What Is a Business Divestiture?
Definition & Examples of a Business Divestiture
Business divestiture is the process of getting rid of business assets, including product lines, services, subsidiaries, business property, or even an entire business.
Learn more about business divestiture, why it's used, and what is involved.
What Is a Business Divestiture?
Business divestiture is the sale of a business asset in the hopes that it may be worth more to someone else than it is to the business at the time it is divested. Divesting is a method that can raise cash, eliminate waste, and streamline a company to perform better in the future. Sometimes divestiture is required as part of a bankruptcy, or it may be ordered by a court as a means of ensuring marketplace competition.
- Alternate name: divestment
How Does Business Divestiture Work?
Maybe your business has a product that's just not bringing in money. Instead of getting rid of it, you throw more money into marketing, trying to find the right customers. But putting more resources into something that clearly isn't working is usually a bad idea.
There is a natural bias toward loss aversion, called the sunk cost fallacy, which tends to make people pour more resources into trying to prevent a loss than is logically prudent or reasonable. Divestiture requires one to override this inclination.
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, while at first seeming like a loss, winds up being a net benefit, as you free up time and resources to focus your business on things your customers actually want and are willing to pay for. This can boost your bottom line, adding value for shareholders, too.
Business divestiture decisions should not be made in desperation, but rather as part of your ongoing business financial planning process.
Periodically sit down with your tax and financial professionals and look at your entire business. What is going well, and what isn't? Look for where you can cut your losses on those parts of the business that underperforming.
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 include:
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 underperforming 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 sold. Other types of business bankruptcy (Chapter 11 reorganization, for example) may involve liquidation of some assets.
Business sale. Business divestiture can also include the sale and closing of the entire business.
Is Business Divestiture Worth It?
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 considering divestiture.
Consider assets. 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 sold.
Determine your break-even. 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 lifecycle is 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.
Evaluate profitability. 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.
Look to the future. 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. It's better to be disciplined in your divestments, with an eye on long-term benefits.
In all of this analysis, you are looking for products, services, and 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, either. It's a tradeoff to take into account when plotting your course of action.
- Business divestiture is the process of getting rid of business assets, such as property, product lines, subsidiaries, or even an entire business.
- A business may divest for many reasons. Often, it's a technique used to raise cash or eliminate poorly performing aspects of the business. Sometimes, divestiture is the result of a bankruptcy.
- Before divesting, a business owner should thoroughly evaluate the company's financials to determine which aspects of the business are working and which are not.