulatory compliance aspect or financial aspect.
The advisor needs to come early on, as soon as possible in order to help with packaging the deal.
Common Divestiture Challenges
When it comes to identifying the divestiture candidate, there should be an agreement between the corporate deal team and a clear set of expectations or guiding principles regarding all aspects of the selling process.
Post close from a buyer perspective is another area where challenges arise. It is important to consider their financial ability and answer questions such as
- Are they able to close the deal?
- What is their operation enablement regarding matters such as private equity?
Some don’t have operational enablement capabilities, especially with a global footprint. Some are very good, and with some, you need to help them set expectations upfront.
Another challenge, especially for the larger, strategic sellers is that they follow a very rigid methodology and aren’t very flexible. They think about strategy, divestiture, execution as a kind of like reversed M&A integration, which it is not.
The rigid methodology will just hamper their activities for pre and post-close matters.
Examples of Buyer Dependencies and Demands
Buyer dependencies are very critical because once you close the deal there is a lot of business enablement that has to be in place and there is a lot going on behind this enablement, regarding procurement, payment, and payroll. The buyer has to be extremely capable to enable these possibilities.
Difference Between Acquisitions and Divestitures
If the question is are divestitures reversed acquisitions, the short answer is no, and here is why.
The buyer influences the structure of the deal, they may negotiate and select the asset liabilities. The seller, on the other side, should have a walk away guidance, such as post-close commitment capture within the TSA or transition service. The buyer may select to restructure the business after the close and therefore impact employee contracts.
With an acquisition, you buy the asset, liability or business and there is a road map and a business plan if required to integrate. However, with divestitures, there are many variables that are impacting the deal, including restructuring the business after the close, where the seller may be stuck doing some of these activities for the buyer.
The focus of M&A integration is mainly to go to market, whereas with the divestiture, the focus should be on the business continuity, customers and employe contractors.
Last, but not the least, within M&A there is no transition service agreement, the agreement between the buyer and seller where the transition service agreement is conducting business on behalf of the buyer and transfers the economic benefit to the buyer for a certain period of time.
Buyer Compatibility Matrix
The buyer compatibility matrix provides vital information about the potential buyer, their capabilities and their fitness. The first step is to identify the buyer type, examine their financial ability and study the baseline analysis. Within the baseline analysis, we are looking at three aspects.
- One is the commercial operations, which include capabilities around sales, marketing, management, supply change product marketing and other elements.
- The second aspect is related to activities regarding offloading and the last one is the issuer services, which are all activities related to legal finance, tax, legal entity, IT footprint, capabilities, and resources.
- The other piece of compatibility matrix is regarding the level of integration and the main question here is what is the level of disintegrating of divested assets from the seller. Another important thing to consider is cultural compatibility, as it ensures business continuity and so is the synergy.
Divestiture Buyers Type
There are two main types of buyers in the marketplace and these are strategic buyers and investment institutions, including the private equity buyer so the seller should be prepared in advance to interact with these buyers.
Strategic buyers are likely to have existing infrastructure and with this type, there is a chance for potential antitrust scrutiny. They may not consider upfront investment because they have these infrastructures in place, so there is no need to build new supply.
On the other hand, investment institutions, including private equity, are less likely to have existing infrastructure in place for the asset that is being sold to them, so a lot depends on what is this asset and what infrastructure comes with it. There is less chance for antitrust risk when it comes to this type of buyer and in this case, it is wise to consider upfront investment and cash flow. There is a need for longer separation post-close, as in most cases with private equity building from scratch and filling large gaps is inevitable.
Divestiture Types and Structures
There are different transaction types and divestiture structures.
- The seller may consider asset sales, which include selling assets, liabilities or both. In this instance, they may offer to sell just IP, real estate or contracts.
- Another type of divestiture is asset and entity sales or entity sales, which is the case where what’s being sold is a legal entity, assets, and liabilities within a legal entity. The legal entity has a legal capacity for entering into legal agreements or contracts, assume obligations and pay debts, and within this category, it is important to understand legal entities and footprint.
- The last category is the carve-outs, which effectively separates a subsidiary or business unit from its parent company as a standalone company, where the parent company usually retains a controlling interest. It requires an upfront investment in order to set up legal entities, especially if there is a large global footprint within that divestiture, as well as necessary time and resources.
Essentially, there are two types of carve-outs.
- The first one is the equity carve-out, when a business sells shares in a business unit, or the business that’s been divested, where a company has some control over the business unit.
- The second type is when the company divests a business unit by making the B.U. it’s own standalone company, where the company does distribution of the shareholders for all stocks and subsidiaries. The parenting company, in this case, may have an interest in the spinoff and is usually doing a good job supporting them to be successful.
The Most Common and Easiest Types of Transactions
The answer to this question is not that simple.
For the seller who just wants to sell their assets, the quickest and the cheapest way would be to do their own asset sales or choose asset sales with entity sales, while avoiding legal entity enablement and making sure the buyer can handle what comes after the close.
The cleanest way is the carve-outs, but unfortunately, with carve-outs, the seller has to pay to enable carve buffs, as there is a necessity to carve out the entity, establish a new entity and enable these entities.
Typical Divestiture Timeline
I have been involved with small divestitures where there is the time needed to start looking at their PNL, make sure they are meeting the criteria to be divested, get to the buyer, do due diligence, close and do a small transition service, so this process usually takes between three to twelve or sixteen months.
When it comes to a larger acquisition, a larger divestiture, the process can last from eighteen months up to three years.
When it comes to the price, there needs to be some flexibility, but it is important to establish the last price, the price that the buyer will not go below.
Negotiating Transaction Service Agreements
The TSA is going to be driven by the type of a buyer, the commitment that the buyer has after the close and also the commitment from the seller to their customers and employees.
I would say that when it comes to TSA, a seller needs to think about the guiding principles and makes sure those principles are provided to a deal team in order to make sure what their commitment exactly is. Whether there is a service TSA, an improved TSA, contract TSA or engineering TSA, all of these agreements create an obligation for the seller when going through a divestiture.
Structuring a Divestiture Team
Usually, in the beginning, there is the in-scope executive, the carve-out deal team and the carve-out finance team working together on the deal. Gradually, they bring in the council such as marketing or executive sales professionals who are in charge of the equity markets, as well as H.R. That is the starting point to understanding whether or not the assets good candidates for divesting.
Once they get a confirmation from the corporate executive that assets are something to consider and an agreement to sell a division or a part of the division, that it’s time for a corporate development team and the separation management office, which is pretty much the operation team to join in.
They will then dive into the details of the structure of enablement, capabilities, and operation and deal with integration and disintegration matters.
In the end, the focus will be on collaboration between the deal team, in-scope executive and employee and suppression management office.
Listen and Subscribe to the M&A Science Podcast
Now available on Spotify
DealRoom is a secure, cloud-based M&A due diligence management platform that replaces overpriced data rooms, email clutter and manual spreadsheet trackers.