5 Signs Your Company Should Be Considering a Divestiture

Divestitures have received bad press over the years because of management hubris.

It’s well documented how hubristic managers splurge on value-destroying deals when business confidence is high, only for the buyer to later admit to their error in acquiring the assets.

The inevitable sale of the asset later on in the business cycle, often at a discount, only serves to perpetuate the negative image around divestitures.

It doesn’t have to be like this.

We at DealRoom help companies to divest and in this article we'll look at the signs you should be considering a divestiture.

What is a Divestiture?

‍A divestiture is the decision taken by management to sell one of the assets belonging to the business, be that a subsidiary, a factory or, as is increasingly common these days, the sale of intellectual property.

As with an acquisition, any divestiture should be a well-considered, value-generating transaction for your business.

And, as always, while there are specifics to each divestiture, the below offers a good roadmap to know when to divest an asset belonging to your company.

1. The asset is clearly overvalued

Every time there’s a hubristic buyer with money burning a hole in his pocket, there are owners of assets that stand to benefit from that manager’s next transaction.

The approach of any such manager is an ideal time to consider a divestiture.

As someone intimately familiar with your company’s immediate environment and prospects, you should have a better handle on the value than most outsiders and when they’re offering a price far above its intrinsic value, it’s time to consider a divestment.

It’s not just hubristic buyers, however.

Just as with other industry factors (see below), owners of assets will become aware of when certain assets are overvalued because of a shortage in the market or a current fad among investors.

When you can see the standard transaction multiple for a particular asset class rising every quarter, and prices are becoming detached from intrinsic value, it may be time to consider whether a divestment may generate long-term value for your company.

2. There are options available

What is a company if not a nexus of real options?

‍You have the option of holding onto the asset and benefitting from the future cash flow generated by that asset, or divesting it, and using the cash flow from the divestment to invest elsewhere in the business.

Naturally, this is easier said than done: the lag that comes with arranging transactions means that an asset that once looked attractive can lose its sparkle and an unattractive asset can later take on strategic importance.

In any case, it’s good management practice to stay vigilant about the options available to you.

Ask yourself, if you were to sell a performing asset tomorrow:

What would you do with the cash that you received from its divestiture?
Would that strategy generate more value for your company than by holding the asset would?

If the answer to this question is a convincing ‘yes’, it’s probably time you started looking at divesting the asset in question.

3. Industry factors

While there’s always an element of management decision making at the heart of a divestiture, outside factors will also play a part in the decision to divest of an asset.

For example, upcoming changes in regulation or lowering of trade barriers may convince a business owner that he can’t stay competitive in a certain segment in the long-term, making the decision to divest of an asset a straightforward one.

A prime example of this can be seen in Europe, where the recent EU-Mercosur trade deal means that pork and beef farmers in Latin America will have open access to the EU market for the first time.

With prices sometimes less than half that of European farmers, several large European food manufacturers must now be considering whether it’s time to divest their meat processing units before the market is saturated with cheap protein.

4. It doesn’t fit your business plan

At any given time, your company has a 5-year business plan which clearly lays out where you want your company to be 5 years from now.

Although this is subject to change, it provides a reference for where you should be at each point along the journey. Most business plans focus on acquisitions at the expense of divestitures, but this is an error.

Ideally, both should be considered in tandem in the business plan.

Including divestitures is a rational way of planning strategy for a business.

Large corporations rarely consider one without the other. Looked at from another perspective, one company’s acquisition is often just another’s divestment.

Often, this process is framed by thinking about ‘core’ and ‘non-core’ assets, where companies are constantly looking to move out of the latter to focus on the former.

And "How to Plan & Execute a Divestiture from HR's Perspectives".

5. It doesn’t fit your personal plan

As a business owner, you have to balance personal interests with those of the business.

That means looking at every investment or divestiture not just in terms of what it will do for the business, but how it will affect your own lifestyle.

Just as acquiring a subsidiary in a foreign country will likely mean that you’ll spend more time on business trips away from your family, so divesting a foreign business could do the opposite.

Of course, the effect that most divestitures will have on your personal life will be much less clear cut than the example given. But that’s all the more reason why you should think divestitures through.

Ask yourself with any asset if the business gain is worth the personal cost. Supporting local employment is a noble pursuit - but is it one which is being made at the expense of your family life?

It’s worth noting that any divestiture can most likely be recovered further down the line, so give ample consideration to the personal gain from divesting of an asset.