Corporate divestitures, the sale of stock or assets of a segment of a business, are an important class of business transaction by virtue of their pervasiveness (more than onethird of all M&A activity in a given year) and their size (averaging more than $175 million per deal).
Divestitures have unique characteristics that distinguish them from other M&A transactions. The need to separate the infrastructure of the business being sold from that of the seller before the sale is executed and the potential instability created by the announcement of a prospective sale place a high premium on a structured approach that incorporates planning, preparation and disciplined execution.
Financial managers are in an excellent position to enable their organizations to navigate the complex issues and management challenges associated with these transactions.
Empowered leadership, retention of key employees, team cohesiveness, clearly defined roles and deliverables, and effective communication and documentation are critical to ensure optimal results.
William J. Gole , CPA, is a business consultant, educator, and author of professional books and continuing professional education courses for accountants and other financial professionals. Paul J. Hilger , CPA, has more than 20 years experience as a senior financial executive, and consults with and advises companies on M&A activities. Their e-mail addresses, respectively, are email@example.com and firstname.lastname@example.org .
I n the arena of mergers and acquisitions, acquisitions tend to attract the most fanfare and enthusiasm within participating organizations. Yet, corporations also divest business units with surprising frequency. Divestitures accounted for more than one-third of all M&A activity from 2002 through 2006, averaging well over 3,000 transactions annually during that period, with an average value of $175 million, according to the Mergerstat Review 2007. Divestiture transactions also present unique challenges to the seller and, despite their prevalence, relatively little professional guidance is available to assist financial managers involved with them.
This article focuses on managing corporate divestiture transactions. It provides financial managers with a structured approach for managing divestiture transactions, describes their role in the process, and discusses some of the factors critical to mitigating risk and increasing the probability of a successful deal.
KEY DIFFERENCES: DIFFICULTY AND RISK
Separating a business from its parent organization (a process also referred to as disentanglement) is generally more arduous than integrating an acquired business because it must be performed under tighter time constraints. While the integration of an acquisition occurs after the transaction is consummated, divestitures require intense planning and rapid implementation of the separation of the business being sold from the seller prior to the close of the transaction . This requires the divestiture team to manage the disentanglement at the same time it prepares for the marketing and selling process.
Divestitures also entail substantial communication and management challenges not present in an acquisition setting, since the announcement of the prospective sale generally occurs months before the buyer’s identity is known.
After the announcement, if the employees of the business being sold are not kept informed and motivated, an environment of paralyzing uncertainty can result, substantially eroding the property’s value. During this period, external stakeholders join the audience of interested parties and would view an extended period with no news from the selling corporation as portending a problem. Knowing that the process is observed this closely, those responsible for the divestiture need to keep internal and external audiences informed through a carefully planned and targeted communications program.
The operational challenges and public nature of the divestiture combine to magnify the potential risks and upside benefits of the transaction. An organization that effectively plans for the operational and transactional aspects of the divestiture, and communicates effectively, has a much better chance of optimizing shareholders’ value than an organization that lacks attention, planning and discipline.
ROLE OF FINANCIAL MANAGERS
Project leadership. The senior financial manager on the divestiture team may, in some cases, be the overall divestiture team leader. Even if this is not the case, that individual generally plays an essentially coequal role, along with the organization’s senior business development executive and legal counsel, in shepherding the transaction from beginning to end. In this capacity, he or she should adopt a broad cross-functional perspective, not unlike that of a CEO, with a holistic view of the transaction. That perspective is critical to the planning process and the efficient and successful execution of the sale.
Resource coordination. Finance and accounting managers usually coordinate the involvement of key external and internal resources, such as an independent accounting firm (if a carve-out audit is required), tax specialists, financial advisers (for example, business brokers or investment bankers), and operational managers within the seller organization. Because financial and legal/regulatory considerations frequently intersect throughout the process, they will also be responsible for coordinating regulatory compliance and providing balanced and informed positions on key documents, such as confidentiality agreements, letters of intent, and the final purchase agreement, with legal counsel.
Operational participation. Financial professionals are major contributors to operational aspects of divestiture transactions. They must be actively involved in the disentangling process, particularly in quantifying the financial impact of decisions. They are also active in the staging and management of due diligence, especially in data room preparation, which is a labor-intensive activity involving a large volume of information, much of it financial data.
Technical expertise. The financial team plays a pivotal role in helping the seller understand the tax and accounting effects of the transaction structure, the details of which can have a profound impact on the shareholder value created by the divestiture. Additionally, the team is responsible for determining the financial reporting impact of the transaction (such as whether the divestiture can be reported as a discontinued operation) and developing pro forma financial statements to present the business being sold as if it were a stand-alone entity, a particularly important step in the selling process. This process is discussed further below.
THE PATH TO STAND-ALONE FINANCIAL STATEMENTS
Performance of a carve-out audit and issuance of an opinion will end the accounting firm’s involvement with these financial statements. However, these statements generally will not reflect the results of operations of the business on a stand-alone basis. The seller will, therefore, want to develop pro forma financials that reflect the impact of certain adjustments, such as:
Removal of cost allocations from the carve-out financials for services provided by the corporate parent that do not reflect stand-alone costs.
Addition of estimated expenses that would be incurred to put the business on stand-alone footing.
Elimination of nonrecurring or unusual items in the carve-out financials to normalize the business unit financials.
The bridge schedule in Exhibit 1 illustrates the adjustments that transition the statements from internal use to pro forma presentation.
CRITICAL SUCCESS FACTORS
Although a highly structured and disciplined transaction approach such as that presented in Exhibit 2 is critical to successfully executing a corporate divestiture, it is just a necessary, but not all-sufficient, ingredient for success. The following critical success factors provide suggestions to guide the team’s management of the transaction and help create the conditions for an optimal outcome.
Empowered leadership. One of the first things to be addressed once the transaction is approved is that of project leadership. Effective implementation is highly dependent on leadership, and effective leadership is highly dependent on empowerment. While certain aspects of divestitures can be learned by doing, the leader should have solid M&A experience and be an excellent communicator. This individual must also have the explicit and ongoing support of those approving its execution, evidenced by a broad and well-understood level of authority to make decisions. In addition, there should be a clearly understood mechanism for the project leader to obtain approval from the corporation when decisions that exceed his or her authority are required.
Adequate resources. The under-resourcing of the divestiture effort, once the decision to sell has been made, is a common pitfall of such transactions, and generally stems less from a conscious effort to withhold support than from the psychological dynamics surrounding the divestiture. There will be those in the organization who view the transaction as a low priority and, when called upon to provide assistance, will be reluctant to do so. Management may be prone to adopt an out-of-sight, out-of-mind mentality once the decision to divest is made. This is the function of a need and desire to focus on issues associated with running and building the business that will be retained. That can result in a blind spot relative to the support and resourcing of the transaction. Such attitudes can seriously undermine the efforts of the divestiture team. Therefore, it is incumbent upon the divestiture team leader to obtain the commitment of corporate management to the transaction, to ensure that this commitment is clearly communicated to all relevant parties within the organization, and to translate that commitment into tangible resources. To the extent that internal resources are not available or forthcoming, the team leader must have the authority to engage external advisers to fill that void.
Retention of key employees. Invariably, key employees of the business being divested are critical to its ongoing operation. The loss or de-motivation of these individuals would have a serious negative impact on the near-term performance of the business, which in turn would impact the parent’s ability to sell the business at a price that reflects its true market value.
It is important that all key individuals are identified as early as possible in the process and that a plan is formed to retain, motivate and reward them for staying focused on the business’s performance, and for supporting a successful transition to new ownership. The broader population of key employees generally would include sales personnel, but may also include operational personnel (such as key programmers in a software business or those with strong business relationships in a service business) whose loss might have an immediate impact on the financial performance of the business. Given the stakes involved, retention/performance incentives should be more appropriately viewed by the seller as insurance premiums rather than as burdensome expenses.
Effective communication. Effective communication within the core team is critical to managing a divestiture. Arguably, the key communication component should be regularly scheduled meetings run by the divestiture team leader. This allows all team members to have a common understanding of the status and current priorities of the transaction. It also exerts peer pressure to reinforce each person’s accountability for delivering results, and more readily facilitates needed course corrections that may be necessitated by changing circumstances. Equally important is the communication with both external and internal stakeholder groups, as discussed earlier. The team can tend to become so absorbed with task management that it becomes too inwardly focused. There is a significant role to be played building and sustaining the confidence of these stakeholder groups, and this responsibility cannot be left unattended without serious consequences for the selling corporation.
Team cohesiveness and ownership in the transaction. In all but the largest corporations, the divestiture team probably will be smaller than most might wish for. As a result, it needs to compensate for its relatively small size by working cohesively. The team often needs to supplement its efforts with partially dedicated internal or external resources, further complicating coordination. The core team members cannot afford to behave in a compartmentalized way, as can sometimes happen in large corporations. All must take a personal stake in the success of the transaction and think holistically, calling attention to items beyond the scope of their traditional, functional responsibility and taking a proactive, problem-solving approach as issues and challenges emerge.
Clearly defined roles, tasks and deliverables. There are a great number of things to do throughout the course of a divestiture transaction. Planning and selling documents must be developed, internal and external resources must be managed, and the transaction itself must be executed— all in a constrained time frame. Tasks must be well-managed to prevent team members from getting overwhelmed and losing direction and focus. That discipline can be exercised only by clearly defining and unambiguously communicating what has to be done, by whom, and when, and by holding the responsible parties accountable for delivering results.
Preparation for operational separation of the businesses primarily entails assigning and mobilizing a cross-functional group of internal managers to assess the nature and extent of organizational interdependencies and to develop and execute a disentanglement plan. These two facets of preparation efforts intersect in the creation of the data room, where the form of transaction (asset or stock sale) and the disentanglement approach (which assets, personnel, and operational components will be included in the deal) are reflected in the documents provided. This relationship is illustrated in Exhibit 3 .
Corporate divestitures are challenging yet commonplace transactions. Financial managers are in a unique position to enable their organizations to navigate the complex issues associated with the divestiture process. Their pervasive involvement— from project leadership to resource coordination through broad operational participation—empowers them to influence every important aspect of the transaction.