What Is a Business Divestiture?
Business Divestiture as a Business Strategy
Business divestiture is the process of getting rid of business assets for a variety of reasons. Business assets can be product lines or services, subsidiaries, assets like business property, or an entire business.
Types of Business Divestitures
Businesses get rid of assets all the time, for a variety of reasons. Some of the most common reasons why businesses divest themselves of assets are:
Getting Cash. A business might sell some property to solve a cash flow problem. For example, a business that needs money might sell or license some equipment or some intellectual property (copyright, trademark, or patent) that it owns.
Selling subsidiaries. Some businesses have gathered up other smaller businesses as subsidiaries. Selling or spinning off a subsidiary might make sense if the business decides the subsidiary isn't working well or 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, and the most common asset to be divested is usually a product or service that isn't performing well. There will always be products or services that do better and some that don't do as well. Getting rid of those that aren't working gives you more time to focus on the products or services that are working and bringing in the highest profits.
Closing locations. Sometimes a business grows too fast, adding too many locations too quickly. It may be necessary to close some of those locations where customer demand just isn't high enough to cover expenses.
Bankruptcy. Businesses that are in the bankruptcy process often need to sell all or part of the business. One type of business bankruptcy is Chapter 7. Chapter 7 bankruptcy is the process of liquidating (selling off) and closing a business. In this, all the assets of the business are liquidated (sold). Other types of business bankruptcy (Chapter 11 reorganization, for example) may involve liquidation of some assets.
Business sale. Business divestiture also includes the sale and closing of the entire business.
Of course, the business divestiture decision is often more complicated than just one simple reason. For example, getting rid of a patented product can solve several problems: getting cash and getting rid of an under-performing product.
What to Consider Before You Divest
Unless you are forced into a business divestiture because of bankruptcy, you have time to decide what to divest and when. Here are some steps to take when you are trying to decide what to get rid of and when.
- Look at the asset side of your company's balance sheet. The assets closest to cash (called current assets) are the most easily and quickly
- Do a break-even analysis on assets, products, or locations that you might be considering. Are you close to the break-even point on a particular product? If so, maybe you need to hang on to that one.
- Consider the product lifecycle, the process a product goes through from introduction, to growth, maturity, and decline. The best time to get rid of a product may be when it has just reached its maturity and may be in decline.
- Do a profitability ratio analysis on specific products or parts of your business. One good profitability measure is gross profit margin––the comparison of gross profit to sales volume. The higher the gross profit margin, the better for the company.
- Consider temporary vs. permanent issues. Solving a temporary situation by selling something that will permanently be gone from your company might not be the best solution to the problem.
In all of this analysis, you are looking for products, services, parts of the company that will bring in the highest amount of money from the lowest performing assets. You don't want to get rid of something that is doing well, but you won't get much for something that isn't performing well. It's always a tradeoff.
Business Divestiture as a Strategy
Maybe your business has a product that's just not bringing in money. Instead of getting rid of it, you might throw more money into marketing, hoping to find the right customers. Holding on and putting more resources into something that isn't working is usually not a good idea.
We all tend to hold on to things too long. We wait to get rid of them, and we often put more money into them to help them along. This desire to hold on too long is a logical fallacy, called the sunk cost fallacy, more commonly known as "throwing good money after bad." The prospect of loss is usually more powerful than the possibility of gain, causing us to avoid the loss by trying strategies to hold on. But the best thing in many business situations is to let go of something unprofitable and move on.
That includes accepting the loss and not adding to it.
The point is that business divestiture decisions should not be made in desperation, but as part of your ongoing business financial planning process. Periodically (once a year maybe?) sit down with your tax and financial professionals and look at your entire business. What is going well? What isn't? Where can you cut your losses on those parts of the business that aren't doing so well? It's always best to plan ahead for divestiture; you will get more for your money and you won't be in a hurry and be forced into a divestiture.