Why a Company Sells Off Its Subsidiary - Key Insights

You may have seen some news about a company selling off a subsidiary, with big numbers slapped on the screen. Sometimes, even billions. You can’t help but envision yourself enjoying the glory of such a glamorous business sale.

But what exactly is a divestiture, and how can you benefit from it as a business owner, CEO, or founder? What impact would it have on your business? Why does it happen in the first place?

In today's discussion, we explore the reasons why a company sells its subsidiary, the impact the sale has on the company, and why divesting is important.

It's worth noting that selling a subsidiary can be difficult. If you are considering it, you'll need the help of M&A experts like wealth advisors, investment bankers, financial accountants, and corporate attorneys.

We at Exitwise can help you find the best M&A professionals in your sector to help you with the sale. They can help you prepare the subsidiary for sale, evaluate it, and even negotiate favorable terms of sale.

Schedule a consultation with our team today to sell off your subsidiary at the best terms possible.

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What is the Concept of Divestment?

Also called a divestiture, a divestment is a way of exiting or selling a subsidiary mainly to increase the value of the parent company.

The subsidiary being divested is usually called the divested subsidiary property/asset/business unit.

Most divestments are completed through a sale, exchange, or closure and are common in large publicly traded companies with many related or unrelated business units or interests.

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Why Companies Sell Off Subsidiaries

The reason for the divestiture of a business differs from one company to another.

The sale may be due to one or a combination of the reasons below:

1. To Refocus on Core Business

You may sell off a subsidiary to remove it as a non-core business unit so you can focus more on your key business areas.

A good example of divestment done to refocus on core business is the WeWork Corporation divestiture of its software and content marketing units to focus more on rental co-working spaces.

The company let go of Conductor, a website optimization and intelligence platform that focuses on search engine optimization. WeWork had bought Conductor before the founder and the company's employees repurchased it.

WeWork also sold Teem, its business management software company, to iOFFICE in 2018.

2. To Satisfy Other Strategic Business Goals

You may sell your subsidiary business to meet business goals, such as raising funds for operations or repaying debt.

For example, in the case of WeWork above, the divestiture was also meant to help the business reduce its debt burden.

Other key business goals for a divestiture include restructuring, reducing costs, and eliminating redundancies.

3. To Improve Efficiency and Company Value

Selling off a subsidiary business asset can improve the value of the parent company and its portfolio. For example, the value can increase because repaying debt leads to a lower debt-to-equity ratio.

The value may also increase if you streamline your operations after removing a non-core business unit.

4. To Overcome Non-profitability of the Subsidiary

A company may dispose off a poorly performing subsidiary business that is not yet profitable or has lost its profitability.

A unit may no longer be profitable if it has lost a significant market share or plateaued at the end of its product life cycle.

5. To Meet Regulatory Requirements

You may have to sell off a subsidiary if the law requires you to do so to maintain, introduce, or protect competition within your sector.

The de-integration of AT&T is a good divestment example caused by regulatory requirements to prevent monopolies and maintain fair trade environments in the sector.

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Importance of Strategic Divestments

Depending on the reason for the sale, divestments are strategically important in three major ways:

• Better Market Adaptation: The parent company can change and adapt to changing market situations. For instance, a divestiture may help a company divert the funds to realign its offerings with new opportunities or emerging trends like AI.
• Reducing Risk Exposure: Selling off a high-risk or unstable business unit can reduce risks to your portfolio.
• Creating or Acquiring New Business Units: While it might sound ironic or counterintuitive, you may sell a business unit to create or acquire new ones using proceeds from the sale. You can also use the proceeds to refocus on the units that align better with your main role.

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Types of Divestitures

Divestitures fall into the following main categories:

• Spin-Offs: The parent company sells a business unit that then becomes a new entity, and existing shareholders (in the parent company) get new shares in the new entity.
• Direct Sale of Assets: A parent company may sell the assets of a business unit under duress to repay debt or avoid bankruptcy. The sale usually involves cash and may have tax implications.
• Sell-Offs: In a sell-off, the parent company gets cash in exchange for the divested subsidiary.
• Carve-Outs: A parent company may sell a portion of its core business through an initial public offering (IPO) to new shareholders. The sale involves selling a non-controlling amount of the shares while retaining controlling shares.
• Split-offs: These are similar to spin-offs, but the existing shareholders can choose to keep their shares in the parent firm or put them in the newly created independent business entity.

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Key Differences Between Spin-Offs and Carve-Outs

Besides sell-offs, spin-offs and carve-outs are the two other most common divestment methods.

Here's how the two differ:

• In a spin-off, the new entity is independent. In a carve-out, the parent firm retains control and management over the new business unit.
• After a spin-off, the current shareholders of the parent company receive new shares in the new entity. In a carve-out, a new set of shareholders is introduced.
• A spin-off doesn't generate cash, while a carve-out involves an equal exchange of shares for cash.

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How to Execute a Successful Divestiture of Business

Divesting a business can be tricky, making it necessary to learn how to execute the process well in advance to ensure success.

Here's how to ensure your divestment is successful:

1. Plan the Divestiture Carefully

The planning stage for the divestment process includes steps such as:

• Identifying the assets or business units you would like to shut
• Evaluating the strategic fit or misfit of the unit within the overall portfolio
• Analyzing market conditions to determine when to sell your business
• Setting clear goals or objectives for the sale
• Assessing your reasons for selling
• Preparing marketing materials or collateral
• Determining the potential value you can get from the sale
• Convincing your management and shareholders that it's beneficial to sell the business unit

2. Determine the Ideal Type of Divestiture

You can choose the most suitable type of divestiture depending on your needs. For example, you can choose a spin-off vs carve-out if you want a non-cash and tax-free divestment.

If you want cash sooner, choose a sell-off or direct sale of assets.

3. Prepare the Business Unit for Sale

Preparing the subsidiary for sale includes steps such as:

• Reverse due diligence
• Gathering all the documents and information relevant to the sale, including legal, financial, and operational details
• Devising a de-integration or separation plan for the newly divested company asset
• Addressing any issues that may impact the sale negatively

4. Determine the Value of the Unit

Calculate the value of the business unit using different valuation methods.

Then, make a detailed business valuation report to showcase the unit's suitability to potential buyers.

Tip: If you want a quick estimate of the unit’s value based on its revenue or EBITDA, check out our free business valuation calculator.

5. Market the Unit

Use comprehensive marketing materials to market the unit to potential buyers through different channels.

Social media and industry circles are great places to market your business.

6. Identify Potential Buyers

Research widely both online and offline to find potential buyers for the business, such as competitors and industry leaders, among other possibilities.

Check if you have any employees or members of the management team who would be willing to buy the business. Use this option only if you feel it's the right time to inform your employees about the sale.

7. Participate in Due Diligence and Negotiate the Sale

Once you have found the right buyer and they've sent you a letter of interest, have them sign an M&A non-disclosure agreement. You can then proceed to the due diligence and negotiation stage.

Ensure you negotiate favorable sale terms. Ask for a favorable type of divestiture based on your needs. If cash is one of your most pressing needs, you can negotiate a sell-off.

8. Close the Deal

After deliberations and agreeing on favorable terms of sale, it's time to complete the deal process.

The buyer will pay for the divested company as agreed, and you'll separate it from your business portfolio and transfer it to the new owner.

Notably, selling a subsidiary isn't a walk in the park. The best exit strategy is hiring and working with an M&A team to help you.

At Exitwise, we help founders, CEOs, and business owners hire and manage their M&A team for a successful sale. We can help you find industry-specific M&A experts such as wealth advisors, financial accountants, and investment bankers.

Reach out to our team today to achieve the successful business exit you've always dreamed of.

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Challenges and Risks in Divestments

As mentioned, divestment can be stressful, especially if it's your first or the business unit you want to sell off is complex.

You may encounter the following challenges and risks in a divestiture:

• Poor Due Diligence: Inadequate or botched-up due diligence can mean missing issues that could lower the value of the unit or ruin the deal if discovered by the buyer. Ensure your team conducts sell-side due diligence intensively and extensively.
• Disruption to Operations: The sale process may interfere with the unit's operations. If the revenue streams and workforce are negatively affected, the unit's value can fall significantly. Having a dedicated internal team to collaborate with your external M&A team can help prevent or minimize the effect of the disruptions.
• Loss of Key Talent: Loss of morale is common when employees learn about a sale. Some may leave, further weakening the unit's value. You should wait for the right time to notify the employees about the sale.
• Unfavorable Market Conditions: Finding a qualified strategic buyer for a subsidiary may be difficult. Market situations such as economic downturns can lower the value and sellability of a business. Ensure the timing of the sale is correct, such as when the sector is enjoying a surge in M&A activity.
• Legal or Regulatory Complexities: Complying with privacy, data, and antitrust laws can be difficult. You'll want to keep tabs on all the regulations that may apply to your divestiture to ensure compliance.
• Securing Shareholder Approval: You may not get unanimous approval from your management and shareholders to sell off a subsidiary. While it's possible to sell without the approval of the management, it is far more tasking. Future benefits tied to the divested subsidiary would be a good leverage point to convince them.

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Frequently Asked Questions (FAQs)

Let's wrap up with a few questions about selling off a subsidiary:

How Does Divestiture Accounting Work?

Divestiture accounting works a lot like regular M&A accounting. Both buyer and seller have to do financial reporting, which includes allocating the purchase price as the case may require.

Basically, the transaction is recorded based on the fair value of the consideration offered or received, which could be cash or stock.

The tax implications of the business sale are that you'll be taxed on capital gains or losses, which should be accounted for according to capital gains statutes.

Accounting for a divestment properly can be tricky. You'll want to work with our team at Exitwise to find the right financial accountants to help you.

How Does a Divested Company Operate Post-Divestment?

The way a divested company operates after the sale depends on the type of divestment applied.

For example, if the divestment was a carve-out, the parent company will have some stake in the new entity. As such, the new entity operates mostly under the control and management of the parent company.

If the divestment was a spin-off, the new entity would be independent and could operate independently from the parent company.

What Is the Impact of Divestment of Assets on Financial Statements?

The divestment of assets can reduce or increase values in different financial statements.

The balance sheet should show the removal of a capital asset.

A gain from the sale should show an increase in values on the income statement, while a loss would show a decrease.

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Conclusion

While the reasons a company sells off its subsidiary can differ from one situation to another, the bottom line is that it can be a great tool for creating greater value in the parent company.

If you are considering selling off a subsidiary, working with M&A experts can help speed up the sale and ensure its success.

You can work with us at Exitwise to find and manage the best M&A experts in your industry to help with the sale. We'll help you collaborate with the best M&A lawyers, finance accountants, investment bankers, and wealth advisors for a streamlined sale.

Consult with us today to kickstart the successful exit you deserve.