What Is Divestiture?

Small business owners sometimes find themselves with a cash-flow problem. Their business is going well, but it needs a money infusion to stay that way. Maybe a venture that seemed promising ends up being less so. Whatever the case, the balance sheet isn't adding up, and you need a new business strategy.

In the business world, divestiture means selling off assets. This strategy can improve a company's value, increase its profile, or obtain more money. Small businesses may divest as part of a Chapter 13 restructuring. This article reviews some of the types of divestiture and the advantages and disadvantages of doing so.

Divestiture Definitions

Divestiture occurs for many reasons and has many forms. In general, it involves selling, closing, or redistributing business assets. Not all apply to small businesses, but a small business may result from a larger company divesting its assets.

• Spin-off: A larger company creates a new business from an existing division. This new business remains part of the parent company.
• Split-off: If the parent company completely divests itself from the new company, and shareholders have no shares in the old company, it is a split-off. These divestitures may occur when a large company is facing antitrust litigation.
• Sell-off: The company sells some or all of its assets for cash. If a sell-off is part of a split-off, the new business owner takes over all the assets of the older company.
• Carve-out: A carve-out creates a full subsidiary from its core business. For instance, a large multinational corporation may create a wholly-owned subsidiary in another country so that shareholders in that country can own the company assets there.

Even small businesses can face these difficulties. In a booming economy, small companies can grow faster than intended and become overextended when a downturn hits. Many small companies faced this during the 2020 pandemic. A partial divestiture helps you get through financial crises without losing your entire business.

Reasons and Ways To Divest

You don't have to be a huge conglomerate to need a divestiture. Some of the common reasons businesses find themselves facing divestiture besides creating new companies may include:

• Bankruptcy: Filing a business bankruptcy is different than filing a personal bankruptcy. A business bankruptcy is a reorganization. Sometimes, the trustee wants the business to stay open until the creditors' judgments are paid. If your business is underperforming and needs to cut some deadweight, partial liquidation can resolve the problem.
• Raise Cash: If there is too much red in the company's balance sheet, divesting some assets can help save others. This may be part of a bankruptcy or court order, or you may need the boost that selling a valuable asset can give you. If you're starting a new product line, you might need to drop an underperforming item to make room.
• Focus: In boom times, small businesses sometimes expand in too many directions, losing focus in downturns. This happened to many intellectual property and tech companies during the dot-com boom of the early 2000s. Eliminating parts of your business that have strayed too far from your core concept helps you focus on the parts that are profitable.

You should take care when divesting any assets. Whenever customers hear of an impending sale, they automatically fear the worst. If your customers or clients hear you're divesting or selling, they may assume you're going out of business, especially in today's high-speed social media world. If you are planning to sell or another company is purchasing yours, rumors of sales can hurt your valuation.

During and After Divestiture

Whatever reason you have for conducting a divestiture, there are some things to keep in mind during the process. Whether you are selling fixtures, real estate, or parts of the business, you should have financial guidance and legal advice.

If you are selling off part of the company, ensure the acquiring company is not a direct competitor. Potential buyers must have access to current financial statements. The split-off portion should be operational immediately.

Be aware of any regulatory or legal restrictions about divesting or acquiring company assets. As with any business purchase or sale, you should consult a business law attorney in your area before finalizing the deal.