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Transaction Advisory Services | June 04
A sneak peek into the concept of divestitures

CONCEPT OF DIVESTITURES 

One of the methods to achieve the desired results from corporate restructuring is divestitures. 
Divestiture refers to offloading of assets of a business for any reason whatsoever. Ordinarily, financial difficulties or lack of operational synergies triggers divestitures. The business asset that may be divested includes subsidiaries, divisions, product lines, or properties. While the reasons for divestitures align with those for corporate restructuring, there are some additional reasons for divestitures. These comprise of.

1. Need To Generate Cash

A business is in perpetual need of cash. There are situations where the cash requirements cannot be satisfied in the ordinary course of the business necessitating divestitures as a means to generate the required liquidity.

2. Getting Rid of Under performing Business Divisions

A company consists of multiple business units or divisions, all of which may not perform as per the expectations of the management. The company can decide to do away with parts of the business plagued with operational inefficiencies. 

3. Increase Resale Value of The Business

Yet another reason for divestiture is selling underperforming business divisions to increase the value of the company for sale. Offloading the undesirable or heavily indebted business divisions increases not only the price for which the company can be sold but also the number of buyers interested in purchasing.

4. Survival of The Business

A specific part of the business, which is capital intensive without the requisite benefits with regards to profitability hampers the survival of the overall business. The prudent decision is to undertake the sale of such part of the business.  

5. Selling Undertaken Under Insolvency Laws

A business undergoing restructuring under the insolvency laws of a country may be compelled to sell its assets or divisions as per the terms and conditions mandated by the relevant court. This is referred to as compulsory divestiture. 
  
A divestiture can take place in many ways. It may be in the form of:

1. Spin-offs

Under the strategy involving a corporate spin-off, a new company is created from the parent company. The parent corporation hives off a part of its business into another company and the shares of the new company are then distributed among the existing shareholders in the manner decided by the parent company. This may be done in either of the two ways. The shares of the new company may be allotted to the existing shareholders in proportion to the shares held by them in the parent company. Alternatively, the parent company may itself hold the shares of the new company. The main objective of a spin-off is to manage costs more effectively.

2. Splits 

Under this form of divestiture, a company is divided into two or more parts. The aim is to maximize profitability by separating the sick business units from the well-functioning units of the company. A split can be affected in two ways: split-offs and split-ups. In split-offs, the shareholders of the company surrender the shares of the company in favour of share for either of the companies. In split-ups, the company gets divided into two or more units resulting in obliteration of the identity of the existing company. 

3. Equity Carve-outs

Carve-outs are a form of partial divestitures resulting in the sale of a slice of equity of the subsidiary of a company. It generally precedes a spin-off. A carve-out creates a standalone company distinguished from its parent company. It establishes a separate identity of the subsidiary or business unit. The creation of a new business identity results in an independent board of directors and a separate set of financial statements. The parent company does not completely abandon its interests in the subsidiary. It maintains a controlling interest in the new company and offers operational and strategic support, along with the resources required by the business to achieve profitability. The strategy of carve-out is used in cases where the business is so deeply integrated within the company that separating it is not feasible.

4. Disinvestment

In simple terms, disinvestment is the sale of assets, property or business divisions of the company without the consequent condition of reinvestment of the proceeds in a particular manner. Disinvestment is a strategy used to sell off assets of the company that do not form part of its core business. Large conglomerates usually adopt this tactic with widespread interests with the view to refocusing on its key business areas. It may also be used to sell poorly performing business units in order to strengthen the bottom line. Disinvestment may be the result of regulatory compulsion also.

In essence, divestitures are possible through myriad modifications in the types as mentioned above. Every divestiture has a significant effect on the company as well as the shareholders. Therefore, it is pertinent to understand antecedent causes and the potential effects it may have on the business of the company before undertaking such a transaction.


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