23 Jun 2020

What is Divestment?

Divestment is the process of selling subsidiary assets, investments or divisions in order to maximize the value of the parent company. Also known as divestiture, it is the opposite of an investment and is usually done when that subsidiary asset or division is not performing up to expectations. Companies can choose to deploy this strategy to satisfy either financial, social or political goals.

Understanding Divestment

Divestment involves a company selling its assets, often to improve its value and obtain higher efficiency. Assets that can be divested include a subsidiary, business department, real estate, equipment and other property. Divestment can be due to either a corporate optimization strategy or be driven by extraneous circumstances, such as when investments are reduced and firms withdraw from a particular geographic region or industry due to political or social pressure.

Many companies use divestment to sell off peripheral assets that enable their management teams to regain sharper focus of the core business. Proceeds from divestment are typically used to pay down debt, make capital expenditures, fund working capital, or pay a special dividend to a company’s shareholders. While most divestment transactions are deliberate, company initiated efforts, at times this process could be forced upon them as a result of regulatory action.

Regardless of why a company chooses to adopt this strategy, divestment will generate revenue that can be used elsewhere in the organization. In the short run, this increased revenue will benefit most organizations in that they can allocate the funds to another division that is performing up to expectations. The exception would be if the company was being forced to divest a profitable asset or division for political or social reasons which could lead to a loss of revenue.

Key Takeaways

  • Divestment is the process of selling subsidiary assets, investments or divisions in order to maximize the value of the parent company.
  • While most divestment transactions are deliberate, company initiated efforts, at times this process could be forced upon them as a result of regulatory action.
  • Divestment typically takes a form of spin-off, equity carve-out or direct sale of assets, and the most common reason for deploying this strategy is to eliminate non-core businesses.

Types of Divestments

Divestment typically takes the form of spin-off, equity carve-out or direct sale of assets. Spin-offs are non-cash and tax-free transactions, when a parent company distributes shares of its subsidiary to its shareholders. Thus, the subsidiary becomes a stand-alone company whose shares can be traded on a stock exchange. Spin-offs are most common among companies that consist of two separate businesses that have different growth or risk profiles.

Under the carve-out scenario, a parent company sells a certain percentage of equity in its subsidiary to the public through a stock market. Equity carve-outs are tax-free transactions that involve exchange of cash for shares. Because the parent company typically retains the controlling stake in the subsidiary, equity carve-outs are most common among companies that need to finance growth opportunities for one of their subsidiaries. Also, equity carve-outs allow companies to establish trading avenues for their subsidiaries’ shares, and later dispose the remaining stake under proper circumstances.

A direct sale of assets, including entire subsidiaries, is another popular form of divestment. In this case, a parent company sells assets, such as real estate, equipment or the entire subsidiary, to another party. The sale of assets typically involves cash and may trigger tax consequences for a parent company if assets are sold at a gain.

Major Reasons for Divestment

The most common reason for divestment is the selling of non-core businesses. Companies may own different business units that operate in different industries which can be quite distracting for their management teams. Divesting a nonessential business unit can free up time for a parent company’s management to focus on its core operations and competencies. For instance, in 2014, General Electric made a decision to divest its non-core financing arm by selling shares of Synchrony Financial on the New York Stock Exchange.

Additionally, companies divest their assets to obtain funds, shed an underperforming subsidiary, respond to regulatory action and realize value through a break-up. Finally, companies may engage in divestment for political and social reasons, such as selling assets contributing to global warming.

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