Doing Divestitures Right

You’ve got an underperforming division or product line. Should you sell?

Perhaps, but only if you get the process right. Too often, merger-and-acquisition experts warn, companies decide to sell a piece of their businesses and then go about it like they are taking out the trash.

“There are large psychological differences between acquisitions and divestitures,” says John McPhee, a partner with Big Four accounting firm KPMG LLP and global leader of the firm’s sell-side services practice. Acquisitions are seen as positive events, like getting married. C-level executives want to be at the closing dinner and say they were part of the deal, McPhee says. “Divestitures can be viewed as negative. Senior management will look at a product line or division and say, ‘You know, this is just not giving us the margins we hoped for or it’s diluting earnings, and we’ve got to get rid of it.’”

Once a business is characterized in that unflattering light, it’s easy to pass off getting rid of it to a junior-level executive with little knowledge of the business and even less in mergers and acquisitions. “Management finds a guy named Joe, and Joe’s skill set is availability. He has time to deal with this,” McPhee says.

Not surprisingly, the consequences can be unfavorable. Companies may fail to get top dollar for the operation they’re selling or complete the deal in a timely manner, if at all. They could wind up selling a business when, with a few changes, it would have been smarter to keep it.

KPMG once advised a company that wanted to sell a business unit that wasn’t as profitable as its other operations. When the advisors reviewed the unit’s income statement, they found that almost every line item represented a share of corporate expenses disproportionately larger than what the unit was really consuming. “Once we started to peel back the layers, we found that the business wasn’t unprofitable at all,” McPhee says. “It was simply overburdened by the company’s corporate cost structure.” The company ultimately sold the unit because it wasn’t a strategic fit. But based on the research, it was able to show a better profit statement with prospective buyers.

In another case, McPhee represented a client that was bidding on assets another company wanted to sell and then lease back from the buyer. The seller had devoted considerable energy to calculating a fair sale price, but neglected to thoroughly assess what a buyer would charge to lease the assets back. As it turned out, that amount was far more than the seller anticipated, so the deal was scratched.

For companies contemplating selling a business unit or product line, McPhee and other experts offer the following tips:

1. Give the assignment to a pro. If you don’t have someone on staff with significant experience overseeing divestitures, hire a business broker, investment banker or accountant. “You want someone who can tell you which things will impact the value of the transaction,” McPhee says.

“Mid-sized companies a lot of times don’t have teams that specialize in this type of activity, yet they still try to handle it internally to save costs,” says business broker Scott Bushkie, president of Cornerstone Business Services in Green Bay, Wisconsin. “That’s penny wise and pound foolish.”

2. Be objective about how much the business is worth. Like homeowners, business owners and managers often attach more value to their operations than outsiders. But going to market with outsized expectations can jeopardize your credibility and push away potential buyers. Failing to understand the flaws in a business causes problems too. “You don’t want to highlight the negatives when you’re selling something,” McPhee says, “but you should be aware of issues that will be thrown at you and have an answer for them.”

3. Define what you’re selling. Detail the physical assets and intellectual property you’re selling and which managers are likely to join the buyer’s organization. “If you haven’t defined which assets and liabilities you’re selling and distilled that into the legal agreements, you will probably have an issue when it comes time to close the transaction,” McPhee says. “You may be headed for post-acquisition disputes, too.”

4. Create stand-alone financial reports. A business unit’s financial results often are commingled with those of its parent company. Before a divestiture, break out those results to create a stand-alone income statement and balance sheet a prospective buyer can study. “The more assumptions a buyer has to make, the more risks they see,” Bushkie says. “The more hard facts they see, the more opportunity they can see. That can lead to a higher price.”

5. Refine your sales pitch. Understand what the business unit you’re selling is all about, including its core competencies and the strategic values it offers potential buyers, Bushkie says. “You want to understand why someone would want it, so you can emphasize that in your presentations.”

Every company wants a top sales price for an operation it’s divesting. Companies that do their homework improve the odds of getting it.