Studies show that more than half of the companies performing divestitures lose value on the deals. Divestitures are complex. Sellers spend considerable time and money separating the DivestCo (businesses or assets being sold) from their organizations, which can distract employees from focusing on the ongoing business. Unexpected issues often arise, which forces sellers to postpone the transaction or not realize the value they had expected.
Companies can pursue a variety of divesture options, including sales, spin-offs and IPOs. Taking the following three steps to get a head start on separation activities before buyers approach can maximize the value of a deal by shortening the separation process, accelerating the closing and maintaining focus on the core business:
- Develop a proactive sales process strategy
- Prepare pro-forma financial statements for the DivestCo and an estimated standalone cost analysis to expedite the buyer’s decision-making process
- Pre-determine how freestanding the DivestCo is and what it will take to separate
Develop a proactive sales process strategy.
Successful sellers focus on key attributes that will create the greatest value for the organization and shareholders. First, define your core and noncore businesses and the strategic rationale for shedding the DivestCo. At least annually, assess your business portfolio against future market trends and your long-term strategy to identify businesses that may not be the best long-term fit. Next, define the deal perimeter (what’s in and what’s out from the perspective of people, assets, intellectual property, infrastructure, etc.). Consider early engagement of advisors, including bankers, lawyers, and separation advisors, and bring all internal and external stakeholders together to focus on key deal objectives. Engage potential buyers in early discussion to gauge their interest. Finally, know the current state of the market so you can choose the best time to sell.
You can identify buyers based on numerous factors, including the current state of the market, the business being sold and its potential fit with other companies, and the overall industry. Generally, there are two types of buyers — strategic buyers, including competitors, and private equity funds looking to add to their investment portfolios. The seller should know the range of potential buyers and how the type of buyer affects the sales process. It may be efficient to host a public auction where multiple potential buyers bid on the transaction, allowing the seller to quickly identify and negotiate the price. Alternatively, if you have a specific buyer in mind, a more personalized approach could be best. The bottom line is to plan ahead and involve advisors as appropriate.
Plan key announcements and milestones to control the sales process. Prepare a Confidential Information Memorandum (CIM) that provides the organization’s history, the background of the DivestCo’s operations, financial performance, legal issues, etc. Host the CIM, and other pertinent information such as financial results or other supplemental information requests, in a data room for prospective buyers. If you are holding an auction, consider how to manage the data room for multiple potential buyers. For example, how many potential buyers can access the data room simultaneously? For how long? How will you handle information requests? Work with your advisors to ensure confidentiality agreements are in place with potential buyers. Sellers can minimize disruption to the business and remain in control by organizing information for potential buyers, preventing redundant data requests and regularly reassessing the buyers’ interest. Finally, consider any contingencies based on the buyers’ interest levels and begin to formulate a negotiation strategy before buyer proposals are submitted.
Prepare pro-forma financial statements for the DivestCo and an estimated standalone cost analysis to expedite the buyer’s decision-making process.
Buyers will want to understand the DivestCo’s financial performance, so you should develop a set of standalone financial statements. The first step is to determine the form and content of the statements, including filing requirements (e.g., SEC, U.S. GAAP, special-purpose financial information) and the number of years of historical statements required (typically 1−3 years). These will vary depending on the type of transaction (e.g., potential sale, IPO, spin-off) and significance/size of the DivestCo.
If you have not implemented ASC 606, the new standard for revenue recognition, this should be a top priority. As the DivestCo’s statements essentially represent a portion of your financial statements, ASC 606 implementation must be complete to avoid significant delays to the separation timeline.
The buyer will also want to estimate the cost to run the DivestCo as a standalone business. Having a standalone cost analysis ready for potential buyers, especially private equity firms, will accelerate the process. As a starting point, evaluate whether costs are properly reflected in your current corporate cost allocation and that appropriate documentation exists should the buyer want to rely on your estimates. The corporate cost allocation should reflect the underlying effort for you to support the DivestCo. Sometimes the allocation method (e.g., based on the percentage of revenue, percentage of headcount, percentage of square footage) may not reflect the actual time and costs involved in running the DivestCo. Conversely, there may be costs (such as shared services) not currently charged to the DivestCo. Also, identify any incremental costs that the buyer needs to consider if the DivestCo was to be stood up as a freestanding entity (versus being fully integrated into the buyer’s organization). Finally, documenting synergy opportunities identified during this process can also positively influence the sales price.
Predetermine how freestanding the DivestCo is and what it will take to separate.
The greater the entanglements between your organization and the DivestCo, the more complex the divestiture. For example, are corporate functions, such as finance/accounting, HR and IT, managed via a corporate shared service? Does the DivestCo provide certain services, such as access to an important home-grown technology or piece of R&D, to the parent and/or affiliate for its use in the normal course of operations? In order to fully understand the depth of these entanglements between the DivestCo and your organization, an interdependency assessment is critical. This allows you to take control of the potential implications for the separation (i.e., cost, process or timeline) by methodically assessing the degree of the interdependency between the DivestCo and your organization. Your objective? Minimize the cost of the divestiture and accelerate the time to closing by proactively managing separation considerations.
The interdependency assessment helps you identify areas in which you are willing to provide support to the DivestCo after the transaction closes (also known as Day 1). These areas may require a Transition Services Agreement (TSA), a legal agreement to provide services to the buyer for a defined duration post Day 1. The areas with higher separation complexity, typically major back office functions such as IT and HR, are most likely to be included. Proactively preparing a list of potential TSA areas and brief descriptions of scope can help shorten the TSA development process. You know your organization and the separation complexities far better than the buyer does. Providing these descriptions will help the buyer determine what functional areas they can stand up or absorb by Day 1, which shortens the separation timeline. There may also be commercial relationships between you and the DivestCo that either you or the buyer may wish to retain. Again, this is why planning is so important.
Companies invest considerable time and effort on separation activities for the DivestCo, but you should also focus on the plan for your remaining businesses. Depending on the people, systems, assets and processes that move to the buyer, you will need to modify or sometimes completely change your vision for the remaining business. Defining that vision early allows you to determine what to retain and how to rightsize to address issues such as excess capacity and stranded costs.
A divestiture is an opportunity to address less-than-ideal functions, processes, tools and even employee behaviors. This will enhance the value of the separation. By acknowledging these as performance initiatives, you can take advantage of the outcomes of the separation by improving your remaining operations. For example, you may decide to outsource a function that is no longer necessary, thereby realizing additional cost savings. A divestiture can also be an opportunity to reflect on the corporate identity of the remaining organization. Should you refresh your corporate culture so that employees continue to connect — and commit — to a purpose that may have been shaken as a result of the separation? Weighing opportunities to improve the efficiency and effectiveness of your remaining business may actually help justify the divestiture.
Plan now to drive value
The complexities of separating a business should not be underestimated. It takes time to understand the value of the business being divested and the degree of entanglements with your organization, which may extend the timeline for closing the sale. It is best to get a head start on this process.
Lack of preparation exacerbates both the timeline to close and resources required to complete the separation, increasing the risk of losing focus on core operations. To avoid this risk and to maximize the value of the transaction, be clear on what is being sold, develop buyer-friendly financial statements for the DivestCo and have a perspective on the overall separation strategy, including TSAs.
It is best to find an advisor with deep expertise in divestitures to help you navigate quickly through the key challenges of separation to drive the greatest possible value.
Scott has worked in industry and management consulting environments for over 25 years supporting clients define and achieve their business transformation objectives.
- Life sciences
- Technology and telecommunications
- Retail and consumer products
- Human capital services
- Mergers and acquisitions
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