Strategic Divestitures: Leveraging Non-Core Assets For Optimizing the Company

Strategic divestitures are a practical approach for leveraging a business’s non-core assets. The company can sell or separate a section of its assets, which may include a service, property, product line, or separate business unit.

Strategic divestitures are an excellent strategy for monetizing non-performing assets to raise funding for their other operations. Companies may use the funds to pay off debts, restructure the business, or invest the proceeds in other value-adding channels.

Divestitures work to capitalize on assets the company is not utilizing. These assets could be obsolete or unused in the current operations because of a strategic pivot. If not an actual sale, companies may also lease the assets.

Raising Funding from Divestitures Is a Viable Option

Divesting assets is a great solution for companies going through economic uncertainty. Statistics indicate that divestitures comprise an average of 2% to the aggregate value creation during an M&A deal. This 2% translates into an increase in value of around $149M.

Businesses across the US are quickly recognizing this strategy. Close to 460 strategic divestitures took place in the third quarter of 2023 and have risen to 512 by the fourth quarter. If you were to focus on the value, 21% of the deal volumes in the latter period were valued at an astonishing $1B+.

And that’s not all. Companies executing divestiture deals valued at between $500M and $1B are likely to have a higher TSR rate. This TSR or Total Shareholder Return is the returns investors can earn after buying a particular stock. By divesting assets, companies can laser focus on their core products.

As a result, they are able to generate a higher cash flow after selling off the non-performing assets. A company that successfully divests unwanted assets will undoubtedly take on less debt. Rolling back the sales proceeds into its operations can potentially earn higher profits and scale quickly.

This approach allows for higher valuation when the business is ready to pitch for funding in the open market. Divestitures enhance its financial position and boost performance thanks to the infusion of cash, free of interest or other obligations.

Why Strategic Divestitures Take Place

A strategic divestiture is the disposal of a company’s assets or business units in part or whole. The sale achieves a specific objective, such as liquid cash to invest in operations. Founders may also negotiate deals to swap fixed or tangible assets like real estate, business subsidiaries, or units.

Aside from fixed assets, divestitures may involve deals driven by acquiring or divesting intellectual property, intangible assets, or exploration rights.

Strategic divestitures are often considered the reverse of acquisitions. That’s because a parent company may identify a particular unit or subsidy that is no longer performing to its full potential. Or if the unit no longer aligns with the parent’s core corporate strategy.

Liquidating the asset allows the parent company to cut back on the costs, personnel, and bandwidth it may be investing. It can divert this liquidity toward developing new product lines to maintain its competitive edge in the market.

Retaining focus on the main company’s core mission statement helps streamline operations for higher profit generation and shareholder value. At times, strategic divestitures are also the result of a court-ordered mandate.

The Federal Trade Commission may direct a corporation to divest or sell a business asset. The sale leads to the creation of a separate competing entity in keeping with the FTC’s anti-trust laws. That’s how it ensures the prevention of unfair and monopolistic practices.

Divesting a subsidiary unit or a recent acquisition in an overseas location or across state lines can sometimes become crucial. This move allows the parent company to pull out of a geographical area.

A timely sale could minimize the risk of substantial losses if the local culture, customs, and laws are misaligned with the parent’s policies.

Understanding the Different Types of Divestitures

Divestitures can be of different types depending on the selling company’s objectives.

Spin-offs

A spin-off sale takes place when the company liquidates a specific division or department, perhaps in response to regulatory compliance. The division then continues to operate as an independent entity.

The parent company’s existing shareholders receive shares in the new company. However, the parent company maintains its identity and continues operating as before.

Sell-Offs

In a sell-off divestiture, the owner company divests or sells the unit for cash or cash equivalents to another company. The parent company remains in existence, but the sold unit operates per its buyer’s objectives and policies.

Split-offs

A split-off divestiture is similar to a spin-off sale but with a key difference. Shareholders have the option to retain their shares in the parent company or receive shares in the newly formed company. This new unit will function independently, potentially earning profits and appreciating its share value.

Carve-outs

A carve-out divestiture involves the parent company separating a portion of its core operations. This portion goes through an IPO and brings in a new pool of shareholders and fresh investment from the market. The new company is essentially a subsidiary, which is legally an independent entity.

Although both the parent and subsidiary operate as separate entities, the parent maintains full control and management rights and equity.

Split-ups

Split-ups occur when a corporate giant splits into multiple smaller companies, retaining a portion of the main company’s operations. The original brand ceases to exist entirely.

Liquidation or Bankruptcy

This type of strategic divestiture involves selling off the company’s assets and properties entirely. The company effectively goes out of business, using the proceeds from the sales to pay off debts and other obligations. Post-bankruptcy, it no longer remains in existence.

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How to Execute Strategic Divestitures

A careful step-by-step plan is advisable to maximize value from strategic divestitures. Founders must create a detailed roadmap by consulting key advisors from the different departments across the organization.

These departments include legal, finance and accounting, advertising and marketing, product ideation and development, and operation management. Each team member will contribute valuable insights into maximizing the asset’s value. Here’s how to execute the sale:

Identify the Asset and its Scope

When creating a list of non-core assets that the company can liquidate, it’s imperative to define the assets entirely. Also, define its scope and dimensions, mainly if the asset is a part of the shared resources between the different departments.

For instance, the non-operational assets are real estate, equipment, unsold inventory, dormant IPs, or underutilized warehouse or office space. A detailed audit can list the assets and their current status and usability. Next, the audit identifies the peripheral assets that must accompany the core asset.

To cite an example, the company intends to sell a computer hardware manufacturing unit. In that case, it should be clear whether drivers and software are a part of the deal. Or if the package will include acquihires, skill sets, human resources, and services like after-sales maintenance.

Prepping the Asset for Sale

Once the particular assets are earmarked for strategic divestitures, the parent company must create a timeline and assign a team. It should also assign the necessary resources to the team and assign accountability for the sale’s execution.

The team will be responsible for undertaking all the next steps to ensure the smooth transition of the divestiture. Whether into the hands of a new buyer or as an independent entity.

The professionals in the team must negotiate with buyers, draw up the paperwork, conduct due diligence, and facilitate seamless execution.

Evaluating Market Demand for the Assets

Before entering into strategic divestitures, the company must evaluate the actual market value of the asset for sale. A great first step in the right direction is assessing demand and whether the asset can fill that demand.

Developing an understanding of the market dynamics will help put the correct price tag on it.

For instance, if the asset is a separate unit that can function as an independent entity, it needs financial statements. Legal and accounting teams must put together historical balance sheets and P&L statements to design a compelling pitch deck.

Once the critical data and other information are in place, the seller is ready to approach buyers in the market. Advertising the unit for sale is a great option to attract offers. Sellers can also approach private investors, investment banks, or family offices who may be interested in acquiring the unit.

Determining the Best Divestiture Strategy

As explained in the foregoing sections, divestitures can be of different types. Accordingly, the parent company must devise the ideal strategy to maximize value from the asset. For instance, if the unit has the potential to operate as a stand-alone unit, the parent company could execute a spin-off.

However, if the unit cannot function independently, its owner may choose to sell it to a buyer from a different vertical. Larger corporations owning subsidiaries are also known to enter them into M&A deals and strategic alliances. They use this approach to oust a competitor and capture a bigger market share.

Conducting Due Diligence

A crucial step in any M&A deal or divestiture is conducting due diligence. Both buyers and sellers may want to hire expert consultants to dig deeper and gather all the pertinent information that can make or break the sale.

The information they uncover can raise the value of the asset. Or raise potential issues that should be addressed before the sale can go through. Due diligence ensures complete transparency so the deal participants can assemble the term sheet.

Communicating with the Team for Integration

Whatever may be the kind of strategic divestiture, the parent company is accountable to its core stakeholders, including the workforce. Whether the subsidiary merges with an acquirer, becomes a separate entity or goes through an IPO–companies owe their employees transparency.

Accordingly, the team must maintain consistent communication channels with the employees. It must inform them about their roles in the new company and if they will retain their employment. In the case of acquihires, the acquirer takes on the workforce of the sold company as is.

Informing the employees of this status is important to ensure smooth integration and a successful deal.

Selling a subsidiary could mean divesting an asset that is lying dormant and not generating revenues and profits. If you need more information about how to value a startup without revenue, check out this video I have created.

Downsides of Strategic Divestitures

Although divesting non-performing non-core assets is a strategic decision with multiple benefits, it does with its share of downsides. Companies should be aware of the potential pitfalls before engaging in this approach.

For starters, accurately valuing the asset can be a complex process since they are dormant until the sale. Assigning market value can be challenging if buyers are wary of purchasing such assets.

Further, non-performing assets may have become redundant, which is why they have zero value in the market. In the case of a unit that can operate independently, it may need significant working capital and other resources. Without this investment to update the unit, it may not be capable of operating.

Factors like these can bring down the market value, and the sale may not yield substantial profits for the seller. Even before the seller company is ready to put the asset up for sale, it may have to prime the asset to make it saleable.

Other than these costs, selling a company involves several expenses, like hiring teams, consultants, and brokers to facilitate the deal. Legal costs for transferring the assets, staff termination payments, severance checks, and evaluation costs are only some of the expenses.

Possibly, the biggest downside is the signal the company sends out to competitors, customers, and shareholders. Information that the company is looking for buyers for its assets may result in losing its reputation.

It could unwittingly project that it is having financial problems and needs liquidity. This sends a wrong message to the market.

The Takeaway-Are Divestitures a Good Move?

Although strategic divestitures can be beneficial to the company, executing it efficiently is crucial. Company owners should be aware of the potential pitfalls and be ready to navigate the challenges of their business ecosystem.

If executed properly, this strategy has the potential to bring in much-needed liquidity for the company to improve performance. It can also sustain growth and streamline operations by getting rid of redundant and non-performing assets.

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