A Guide to Planning Successful Divestitures

I'm Kisam Patel and you're listening to M and A Science, where we talk with deal professionals and learn valuable lessons from their experience. This podcast focuses on stories, strategies and what actually happened during M and A deals. Welcome to M and A Science. I'm Kisan Patel. Today here with Al Ansari, an M and A and Divestiture advisor, currently assisting Cisco with the development of their divestiture methodology. Al has over 20 years of experience as a Chief Executive Officer and an M and a divestiture and Integration advisor. Al, you've been involved with over 80 acquisitions and divestitures. My first question for you is why does a company divest?

Thank you Kasan for the opportunity. It's a pleasure spending time with you and your audience today. There are many reasons why a company may choose to divest its asset. It could be that the asset is no longer a core business or the seller may facing new regulatory compliance requirement and need to divest the asset. There are other reasons such as the seller may looking to raise capital or reducing debt and also the seller just want to stop bleeding and cutting the loss. So there are many ways to look at why we're doing the divestitures.

How typically does a company come to the decision to divest?

Yeah, the most common divestiture challenges that I have encounters are to identify and agree on divestiture candidate. It could be asset or liabilities or both across the company and there should be agreement between the corporate business and the NSCOPE bu which I call it a divestiture candidate. There should be also a clear expectation what I call the guiding principle what are we selling? How are we going to sell and what is our seller commitment post close. So it's very important to understand those commitments post close and start drawing the line. The other point here is the buyer dependencies. The buyer dependencies another challenge that sellers should consider their financial and especially around the operation enablement capabilities and capacities. The other challenges, especially for a large strategic seller is that they follow a very rigid methodology and they are not open minded and flexible regarding divestiture. Divestiture could be a new things for them and they maybe have a very robust let's say integration M and a process in place. But divestiture is just a different breed and you have to deal with it accordingly. The rigid methodology regarding the pre and post activities are very important to consider and the key to divestiture is to be flexible and agile. And finally it is important how to handle the buyer demands before, during and after close and the seller must know when to say no, whether say no to post close activities such as restructuring the business which affecting their capability to divest their asset quickly according to agreed schedule or the customer reaction or impact, you may end up divesting asset that has a contract and the customer may refuse to assign the contract to the buyer.

I want to back up a little bit, Al. What would you say are the benefits of divestitures?

The benefit is cutting the loss, raising the capital, reducing the debt and reducing the risk for regulatory compliance. Focusing on the core strategic business.

Gotcha. Okay, so you covered that then. What advice do you give to companies considering to divest assets?

Sure. I think my main advice is to be prepared to answer questions such as what am I selling, how am I planning to sell it? In another word, how I'm going to package the deal and who is my target buyer. With these questions, you basically set up the roadmap going forward with your divestiture journey.

Gotcha. And then when they're thinking about the potential acquirers of the company, is that something that's really crafted in house and you start identifying potential companies or are you working with outside advisors to do that?

I would say it's a combination of both. You, you definitely use outside counsel and investment banker and potential buyer who are coming to you and you got to do your own homework to basically see which one is the best fit.

I know there's a lot of work that goes into divestiture, but say we're going to bring a banker into this, at what phase would that happen? Because it seems like there's so much work and we'll probably get into deeper about it, about carving out. Is that something we sort of get the company ready to divest and then talk to a banker? Or does that happen much earlier while we're still in the process of actually carving it out?

Yeah, this is happening at the very, very early stage. I would say. There are obviously there's some homework that has to be done early on within the internal company and the insco bu to identify these assets. Package it the way you would like to put in front of the buyer and those advisors will help you on all aspects of it, whether it's a legal aspect or regulatory compliance aspect or financial asp. These advisors have to come early on as soon as they can, and then they help you help the seller with packaging the deal.

Got you. So you want to think about that pretty early. What would you say are the common divestiture challenges?

Yeah, so the most common divestiture challenges that I have encountered are to identify and agree on the divestiture candidate. I call them Inscope Euro. It could be asset or liability across the company. There should be agreement between corporate deal team and also the ensco bu There should be a clear set of expectations or guiding principle. Regarding as I mentioned early, what are we selling, how are we going to sell it and what is our commitment? Post close from the seller perspective and buyer dependency is another challenge that sellers should consider. Their financial ability, are they able to close the deal? Are they depends on some other triggers for the financial or also think about their operational enablement, especially with the investment buyer such as private equity. They usually do not have operational enablement capabilities, especially with a global footprint. Some of them are very, very good. Some of them you just have to help them to set that expectation up front. Another challenge, especially for a large strategic seller, is that they follow a very rigid methodology, are not open minded and flexible. They think about strategy at the divestiture execution as kind of like a reverse M and a integration which is not and we're going to talk about it later with you. A rigid methodology will just hamper their activities for pre and post close activities and the key to divestiture is to be flexible and agile. Finally, it's important how to handle buyer demands before and after close. As a seller you must know when to say no. Whether it's regarding restructuring the business on behalf of the buyer or customer reaction for assigning the contract.

Can you give me some examples of buyer dependencies and buyer demands that you come across?

So the buyer dependencies is very critical because once you close the deal, there's a lot of business enablement that has to be in place. Such as, let's say, you know, you close the business, you close the deal and what's happening is you gotta do your payroll 15 days or 10 days or 5 days after close and you have to make sure that the buyer have that capability to do that. And there's a lot going on behind these enablement, whether it is a procurement, whether it's payment, whether it's payroll. So the buyer has to be extremely capable to enable these capabilities right after close.

Al, you mentioned there's a pretty big difference between divestitures and acquisitions. Can you elaborate on how they differ.

At the end of the day? If the question is are divestitures reverse acquisition, the short answer is no, the divestitures are not reverse acquisition and here's why. The buyer influences the structure of the deal. They may negotiate and select the asset liabilities and the seller also should have A walk away guidance. For example, for post close commitment, capture within the TSA or transition service agreement, pricing and etc. The buyer may select to restructure the business after the close and therefore impacted the customers and employee and contracts. And so this is a big distinguish between divestiture and acquisitions where you know within acquisition you bought the, you bought the asset or liability or business and you have a roadmap and business plan of record to integrate. But within divestitures you have all these variables that impacting your deal including restructuring the business after close and you as a seller, you may start doing some of these activities for the buyer. The focus of the MA integration is mainly on go to market, what am I selling, how am I going to go to the market, so on and so forth. Whereas the divestiture focus should be on the business continuity, customers and employee contractors. For example, you may have a commingled contract which impacts your customers, your current customers, or you may have, you know, the employee, you may run into the employee retention after the deal closed and the buyer decided to do a carve out. Last but not least is within the ma, you don't have something called transition service agreement and this is a good time to provide a definition for that. Transition service agreement is basically the agreement between the buyer and seller where the transition service agreement is conducting business on behalf of the buyer and transfer economic benefit to the buyer for certain period of time. You don't have that in MA integration. And so all of these factors, whether it's a buyer influence, whether it's a focus, whether is the TSA for post close or the main reason that the divestitures are different than MA integrations.

What is the buyer compatibility matrix?

Great question Kasan. The buyer compatibility metrics provide vital information about the potential buyer, their capabilities and their fitness. First step is to identify the buyer type. We examine their financial liability. We study what I call the baseline analysis. So within this baseline analysis we're really looking at three aspects. One is the, what I call it the commercial operations, you know, their capabilities around sales, marketing, order management, supply chain, product marketing, and so on and so forth. What capabilities do they have currently or they don't have and what capabilities that we as a seller have and we can transfer it as part of the transaction. The other bucket, I call it the workforce separation. The workforce separation is all the activities regarding offloading your employee as an asset to the buyer. And so these capabilities, the capabilities that goes to support your employee, whether is their payroll or stocks or benefit will have a huge impact after they close and can interrupt a large portion of your transaction activities. And then the last bucket is the shared services, all the activities regarding the legal finance, tax, legal entity, legal entity enablement, which I think we will cover it in some other podcasts and obviously their IT footprint. What kind of capabilities do they have, what kind of resources they have or they you don't have? The other piece of compatibility matrix is regarding the level of integration and the question here is that what is the level of disintegrating of divested asset from the seller. You may bought this asset 510 years ago and you really fully integrated into your current processes. Now it's time to divest this asset and the question of the day is that how difficult it is to untangle it. Cultural compatibility is a big part of the buyer compatibility matrix where what I'm looking to is the retention of the employee is the key to business continuity. If the buyer decides to restructure the business after close, it may impact the employee morale and cause a drain of talent and interrupt the business continuity. And last but not least is the synergy if you are selling let's say software company to investment buyer who are selling let's say windows or doors or polymer. Completely different business.

You mentioned buyer types. What types of buyers are interested in divestitures?

Sure, there are two major buyer types in the marketplace and these are strategic buyers and investment institutions including the private equity buyer. Sellers should prepare in advance to interact with these buyers. The strategic buyers more likely have existing infrastructure in place for R and D go to market, legal entity and legal entity enablement and all their job gna function. There is a high chance for potential antitrust scrutiny with the strategic buyer and also the in scope BU and founder usually like strategic buyer. Whereas private equity we also within the strategic buyer may not consider upfront investment because they have these infrastructures in place so they don't have to build a new supply chain or order management or new capabilities that requires and may also requires a transition service agreement for the post close operation after the deep close. On the other hand, investment institution including private equity are less likely have existing infrastructure in place for that legal for that asset that we're selling to them. So there really depends on what asset is coming over and all the infrastructure that comes with that asset. Whether it's IT infrastructure, whether it's a sales infrastructure, whether it's a go to market and so on and so forth. There is less chance for antitrust risk for private equity and investment institution. And you may consider upfront investment and cash flow you being the buyer as an investment, they require TSA obviously. And there is a need for longer separation post growth because in most cases private equity, you have to basically either build from scratch or, or you have a large gap that has to be fulfilled.

Now that we discussed buyer types, let's address transaction types and structure. Are there differences in the divestiture types and structures?

Yes, there are different transaction types and divestiture structure. Seller may consider what I call the asset sales which is basically selling asset liabilities or both within legal entity and not selling legal entity. For example, selling just IP or real estate or contracts or account receivable, account payable or even employee within scope bu. Another type of divestiture is asset and entity sales or entity sales. In this case we are selling a legal entity and assets and liability within legal entity. We can talk about the legal entity here or we can have a follow up discussion. But very shortly, the legal entity has legal capacity to enter into agreements with or contract, assume obligations, incurring and paying debts, sue or to be sued in its own right and to be held responsible for its action. So within, let's say, you know, if I want to do a business in California, I got to set up my legal entity in California. And then within that legal entity I may have asset, I may have contract, I may have real estate or site, I may have employee, I may be able to buy and sell within that entity. I may take advantage of certain tax advantage that has been set up within that jurisdiction. So it is important to within this category, the asset and entity sales is that understanding these legal entities and footprint, what are we selling and the legal entity enablement, those enablement within that legal entity. Payroll, procurement, payment are the main focus of these legal entities. And then the last category is the car vat. The Corvette effect effectively separates a subsidiary or in scope business unit, I call them bu, from its parent company as a standalone company. The BU has its own board of directors and financial statements and the parent company usually retains a controlling interest in the new company. It usually done by carving out the in scope bu to separate legal entity or entities and enable the in scope BU within these legal entities. The Carbat requires upfront investment, obviously because you gotta enable these capabilities and it's gonna cost you to set up these legal entities, especially if you have a large global footprint within that divestiture. And also you need, you know, time and resources to set it up. It's not something like you can set it up in 24 hours, you know, 24 legal entities globally, you, you have to work with each jurisdiction and you want to make sure that you've done all your paperwork up front and, and you got to go through that process. Within each country and entities, there are two types of carve out. The first type is the equity carve out which is a business selling shares in business unit or the business that you're divesting. The company receives cash for selling shares and the company has some control over the business unit. The company in this case is a parent company who's divesting the business unit. The company may also realize that the sale of the BU is not imminent and it may take longer. And that's one of the technique that you use for the carve out, you know, using the equity carve out. The second type of the carve out is a spin off is that the company divests a business unit by making the BU its own standalone company. The company does provide a distribution of the shareholders for all the stocks and subsidiaries. These are basically the company by itself and it again has its own board and has its own financial statement. And the parent company may have interest in this spin off and they usually pretty good at supporting them to be successful.

On these transaction types. Is there a certain transaction type that you see as most common and also easier to do?

That's a million dollars question. So I would say yes and no. So if you want, if you, if you're a seller and you, if you just want to sell your asset the quickest, well, the quickest way and the cheapest way, I would say do your asset sales or choose the asset sales with the entity sales and stay away from legal entity enablement. Push that on the buyer's court and make sure that the buyer has the capability to do that. In other words, once you close the deal, the buyer should be able to say, okay, I have this business, I know how to run the, how to handle the contracts, I know how to handle the payrolls, I know how to handle the customer support, so on and so forth. Right. That's the cheapest way. But it has more headache. Right. If. What if you know you have a buyer that don't have those capabilities? Well, you know, now you're getting into all kinds of various tsa, whether it's a service tsa, whether it's an employee TSA where you as a buyer have to perform certain activities on behalf of the buyer. Now the cleanest way is the carve out. Unfortunately, with the carve out, you as this seller has to pay upfront investment to enable these carve outs in other words, first of all, you have to carve out the entity, you have to establish a new entity and you have to enable these entities. And then once the company become independent, whether it's a subsidiary or a carve out of your parent company, then you can say, okay, you know, Mr. Buyer, I have this, you know, wrapped in the bow. Everything is there. They're capable of doing this and here it is. Right. So from the buyer, from the seller perspective, it's less headache. But on the other hand, the seller may come to you and say, you know, that's great, this is a very clean business that I want to buy, but I'm not willing to pay for all this enablement capabilities. I don't want to pay for, let's say, ERP system or for your fancy customer support systems or your IT systems. So those are. They may just kind of start having a negotiation with the buyer over the price. So from the buyer perspective, when you go and talk to the cfo, you said, hey, Al, I don't want to pay upfront 10, 20, $100 million to enable these capabilities. And I don't know if I'm going to get my money back. That's the short answer. Wow.

So it's a lot to consider.

Yes.

What's the start to end timeframe look like on a divestiture?

It really depends. So I've been involved with the small divestitures where you basically divest, you know, 5, 10, $20 million business with 10, 20 employees and usually, you know, by the time you start looking at their P and L and you kind of make sure that they are meeting the criteria to be divested from the company, by the time you getting in front of the buyer, doing the due diligence, closing and doing a small transition service agreement, it usually takes somewhere between three months to 12 to 16 months on a larger acquisition. Larger divestitures I've seen between 18 to three years, 18 months to three years. Wow.

So they're definitely not as easy or even as complicated as integrations are, but it seems like this is even much more complicated.

Yes, it is. And the key, as I mentioned, is agility and flexibility. Make sure that, you know, up front, what are you getting into? Because most of these challenges that you see down the road within divestiture, especially on the post close, is the notion that you haven't done your homework up front. You didn't really, you were flexible on negotiating the deal so much that you forgot about all the commitment that you are having later on as a buyer. After Close. So you have to do a lot of activities for the seller and you stuck with the deal.

Gotcha. Now, you mentioned a couple tools along with it is tsas or transaction service agreements. And then I think you mentioned pricing agreements too.

Correct?

I guess with pricing agreements, could you elaborate? What does that entail? Exactly.

So I mean, at the end of the day it is simple. I mean, if you have a business that they have, let's say, a revenue of, I don't know, $5 million, you don't want to sell it for, you know, $1 million. I'm just giving you an example. Right. So there are price for the deal that say, you know, these are the prices. I'm not going to go below that because I know, you know, it's not going to work unless, you know, you have a guidance that say, I don't care, you know, let's offload it and you know, let's sell it and for a million dollars and make sure that I'm not stuck with the deal for 18 months. So again, those are the flexibility regarding the price.

Interesting. So it's really around the transaction price itself. And then I heard TSAs are pretty complicated to negotiate. Can you tell me maybe a little bit in terms of what are good approaches or sort of how does that end up transpiring?

Sure, great question. So on the tsa, I would say TSA pretty much going to driven by the type of the buyer, the commitment that you as a buyer has after the close and also the commitment from the seller to his customers and to their employees. So you may end up having a seller who said, you know, I am selling this asset, this asset including 500 employees and once they're off my book, I don't care. And that's the culture. But in some other companies, on the other hand, they make sure that this employee been taken care of, this employees. It's just a different culture really. I would say the TSA as a seller, you have to start thinking about the guiding principles and make sure that you as a seller provide that guiding principle to your deal team to make sure what kind of commitment we as a seller going to have on those tsa. I'll give you an example. If I have, let's say a building in, I don't know, in Israel, and that building is going to be part of the asset that I'm selling to the buyer. And that asset on the day one is going to the buyer, the buyer should be capable to take over that lease. Now, to make the matter complicated, the landlord may Say, you know what, I don't feel comfortable to assign the lease to this buyer whether they are not credit worthy or they don't have a credit with them before whatever reason is. So you as a seller suddenly stuck with this lease for the next, let's say three years to make sure that if the buyer defaults you will be responsible. You being the seller. Again, these are whether it's a service TSA or whether it's an employee TSA or whether it's a contract TSA or whether it is an engineering tsa. All these various TSA create an obligation.

For the seller when going through a divestiture. Al what does the structure look like in terms of building a team to manage that process?

Great question. So from the beginning usually it's the in scope executive of that BU that you're planning to sell and the the carve out deal team, the carve out finance team are working on that, you know, deal and gradually they're going to bring you know, obviously the council and some other aspects of the business like you know, product marketing guy, the executive sales guy, whoever is in charge of their go to market and then you know later you're going to bring HR and the BU and all that. That's the beginning to really understanding if these assets are a good candidate for divesting. And then once they have a commitment from corporate executive to say yes, we feel like this is something that we want to sell and the in scope executive are in agreement to sell that division or part of the division, then you're going to bring the corporate development team, the Separation management office which is pretty much the operation team where they now going to look at more detail on the structure of the enablements and capabilities and operation and find out how deeply is integrated to the rest of the company and what efforts is going to take to disintegrate this business from the corporation. And then later on it's going to be basically a collaboration between the deal team, in Scope Executive and employee and Suppression Management Office.

That's all the time we have right now Al More to come we have additional series to continue our talk about divestitures and really get into the weeds and have a lot more educational topics to cover within divestitures. Look forward to our next conversation. Thank you for taking the time to explore the world of M and A with our podcast. Please subscribe for more content and conversations with industry leaders. If you like our podcast, please support us by leaving a five star review and sharing it. I enjoy hearing feedback and connecting with our listeners you can reach me by my email. It's Kisan K I s o n dealroom.net M&A Science is sponsored by Deal Room, a project management solution for mergers and acquisitions. Additional educational content is available on Dealroom's blog@dealroom.net blog thank you again for listening to M and A Science. See you next time.