M&A Basics | Can I Sell Part of My Business?
I’m in discussions with a prospective buyer who has a keen interest in acquiring my business. Our discussions have revolved around his potential purchase of the manufacturing segment of my enterprise, while I intend to retain ownership of the wholesale division.
Could you assist us in devising a well-structured deal and determining the appropriate asking price for each of these divisions independently? While I’m contemplating this approach, I’m uncertain if it’s the optimal strategy and seek guidance in formulating a robust plan.
Selling a business doesn’t always necessitate an all-or-nothing decision, as exemplified by the strategic approach of Jack Welch, the former CEO of General Electric (GE). Jack Welch was renowned for strategically divesting business units to enhance the growth prospects of GE’s remaining entities. During his initial four years as GE’s CEO, he successfully divested over a hundred business units, representing approximately 20% of GE’s assets. This initiative involved significant workforce changes, including layoffs, retirements, and divestitures, resulting in the elimination of over 100,000 jobs. Over his 20-year tenure, Welch steered GE to remarkable financial achievements, with profits skyrocketing from $1.5 billion to $15 billion, and market valuation surging from $14 billion to an impressive $400 billion.
When contemplating the sale of your company, the idea of selling a specific portion may indeed cross your mind. You might find yourself pondering various aspects of this process, including its wisdom and prevalence.
Numerous business proprietors have their entire wealth invested in their companies, despite the associated risks. Opting to sell a segment of your enterprise can facilitate the creation of liquid assets while retaining full control over the remaining components. This approach also allows you to channel your talents and resources toward the division you believe holds the greatest growth potential.
In the following article, we address critical questions, such as:
- Why do businesses choose to divest divisions?
- Is selling a portion of your business a viable option for you?
- What operational considerations come into play when selling a segment of your business?
- What are the legal aspects to consider when pursuing such a sale?
- How can you establish an appropriate asking price for a specific division of your business?
It’s worth noting that publicly traded companies, often under immense pressure to meet quarterly earnings projections, frequently opt to divest non-core divisions. You too can explore this avenue, even if you’re not Jack Welch. To delve deeper into these insights, read on…
Why Businesses Sell Part of Their Companies
Divestiture, in the realm of business, refers to the sale of a segment or asset of a company. This action is typically taken when a company’s management decides to discontinue its involvement in a specific business unit or asset.
Now, let’s delve into the reasons behind businesses opting to sell a part of their operations:
- Streamlining Core Competencies: Divestiture is often employed as a strategic move to sharpen the company’s focus on its core competencies. In simpler terms, businesses may choose to divest divisions that fall outside their primary operations. This allows the entire company to channel its efforts into what it does best.
- Correcting Acquisition Mistakes: Companies can find themselves in situations where they’ve made less-than-optimal acquisitions. In such cases, divesting these investments becomes a means to rectify their missteps. Perhaps the acquiring entity was too vast, causing the newly acquired business to lose its identity and suffer from neglect. Occasionally, poor management decisions may necessitate the divestment of underperforming business units. Selling off a weak division becomes a straightforward solution.
- Fundraising through Asset Sale: Another compelling reason for selling non-core divisions is the need for capital. Divestitures inject cash into the company at the point of sale. This liquidity can then be directed towards more promising opportunities that offer higher returns. Additionally, there are instances where a company’s individual components possess greater value than the company as a whole. Consequently, breaking up the company and selling its individual parts can yield a more substantial return than selling the entire business entity.
So, Should You Sell a Portion of Your Business?
With meticulous strategic planning, it’s often feasible to divest only a portion of your company. This approach empowers you to unlock additional resources for your retirement or channel growth capital back into your business.
For small to mid-sized business owners, the decision-making process may not be as straightforward as it is for larger corporations like General Electric or the Hewlett-Packard Company.
When contemplating whether to sell the entirety of your company or just a segment of it, the prudent approach is to assess the overall value of your business and the individual worth of each division. In some cases, selling your business in segments may yield the most favorable outcomes.
You have two primary avenues for selling a portion of your business:
- Selling a Percentage of Your Company: This entails selling a specific percentage of your entire company, often structured as a portion of your company’s stock. This form of sale is commonly referred to as a recapitalization and is frequently embraced by business owners seeking a phased retirement strategy. These entrepreneurs may opt to secure a portion of their investment in the form of cash.
- Selling a Division or Unit: Alternatively, you can opt to sell a distinct division, unit, or category of your business. Many such transactions are driven by strategic considerations. A prospective buyer may perceive substantial value in one division of your company while assigning less value to others. In such cases, a spin-off of the valuable division becomes a viable option to explore.
Selling a Division is a Strategic Decision
Selling a portion of your business doesn’t signify relinquishing something; instead, it’s a strategic move to nurture the overall growth. The expense of retaining a non-performing or non-core division can outweigh the returns generated by selling it. This calculated decision can liberate your time and resources, empowering you to concentrate on your core operations, potentially amplifying their value.
Numerous business owners hold a substantial portion of their personal wealth tied up in their ventures. Divesting a segment or division provides a means to create liquidity while retaining full control of the remaining entity. It also grants you the opportunity to harness your skills and passion, focusing on the division with the greatest potential or the one that aligns best with your preferences and work-life balance.
Consider a common scenario: a business that began as a single retail location and evolved into a multi-location enterprise with a significant online presence. Dividing the business into two distinct divisions – one online and one retail – can enhance its marketability and potentially maximize its value. Many buyers exhibit a strong preference for either online-based or retail businesses. Selling these divisions separately effectively addresses this challenge.
The decision to split your company can streamline its sale, elevate its value, and ultimately lead to a higher selling price.
It’s essential to recognize that value and risk share a direct relationship. Lower risk translates to higher value, while higher risk diminishes it. By dividing your business into two, you have the potential to diminish the level of risk for prospective buyers, making your offering even more attractive.
Why? Because it’s a fact that very few buyers possess the multifaceted skills and knowledge required to excel in diverse domains, such as both the retail and online sectors. Typically, a buyer’s expertise is concentrated within a specific domain.
If your business comprises two distinct segments but must be sold as a whole, potential buyers may perceive one of these segments as unduly risky if it falls outside their area of expertise. Consequently, this mismatch can lead to a lower valuation. However, if you have the option to sell the online and retail divisions separately to buyers well-versed in each realm, the risk diminishes for each buyer. This reduced risk factor can potentially translate into a higher purchase price.
It’s not uncommon for businesses to expand their product lines as part of their overall growth strategy. In this process, business owners sometimes venture into product lines that later prove regrettable. These product lines may not align with the core operations or may divert attention from the primary business focus. In such cases, divesting the product line becomes a logical step.
Furthermore, many buyers actively seek strategic acquisitions with specific criteria in mind. They might express interest in just one facet of your business, disinclined to pursue the entire entity because other divisions don’t align with their strategic objectives.
Consider the recent noteworthy example of Hewlett-Packard CEO Meg Whitman, who opted to spin off and merge the non-core software assets with Micro Focus, a British company. This transaction carried a valuation of approximately $8.8 billion, notably less than the $11 billion initially spent on acquiring the division five years earlier.
Even small businesses can reap rewards from segmenting their operations into distinct divisions and offering them for individual sale. For instance, certain businesses require specialized licensing, making the division of the business a prudent move, especially when some potential buyers may exclusively target divisions not requiring special licenses.
Ultimately, the decision should commence with a strategic evaluation, aligning with your long-term objectives. Only after this strategic consideration should you delve into the tactical aspects, which we’ll address in the following section.
Consider the Operational and Legal Implications
Before diving into the legal intricacies, it’s crucial to ensure the practical feasibility of dividing your business into two separate entities on an operational level.
Some divisions within a business can be so intricately intertwined that attempting to disentangle them would either prove unworkable or incur exorbitant costs. Ideally, businesses best suited for division are those that can be smoothly split operationally.
Here are some key operational considerations to weigh:
- Do you maintain distinct websites, phone numbers, and facilities for each division?
- Can costs be accurately allocated between these divisions?
- Do your employees have shared roles across divisions, and if so, which division would they align with in a split?
Addressing these questions at an early stage is crucial to ascertain the practicality of operational division. In many instances, substantial effort may be required to ensure a seamless separation.
It’s worth noting that potential buyers are generally reluctant to undertake the challenges of creating separate websites, hiring new personnel, and managing the numerous other tasks involved. This reluctance is unless you’re selling a division that can be seamlessly integrated into another company, such as a product line.
If the prospective buyer intends to operate the division as a self-contained entity, it’s advisable to run it as a standalone business for as long as possible before initiating the sale process. This approach streamlines the sale and simplifies the valuation of each division independently. Additionally, it enhances the buyer’s prospects of securing third-party financing for the transaction. The more autonomously the division functions before being put on the market, the smoother the sales process. Conversely, the more interdependent the two divisions within your company, the more challenging they become to sell.
When it comes to the legal aspects of selling a division, there are two primary deal structures to consider: an asset sale or a stock sale.
Asset Sale: If your business functions as a single entity (e.g., corporation, LLC) with distinct segments, your sole option is to structure the sale of one of the divisions as an asset sale. In this scenario, your entity sells the individual assets of the division to the buyer through an Asset Purchase Agreement (APA). The assets are itemized and transferred separately in a bill of sale. The term “Definitive Purchase Agreement” is sometimes used interchangeably, signifying that the agreement is definitive and finalized at the closing.
Stock Sale or Asset Sale for Separate Entities: If each division operates as a separate entity, you have the flexibility to structure the sale as either a stock sale, facilitated by a Stock Purchase Agreement (SPA), or an asset sale via an APA. In a stock sale, you sell the shares of the entity that owns the division and its assets. Since the entity already owns the assets, there’s no need for separate asset transfers.
Recapitalization (Recap): Alternatively, you can consider selling a percentage of your company, essentially a portion of your shares within your entity. However, this approach retains ownership of both divisions post-closing and is commonly referred to as a recapitalization or “recap” for short. It’s often embraced by business owners who contemplate retirement but aren’t ready for a complete exit.
A recap allows business owners to secure some liquidity while diversifying their risk. Typically, recaps are funded by financial buyers, such as private equity firms, who acquire a minority position in your business. The expectation is that a significant portion of the equity injection will serve as growth capital for the company.
Private equity firms operate with a defined time frame and anticipate business growth, aiming for a second exit within three to seven years. While corporations can also make minority investments, this is less common than investments from financial buyers. Recaps are an ideal choice for business owners seeking immediate financial gains while receiving support from sophisticated investors willing to inject growth capital. This strategy results in a dual exit strategy – a minority exit initially, followed by a majority exit in the subsequent three to seven years.
Ultimately, the decision to sell a division should align with your long-term objectives. If your goal is to concentrate on your core division, a recap may not be the optimal choice. However, if you intend to diversify your risk, secure liquidity, and are willing to continue managing the business for an extended period, a recap may indeed be a prudent strategy for you.
Determining an Asking Price for a Division
Determining the asking price for a division or segment of your business follows the same principles applied when valuing the entire business. Essentially, you’re assessing the sale of a cash-flow stream. To accurately gauge its value, you must begin by measuring it. Here’s where the process can get intricate.
In cases where the two segments are closely intertwined, calculating the EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) for each division separately can be challenging unless these divisions operate as independent units.
If your businesses aren’t operating as standalone entities, it becomes essential to create a pro forma. However, it’s crucial to understand that any inaccuracies in this pro forma will have a magnified impact when multiplied.
Let’s illustrate this with an example: If you overstate income by $500,000, and your business is valued at a multiple of 4.0, your business could end up being overvalued by $2,000,000 ($500k x 4.0 = $2 million).
Preparing a pro forma for a division presents challenges, primarily due to the intricacies of appropriately allocating expenses between divisions. While revenue allocation may be relatively straightforward, it’s essential to consider the effects of any inter-division transactions on revenue. When it comes to expense allocation, you’ll need to make decisions about how to apportion fixed expenses.
For instance, if your facility costs currently total $20,000 per month for both divisions, you must determine a reasonable rent allocation for each division separately. Similar considerations apply to the allocation of other corporate overheads, including salaries, insurance, professional fees, advertising, marketing, and more.
Another approach, if it’s feasible for your situation, is to value the business as a whole and then allocate values to each division based on their respective revenue contributions.
For instance, suppose your company generates $20 million in revenue and holds an overall valuation of $10 million. If “Division A” contributes $12 million in revenue (accounting for 60% of total revenue), and “Division B” brings in $8 million in revenue (representing 40% of total revenue), you would assign a value of $8 million to Division A ($10 million x 60%).
While this may appear to be a straightforward calculation, it’s important to note that some buyers might not readily accept this method. The concern lies in the potential underestimation of fixed expenses and the resulting overstatement of income or profit margins. Consequently, the profitability between divisions could differ significantly.
This allocation method holds merit when the two divisions exhibit similar margins and expenses, as seen in cases like two closely related product lines (e.g., two clothing lines).
Ideally, valuing the divisions based on their net profit contributions would be preferred. However, this approach involves numerous assumptions that are susceptible to errors. While a quick ballpark valuation for each division can be obtained, it’s essential to recognize that such estimates may not meet the requirements of most prospective buyers. Such ballpark figures are best suited for internal planning purposes.
When a buyer seeks a division of your company for strategic reasons, it calls for a distinct approach to valuation.
In this scenario, your focus should be on creating a pro forma Profit and Loss (P&L) statement that envisions your division seamlessly integrated into the buyer’s organization. It’s highly probable that certain functions within the division, such as HR, legal, and accounting, will be centralized by the buyer. This centralization will drive down expenses, boost income, and consequently elevate the overall value of the business.
While it’s generally a safe assumption that reduced expenses will be a key driver, it’s important to recognize that buyers tend to place less emphasis on paying for revenue synergies compared to the cost-saving synergies. Even when it comes to operational synergies (i.e., cost reductions), vigorous negotiation is often necessary to secure the full value.
Complicating matters, buyers typically do not readily share their financial models or pro forma statements. Therefore, your best approach is to prepare a well-informed estimate and engage in negotiations to secure the highest possible percentage of the synergies.
Selling a Division is a Strategic Decision
In certain scenarios, the decision to sell your business as a whole or to divest its divisions separately can significantly impact your future. The right choice hinges on various factors, and seeking professional guidance is advisable.
Your initial step should involve a thorough assessment of your entire business’s value and the individual worth of each division. Once you’ve accomplished this, it’s essential to clarify your long-term objectives. Determine whether selling a division or opting for a partial sale, like a recapitalization, aligns best with your overarching goals.
Whether to sell a division or segment of your business is a strategic choice deeply rooted in your long-term vision. As you deliberate, consider these pivotal questions:
- Will streamlining operations and focusing solely on my core business bring greater satisfaction?
- Have I extended my reach too far, and could divesting a division enhance my concentration?
- Given my current insights, would I initiate both divisions again?
- Which division generates the most significant profits for me?
- Which segment of the business aligns most closely with my skills and strengths?
- How feasible is it to sell each segment separately?
- Is it practically viable to pursue separate segment sales?
- What is the potential value of each division?
- What is my primary operational bottleneck at present?
- Do I require growth capital to substantially expand my business, and if so, would selling one division free up resources and energy for my core competence?
- If I divest one of my divisions, could reinvesting the proceeds in the remaining division result in a significant revenue and income boost?
Once you’ve carefully considered these questions, along with the operational and legal aspects we’ve explored earlier, you’ll be well-equipped to make an informed decision regarding the sale of a portion of your company.
Business owners opt to sell segments of their companies for a multitude of reasons, and selling just a part of your business can indeed be a prudent move. It’s a practice with a solid track record, often providing you with the cash flexibility you need.
However, it’s crucial to enlist the expertise of a professional to assess your specific situation and provide tailored guidance on the best course of action.
The decision to sell your business as a whole or in parts hinges on a complex interplay of factors, including your desired level of involvement in the company’s future. Moreover, obtaining valuations for both the entire business and its individual components will empower you to make financially sound choices for your enterprise.
Rest assured, seeking professional advice is a prudent step in this process. Remember that selling a portion of your business doesn’t equate to surrendering something; rather, it’s a strategic move to allow the entire entity to flourish. In the end, the cost of retaining an underperforming or non-core division may far outweigh the potential returns.