What is Divestiture? (And 5 Reasons Why Software Companies Divest)

What is Divestiture?

A divestiture (or divestment) is the partial or total sale of an asset or subsidiary by a parent company. More simply, it is the opposite of an investment. Instead of allocating more money to a particular asset, divesting is the act of selling off some portion of your business.

What constitutes a business asset varies by company. An asset could include any of the following:

• smaller subsidiary company or brand within a larger organization
• product lines
• IP
• trademarks
• equipment
• real estate (store locations, warehouses, factories)

Companies often pursue divestiture as a way to restructure or optimize their business. There are also instances when companies are forced to divest an asset due to foreclosure, bankruptcy, or to comply with certain regulations. Founders are choosing to divest based on their own goals for their companies.

5 Reasons Why Companies Consider a Divestiture

Whether it’s a product line or a small division of a larger company, divesting a portion of a business isn’t always an easy decision, even if all signs point to it being necessary.

That being said, there’s no one single sign every company can look for when considering a divestment. However, there are a handful of common circumstances to keep in mind when evaluating the state of your business.

Divestitures drive value in a parent company.
It might seem counterintuitive to let go of a portion of a company in order to achieve growth, but the truth is, holding onto an asset that should be divested can decrease the parent company’s value. In some situations, both the parent company and spun-off subsidiary can have greater value post-divestiture.

Divestitures eliminate or reduce costs.
It’s more productive and financially prudent to sell part of a business than waste valuable resources on something that no longer fits with or serves your company. Any additional funds resulting from the divestiture can be redirected to initiatives or areas of the business that align with the long-term vision for the company.

Divestitures cultivate a better focus on core competencies.
Divestments become more strategic (and some might even say vital) as companies grow. Whether through acquiring IP, creating new product lines, or developing a broad array of services, at some point, a company’s focus can be pulled in too many directions. This can lead to lack of mastery or expertise — essentially, a “jack of all trades, master of none” scenario. A strategic divestiture can help a company regain focus on its core competencies.

Divestitures reduce instances of underperformance.
Divesting underperforming or unnecessary assets is financially responsible in the long run for both the company and its shareholders. A strategic separation can free up vital resources that can then be devoted to bolstering the company’s strengths.

Divestitures eliminate overlapping sectors or departments post-merger.
Large corporations sometimes find a need to divest after merging with another company. Divestitures can be a smart strategy to address redundancies, whether in business sectors or smaller departments, that come to light following the merger.

The Different Divestiture Strategy Formats

Companies have their own sets of variables to consider when looking at divestiture; thus, one size doesn’t fit all when divesting an asset. Each of the following examples is a type of divestiture.

Spin-off.
In this scenario, a smaller subsidiary becomes its own standalone entity after being “spun off” from a larger parent company. The parent company still holds a minority stake in this new separate entity, but relinquishes a majority of its shares to current shareholders.

Equity carve-out.
Outside investors have the opportunity to purchase a minority amount of equity in the company through an initial public offering (IPO); however, the parent company retains majority control.

Split-off.
Current shareholders are given the option of retaining shares in the parent company or the new standalone entity, but not both.

Demerger.
A demerger results in two separate companies with no parent company remaining.

Trade sale.
In trade sales, a subsidiary is sold to another company and no longer has ties to the original seller.

Each form has pros and cons, which is why it’s important for companies to regularly assess their financial situations to make sure they know which route to take when the time comes.

Questions to Ask Before Planning Your Divestiture Strategy

Some companies look for reasons to retain every piece of their business only to later realize how much good it would have done to divest an asset sooner. Avoid this kind of regret by regularly evaluating where your company stands in relation to the market. Even an annual analysis can offer essential insight and better equip your team to make divestment decisions.

In addition to an annual review, here are a few other important questions to consider:

What are your core and non-core businesses, products, or services?

Reflecting on why a particular asset originally made sense for your company is key because:

• it helps you develop a rationale for divestment for whatever doesn’t support your core business.
• outlining an asset’s strengths (even if they are no longer strengths for your company) can help your team determine potential buyers who could be a good fit, further expediting the separation process.

What are the asset’s most defining features?
You can’t properly market what you can’t define. Knowing an asset’s most important value drivers helps to clearly demonstrate its value and growth potential to buyers.

Current, accurate data and information are crucial to correctly defining and marketing the asset. It clears things up for the buyer, but more importantly, it puts your team in a better position to maximize value and mitigate substantial risk.

Who’s the right buyer?
Once you have a full grasp of the asset being sold and its unique value proposition, it’s easier to identify the potential universe of interested buyers. Studying the landscape will help to identify and subsequently highlight the asset’s most desirable aspects.

Do you have anyone who can work on this endeavor full-time?
A dedicated divestiture team streamlines the separation process significantly because they can focus on executing your strategy without being pulled in various directions. The team should include people with big-picture experience who are able to view the pros and cons of the transaction from the perspectives of both seller and buyer.

Timing is (almost) everything when it comes to your divestiture strategy

Once you decide that divesting an asset is the right choice, it’s important to move quickly (though prudently; it’s a fine balance). This is why preparing your divestiture strategy is key: a drawn-out separation can decrease the value of the sale, discourage buyers, and result in a less favorable outcome.

Executing a Successful Divestiture Strategy

Once you’ve defined the asset, surveyed the landscape of possible buyers, and determined you need a divestment, you can begin the plan for separation.

The finer details of a divestiture strategy are bound to differ from company to company. For example, retention figures and unit economics are especially important in software divestitures because they impact the long term profitability of software assets.

Every industry is different; buyers will have their own concerns and requirements, and the ultimate divestment goal of one company could be completely different from one of their competitors. But the following steps can provide general guidance to make the process as clear-cut as reasonably possible.

Establish the deal parameters

The scope of the divestiture must be clearly defined before making any announcements or entering into discussions with outside parties. Consult with your divestiture team and trusted experts (advisors, lawyers, etc.) to determine what’s included in the deal.

• IT infrastructure
• customer contracts
• IP
• personnel
• operations

Consult with key advisors and divestiture strategy team

After determining the deal parameters, closely examine the asset’s performance as though it were a standalone entity. The goal of this analysis is to understand the asset’s current performance and potential future value so well that it takes the guesswork out of the deal for interested parties.

Again, as the strategy team separates out information specifically related to the soon-to-be divested asset, they’ll get a better sense of when the market timing is right. Ideally, they will also be able to advise the company as to whether a broad, public announcement or a personalized approach to a smaller, select group of buyers is the right path for the deal.

Organize pertinent information for interested buyers

Detailed plans not only help sellers establish a competitive position; they streamline the divestment process for buyers, as well. The fewer requests buyers need to make for data, customers data, product information, and other relevant information, the more time everyone has to discuss the finer points of making the proposed divestiture a reality.

Organizing materials such as historical customer data and carving out financial statements presenting the asset as a stand-alone entity can help to: 1) lower the perceived risk from the buyer side; and 2) justify a higher value by rationalizing potential risks.

Determine how much of the unit is tied to other parts
of the business

Earlier, we discussed the importance of moving quickly yet prudently in your divestiture strategy. The “prudently” part comes into play when reviewing how the part of your company you want to divest is tied into the rest of your business. If you move too quickly on a deal, you might find that other parts of the company can’t stand alone or function cohesively without the divested unit.

An interdependency assessment and transition services agreement (TSA) certainly benefit the buyer’s side of a deal, but this information is critical to the seller, too. The research that goes into the assessment and development of a TSA can help you determine what you’ll need to modify or shift on the part of the business you retain.

Regarding TSAs: depending on your situation, this agreement can be extremely useful and make the transition more seamless on the buyer’s side; however, it’s recommended to use TSAs sparingly. The ultimate goal of a successful divestiture is to separate your company from this asset, and a poorly structured TSA can prolong the separation process and strain resources you wanted to alleviate in the first place.

Create a divestiture strategy timeline addressing each
team’s involvement

Each segment of the divestiture strategy team (sales strategy, operations, etc.) has its own set of actions to follow through the divestment process. Ensure each team is moving at the same or similar pace by creating regular checkpoints. This will help everyone monitor their progress, adjust timeframes, and, if necessary, regroup and make other adjustments.

Divestiture Example: RentPayment and MRI Software

At SEG, we use our deep understanding of the market to guide our clients through M&A options, including divestment. One such instance involved the sale of RentPayment to MRI Software.

In this divestiture example, Priority Technology Holdings, Inc. (the parent company) was divesting RentPayment, one of its platforms. MRI Software, a provider of real estate software solutions, acquired RentPayment. This included the real estate payment brands RentPayment.com, StorageRentPayment.com, and DuesPayment.com.

MRI Software wanted to scale its global payment offerings, and the acquisition of RentPayment fulfilled that need. In the case of RentPayment, they can continue serving their pre-acquisition customers while also entering the fold of MRI Software’s payment options and directing more resources to MRI Software’s goals.

As part of the agreement, Priority provides payment infrastructure “as a service and processing to the new platform at MRI,” aiding in the transition of services.

Although divestiture strategies require a substantial amount of planning and coordination, they can ultimately be a great service to your company. Regularly assessing your business, keeping accurate financial records, and working with a team you trust can make something as complex as divestment more of an opportunity than a challenge.