Addition by subtraction
Executing successful corporate divestitures
The days are gone where divestitures are an afterthought in boardrooms. Divestitures are now a fundamental part of corporate strategy, undertaken on a “proactive” rather than a “reactive” basis, with executives divesting non-core or underperforming assets or business lines to unlock value, increase portfolio profitability, and enhance organisational efficiency. However, divestitures can be tricky as they usually require assets which are deeply integrated in the organisation to be disentangled and sold, listed or “spun out”. Here we provide some useful tips on how to execute a successful divestment and chart some of the legal options available to executives.
Divestitures, also known as demergers or spin offs, are transactions in which a company sells or spins off part of its business to another entity. They can be a powerful tool for enhancing corporate strategy and creating shareholder value, but they also require careful planning and execution.
Why divest?
The most common reasons for undertaking a divestiture are:
Operational efficiency: Two entities in the business may have different commercial goals, leading to inefficiencies. Executives may realise it’s time to “cash out” on an underperforming entity. The dangers of holding on to a non-core or underperforming asset or business line for too long are well understood. A divestiture allows executives to remain out in front and realise returns on assets which are underperforming within one group but can be profitable within another.
Maximising valuations: Leaving aside operational efficiencies, there can be strategic value inherent in a divestiture that allows a spun-off entity to present a more focused strategy or more compelling growth story. This can help to maximise share capital valuations for both the new entity and the parent, providing access to capital on better terms or on higher valuations as may have been available as a combined entity. Splitting such businesses out can allow each to pursue divergent strategies, and for each entity to prioritise its own goals, resulting in more valuable and profitable standalone ventures.
The importance of tax planning cannot be overstated and indeed, tax-efficiency and shareholder value are often the driving factors underpinning a decision to divest.
Regulatory or geopolitical concerns: Executives may divest assets if their risk profile spirals due to geopolitical events or changes in regulation. Competition concerns may also result in the voluntary or mandatory spinning out of selling certain assets.
Liquidity: Divestitures represent an opportunity for executives to shed their loss-leaders or non-core assets and to receive capital in return. This capital can provide much needed liquidity to pursue new opportunities, working capital or for general corporate purposes that benefit the remaining business.
What is being divested?
Divestitures involve complex legal, financial, operational, and organisational workstreams. Even if businesses are legally separate, they may be operationally intertwined. It is therefore essential, before effecting a divestiture (usually at the portfolio evaluation stage), to identify what form of divestiture is deliverable and which businesses, processes, assets, systems and entities are capable of being sold or spun out. The importance of tax planning cannot be overstated and indeed, tax-efficiency and shareholder value are often the driving factors underpinning a decision to divest.
If a business is to be sold or listed, executives are also faced with the challenge of communicating the value of the assets to be carved out, not only to prospective buyers and investors, but also internal and external stakeholders, such as employees, customers, suppliers, regulators, and shareholders. Having a clear understanding of the assets being divested at an early stage is imperative in developing an effective communication strategy.
Having a clear understanding of the assets being divested at an early stage is imperative in developing an effective communication strategy.
Where relevant exchange and regulatory thresholds are met, both public and private companies have the option to IPO or list a spun-out business so that the shares of the new streamlined entity will be publicly traded on a stock exchange. This option can provide a company with a feasible route to the public markets which offers the benefits of future liquidity and is particularly useful in circumstances where the growth story of the entity to be listed is more compelling than that of the previously combined entity. As with all listing and initial public offering processes, this would involve additional legal, financial, and organisational workstreams in order to meet the relevant requirements of the exchange and regulator for the issuing, listing and trading of shares in the new business.
The structure of divestitures
Divestitures can take many forms and are generally distinguished by whether the shareholders of the parent will own the shares in the divested business unit or entity. The most common types of divestitures can be summarised as follows:
The disintegration and sale of an entity or assets within a group by an initial public offering (IPO) or a private sale.
Usually undertaken to strengthen the balance sheet of the parent or raise capital. Sometimes carve-outs may be used where a spin off announced to the market draws interest from prospective buyers or investors, leading to a pivot from the spin-off structure contemplated initially. Partial carve-outs also allow parent companies to test a business entity's standalone performance in the market (while maintaining a controlling interest), before attracting a full takeover.
Business units, assets or the shares of subsidiaries will be transferred to a newly incorporated company with the same shareholders as the parent (often on a pro-rata basis).
Often used where a sale of the business is not possible or to unlock value of specific business units / assets (which are undervalued within the group). The separate businesses may then become more attractive to investors.
The shares in a parent are swapped for shares in a new entity.
Shareholders are given a choice of “which horse to back” (often at a discount to the market value of the exchange shares). As well as being tax-efficient, split offs allow executives to narrow the company’s focus.
Similar to a spin off, but the parent retains a minority interest in the subsidiary.
The selling business usually retains a controlling interest in the divested company, allowing it to protect its own interests and exercise control over the management of the divested business.
Once the structure of the divestiture has been decided upon, the legal steps required to effect the divestiture may involve a series of distributions, capital reductions, share transfers, liquidations or court mandated processes, such as schemes of arrangements. The requirements will vary on a jurisdiction-by-jurisdiction basis. There is no substitute for good legal and tax advice as the structuring may be complex, the steps numerous and resources required extensive.
A transitional services agreement may be required to provide the divested business with critical services post-close, especially if the divested business is not capable of being fully disentangled from its previous parent at close.
Additional legal considerations include evaluating “change of control” clauses in commercial and banking contracts, licences and permits; complying with employment law (especially if employees are to be transferred with, or to, the divested business); considering the impact on any employee incentive schemes; and analysing pension obligations to consider whether, and how, to communicate the transaction to pension trustees. Each has an impact on the timings involved in the divestiture (which can range from weeks to years to implement).
