What is A Corporate Divestiture?

Some business owners choose to sell part of their company’s assets or operations through a corporate divestiture. A corporate divestiture is different from a typical business sale in that only part of the company’s assets are sold while the balance is retained by the seller or parent company. Most corporate divestitures occur because the divested operation no longer fits in with the overall strategy of the parent company, the parent company needs funds to expand its core operations, or the divested asset is redundant and creates inefficiencies in relation to the parent company. Prior to a corporate divestment, it is imperative that the financials of the divested assets are separated from the parent company to the best extent possible, and that the assets being divested are clearly identified in a logical and coherent manner.

Identify Divested Assets

Most corporate divestitures involve selling a product line or territory which does not fit in with the corporate strategy of the parent company. The product line or territory may be made up of several types of assets owned by the parent company, all of which may be fully or partially included in the corporate divestiture. The assets may include tangible assets like equipment or machinery, and intangible assets like customer lists or trade secrets associated with the divested operation. The purchase agreement governing the sale of the divested assets should clearly identify which corporate assets are being divested, which corporate assets are being retained by the parent company, and disclose any restrictions on the use of any intangible assets by the divested business which may interfere with the parent company’s operations.

Divesting the Brand Name Problematic

In many instances, corporate divestitures exclude or severely restrict the use of the parent company’s brand name. Use of the same brand name as the parent company by the divested entity is likely to confuse customers and may possibly impair the value of the brand. Consider a pizza restaurant chain operator with four locations who is selling one location through a corporate divestiture. If the sale allows the buyer to use the same brand name of the parent company, this may create customer confusion and uncertainty. Further, the buyer may impair the value of the brand name by making lousy pizzas or providing subpar customer service. This in turn may adversely affect the parent company, and demonstrates why allowing a buyer the use of the parent company’s brand typically occurs only in franchise and dealership transactions.

Separate Financials

The hardest part of most corporate divestitures is separating or untangling the financials of the parent company from the divested operation. The financials of the divested operation should reflect what its sales and expenses would have been as a stand alone entity during the most recent twelve month period prior to the separation. Often times, best guesses and estimates must be made since it is impossible to clearly separate the two entities. For example, some customer sales purported to be of the divested entity may be mixed with the parent company or may not have occurred at all if not for being associated in some manner with the parent company. Overhead expenses (rent, utilities, insurance, marketing) may be difficult to separate, and requires estimating what the cost structure of the divested entity will look like after the sale. It is best to obtain a specialized business broker experienced in corporate divestitures in order to untangle the financials and approximate the adjusted owner benefit (or true economic profits) of the divested entity that will be used for valuation purposes.

Value Divested Entity

Once the financials are separated and the corporate assets (in whole or in part) included in the sale are identified, the business broker must value the divested entity.
The valuation is a multiple (usually 2-4 x in small business sales) of the adjusted owner benefit based on comparable sale prices of other businesses within the same industry.
The valuation of the divested entity should reflect its historical growth rate, management expertise, and the overall strength of the corporate assets (both tangible and intangible) received from the parent company.
To illustrate some common issues faced when valuing a divested operation, let us suppose that Tim owns a property management business with a landscaping division.
Tim wishes to sell the landscaping operation through a corporate divestiture.
In order to properly value the divested landscaping operation, a business broker must first determine its current annualized level of adjusted owner benefit as a stand alone entity.
This requires separating the landscaping operation revenue from the property management revenue, and separating overhead costs associated with the landscaping operation from costs associated with property management.
It will probably entail estimating allocated portions of shared expenses (such as marketing, rent, and management expenses) between the landscaping and property management divisions.
After determining the estimated or ‘pro forma’ level of post-separation owner benefit, the valuation multiple must reflect the extent to which the loss of any current management members (including the owner) due to the separation will adversely affect the future level of sales and profits.
Lastly, the broker must determine whether the divested landscaping operation will have the same level of sales and profits after the sale based on the assets that are included (or not included) in the sale.
If the sale excludes the brand name and associated social media marketing presence, for example, then the expected future sales and earnings of the divested landscaping operation may be adversely impaired, and hence its valuation.

Corporate divestitures are somewhat rare in small business sales, since it is often difficult and cumbersome to properly separate the financial history and company assets of the divested entity from the parent company. When feasible, corporate divestitures allow business owners to get the benefits of a cash infusion along with owning a more efficient and focused company after the sale.

Give Martin at Five Star Business Brokers of Palm Beach County a call today at 561-827-1181 for a FREE evaluation of your business.