In the world of business nowadays, companies have other subsidiaries and assets that are not generating income. However, instead of keeping them, businesses today, prefer to dispose of those assets and making a profit from it. Hence, redirecting that revenue generated to other parts of the business that is yielding income.
The process of these selling and disposing of assets is what is known as Divestiture. However, this article will discuss some of the definitions, strategies, and frameworks in business divestiture.
If you are trying to divest some of your assets or businesses, then this article is for you. Before we go further, let’s discuss some of the definitions of divestiture.
Definition of Divestiture
There are several definitions to divestiture and all are saying the same thing
Divestiture is defined as the transfer of a company’s assets or a business unit through a sale, exchange, closure, or bankruptcy. However, divestiture can also be called divestment. Another definition of divestiture, it is the act of selling subsidiary assets or divisions of a company. The purpose of divestiture is to maximize the value of the parent company.
In addition, divestiture is definitely the opposite of an investment. However, it is often done when that subsidiary asset or division is performing below standard. In some situations, companies are forced to sell assets as due to result of legal or regulatory action. However, Companies can also look to a divestment strategy to settle other strategic business, financial, or political goals.
Nevertheless, partial or full disposal can occur, depending on the reason why management decides to sell or liquidate its business’ resources. Examples of divestment include trading intellectual property rights, corporate acquisitions and mergers, and court-ordered divestments.
Divestiture strategy involves a company disposing of a portion of its assets, often to grow company value and obtain higher efficiency. Also, many companies use a divestiture strategy to sell off external assets that enable their management teams to focus on the main business.
Divestiture can occur from either a corporate optimization strategy or being forced by external circumstances. An example is when investments go down and firms withdraw from a particular region/industry due to social pressure.
However, the divestiture item may include a subsidiary, real estate holding, equipment, and other property, or financial assets. Also, returns from these sales are often used to pay down debt, make capital expenditures, fund working capital. While most divestiture transactions are planned, sometimes this process could be forced upon them as a result of regulatory action.
Despite why a company decides to adopt a divestiture strategy, asset sales will create revenue that can be used elsewhere. However, in the short run, this increased revenue will help the organizations. Hence, they redirect the funds to help another division that is performing below expectations.
Furthermore, divestment is made within the framework of restructuring and optimization activities.
Now, let’s discuss briefly some of the divestiture framework.
Categories of Divestiture Framework
There are three different frameworks in approaching a divestiture strategy.
Companies that are aware of the need to change some business units often use this framework. However, they are unsure of where exactly to begin. The idea is that all business units are assigned to a strategy canvas against the criteria of performance and strategic fit.
Both performance and strategic fit could be the sum of a number of metrics and, therefore, represent an aggregation. For instance, a company might consider revenue, revenue growth, return on capital employed, etc. However, Strategic Fit could be a sum of metrics such as geography, product/service offering, risk profile, etc.
In the diagram above, the horizontal axis shows the market share of a business unit and its strength in a certain market. However, by using relative market share a company can approximate competitiveness. Also, the vertical axis shows the growth rate of a business unit and its ability to grow in a particular market.
Furthermore, question marks are linked with rapid market growth but low market share. However, question marks are time-intensive and require strong investment and resources to increase their market share. Moreover, investments into question mark business units are often funded by cash flows created from so-called cash cows.
This is another framework to consider when it comes to the divestiture decision-making process. The aim is to focus on market attractiveness and financial performance, hence, ascertaining how to choose capital allocation or whether to divest.
Additionally, future market growth and a business unit’s current relative market share often determine market attractiveness. Hence, the opportunity for growth in any business unit is to capitalize on this. However, current returns and the opportunity for future value generation determine financial performance.
Business divestiture is the process of selling business assets, product lines, services, subsidiaries, business property, or even an entire business.
Also, this is done in the hopes that it may be worth more to someone else than it is to the business at the time it is divested. Business Divestiture is a means that can generate cash, eliminate waste, and help a company to perform better in the future. Sometimes divestiture is demanded as part of a bankruptcy, or it may be ordered by a court as a means of ensuring marketplace competition.
Practical Approach to Business Divestiture
For example, your business has a product that’s just not generating revenue. Instead of disposing it, you invest more money into marketing, trying to find the right customers. Moreover, investing into something that clearly isn’t working is often a bad idea.
Instead, you might consider divesting the product line altogether. No more wasteful marketing spend, no more production costs for a product that doesn’t sell, no more holding inventory that isn’t moving.
Divesting the product at first may look like a loss, turns out to be a net benefit. Because you free up resources to focus your business on things your customers want and are willing to pay for. This can raise your bottom line, adding value for shareholders, too.
However, business divestiture decisions should not be made in fear, but as part of an ongoing business financial planning process.
Types of Business Divestitures
Businesses dispose of assets all the time, for several reasons. Some of the most common reasons why businesses divest themselves of assets include:
A business can sell some property to generate revenue. For example, a business that needs money might sell or license some equipment that it owns.
Certain big businesses have other smaller businesses as subsidiaries. However, selling a subsidiary can help if the business decides the subsidiary isn’t working well. Also, they sell if the subsidiary business doesn’t fit well with the rest of the company.
Selling under performing assets
This is probably the most common type of business divestiture. However, the most common asset to be divested is usually a product or service that is not performing well. There will always be products or services that perform better than the other. Getting rid of those that aren’t performing gives you more time to focus on the products or services that are working and bringing in the highest profits.
Having lots of subsidiaries bring about too many locations too quickly. Therefore, it may be important to close some of those locations where customer demand just isn’t high enough to cover expenses.
Businesses that are in the bankruptcy process usually need to sell all or part of their business. Also, one type of business bankruptcy is Chapter 7. Chapter 7 bankruptcy is the process of liquidating and closing a business. In this, they sell all the assets of the business. Other types of business bankruptcy (Chapter 11 reorganization, for example) may involve the liquidation of some assets.
Business divestiture can also include the sale and closing of the entire business.
In conclusion, there are several definitions to divestiture and all are saying the same thing. Also, instead of investing on products or businesses that aren’t yielding income, it’s better to divest that product.