Managing Divestitures For Value And Liquidity

Corporate Development Roundtable

By Curt Cornwell, James Flanagan, Mike Wathen –  PricewaterhouseCoopers

Divestitures are a strategic imperative

The management challenge of divesting a business for value and liquidity

Companies sell businesses for three inter-related reasons: to meet corporate strategic goals, to take advantage of an opportunity to sell a property at its peak value or to raise cash during hard times. While these reasons seem clear enough on paper, the panelists at our corporate development roundtable will tell you that assessing when it is time to sell and then carrying it off successfully is a demanding task, fully equal in complexity to making an acquisition, although frequently less glamorous and exciting.

No one says you have to enjoy doing a divestiture, but you do have to work hard at it if you want to achieve your strategic and financial goals and do the job cleanly, without a tangle of liabilities and responsibilities that linger for months or years after the deal is closed.

In the fall of 2004 PricewaterhouseCoopers arranged for nine leading corporate development executives from large companies to meet in New York and take a critical look at the approaches companies use to sell businesses. Most of the executives at this roundtable are experienced sellers, which makes their observations all the more valuable to managers and companies who are less familiar with the obstacles and pitfalls that divestitures present. These executives play key roles in implementing their companies’ growth strategies in a wide range of global businesses, from telecommunications to consumer products to aerospace.

Their conversation, during a three-hour session in New York in late 2004, ranged over many subjects. The key discussions centered on these topics:

• How companies reach the decision to divest. Most of the companies represented at the roundtable have established methods for determining when it might be appropriate to divest a company. Some have aggressive divestiture programs underway.

• Popular structures for the sale. Many companies look first in their own or a related industry for a buyer that will see the unit being sold as a growth opportunity and be willing to pay cash. Private equity buyers with cash seem to be next in line in terms of preference.

• Common pitfalls. Most of the pitfalls arise from failure to recognize the hard work and careful planning a divestiture requires or from inexperience with this type of transaction. Either can steal a great deal of value from the sale.

• Self /Sell Side due diligence. It is difficult to dig deeply into the financial and operating structure of the unit for sale and keep your plans a secret at the same time. But thorough due diligence, the panelists said, is critical. Unpleasant surprises uncovered by the buyer can blow up a deal.

• The best route to a sale. Experienced sellers have developed a formal and rigorous process to analyze and present the asset to sellers. One such approach was discussed in depth at the roundtable.

• Handling post-closing matters. There are lingering responsibilities for the seller after the contract is signed. The seller also usually has made warranties, representations and indemnifications about the financial condition of the enterprise. If these turn out to be false, penalties may have to be paid.

This roundtable was one in a series that began in 2002 in New York and has since been replicated in Silicon Valley. We have learned that these discussions are a fruitful source of new ideas and emerging best practices, not only for the participants but for anyone with corporate development responsibilities.

PricewaterhouseCoopers’ Transaction Services Group works on thousands of deals around the world every year, helping clients evaluate every M&A decision point — from the initial steps in deciding to buy or sell to implementing integration plans that capture profits or value after the deal is done. Our goal is to help our clients beat the odds of failure that experts have observed are so high in this field.

We believe you will find this report informative and enlightening. We especially thank our panelists for so generously sharing their insights and experiences.

Divestiture Options

Divestitures: Sometimes demoralizing, but a strategic necessity

“They don’t give you a Lucite when you do a divestiture.”

That pungent remark from one of the panelists sums up a popular view of divestitures in corporate America. When you buy a company, it’s a heady time for celebrations and lucite trophies. But when you sell one, it’s often seen as an admission of failure. It seems to say that the company or division has not lived up to expectations or that management couldn’t deliver on its vision for the unit. As a result, according to common wisdom, an aura of disappointment permeates many divestiture attempts. When that happens, the people in charge tend not to attack a sale with the same vigor and discipline as an acquisition; insufficient resources are committed to the effort; planning is less rigorous; it’s hard to attract good leaders to manage the deal, and the departing unit, with disgruntled, unproductive employees and competitors devouring its market, seems to lose value by the day.

As the panelist put it, a divestiture is under constant attack by a swarm of “Killer D’s.” They are, he said, “Defeat, demoralization, dissension, disruption, defensiveness and division of loyalty.”

The panelists as a whole seemed to agree that the Killer D’s are a constant threat to the value of any divestiture, but they also indicated that their companies are learning how to manage divestitures more effectively and have found that in some cases a sale can be almost as exhilarating and rewarding as a successful acquisition. Divestitures, the panelists seemed to be saying, are increasingly viewed not as a shameful indication of poor business operations, but as an essential process in achieving corporate, strategic and financial goals.

Clearly, divestitures are a common practice among the large, multinational companies represented at the roundtable. The panelists described slightly different processes by which their companies reached that decision to sell a unit or product line, but it was clear that their managements had little reluctance to pull the trigger. Here are the typical approaches described by the panelists.

Aggressive divestiture programs. At least two of the companies are engaged in actively divesting non-core businesses through ongoing reviews by senior management and the corporate development staff. One company, which had acquired numerous businesses over many years in the pursuit of revenue growth, is now systematically analyzing its portfolio to cut those that are not generating sufficient value or that do not fit into the strategic plan for the future. More than 50 units were divested in the first year of the review. The other company, which has cut about 25 units in the past five years, is using a strategy of “harvesting” the value of successful units, then selling them to “strategic” buyers who will want to invest in them for growth.

Ongoing strategic reviews. Other panelists said their companies have instituted procedures for regular reviews that involve both corporate strategists and business unit leaders. The goals here are not only to assure that all units are aligned with corporate strategy, but also to identify businesses that may be maturing or under-performing. A struggling business may need more capital than senior management wants to commit. “We’ve been known for buying at the peak and selling at the trough, ”said one panelist, drawing laughs from the panelists who had experienced the same feeling. “Now we’re trying to get ahead of that through regular reviews. ”Another panelist described ongoing reviews that involved studying not only financial measures, “but a whole host of other factors as well.”

Operating reviews. Sometimes the decision to divest comes as an outgrowth of operating reviews, said another panelist, whose company is generally slow to divest. When the unit’s request for capital seems too large, management begins asking what it will take to turn the unit around. “If the problem is not something within our purview to change, even if the unit is considered core, we’ll start to look at divestiture options. ”The problem here, the panelist said, is that operating management is often reluctant to give up on the unit, and “you ride the value line so far down you can’t even get a presentable offering to market. It becomes too late to say, ‘Would anyone else like to try this?’”

Recently acquired non-core businesses. There are cases, too, several panelists noted, in which non-core operations are picked up in the process of a larger acquisition. Here, companies often decide during the acquisition process that the unit should be sold, then move promptly to do so after the closing.

“They don’t give you a Lucite when you do a divestiture.”

“If the problem is not something within our purview to change, even if the unit is considered core, we’ll start to look at divestiture options.”

“When management wants it gone, they want it gone.”

“We kept an ownership stake and the other company made commitments to buy a certain amount of volume and over a period of a few years the unit was totally absorbed by the other company.”

 

 

Recently acquired non-core businesses. There are cases, too, several panelists noted, in which non-core operations are picked up in the process of a larger acquisition. Here, companies often decide during the acquisition process that the unit should be sold, then move promptly to do so after the closing.
“They don’t give you a Lucite when you do a divestiture.”
“If the problem is not something within our purview to change, even if the unit is considered core, we’ll start to look at divestiture options.”
“When management wants it gone, they want it gone.”
“We kept an ownership stake and the other company made commitments to buy a certain amount of volume and over a period of a few years the unit was totally absorbed by the other company.”

Wanted: buyers with cash

When it comes time to sell, the panelists seemed to agree, the preferred buyer is usually “a strategic” — a company in the same or related industry that sees the unit as a growth opportunity and is willing to pay full fair value for it. Private equity firms are also frequent targets, but panelists pointed out that these firms tend to be more demanding in their due diligence than strategic industry buyers and that they usually are unwilling to pay as much since they often have a shorter timeframe for harvesting their investment.

A third approach, spinning the units off in a sale to the public, is not a happy option, the panelists said, in part because the units being sold are rarely stand-alone companies and the tax consequences of this approach are often prohibitive especially if it’s a worldwide business.

A fourth approach — entering a venture to jointly manage the unit with another company, then transitioning away from ownership after a period of time, also had little appeal for the panelists. “When management wants it gone, they want it gone,” said a panelist. One company, however, did use a joint venture successfully when it sold a unit to the unit’s largest customer. “We kept an ownership stake and the other company made commitments to buy a certain amount of volume and over a period of a few years the unit was totally absorbed by the other company.”

Ultimately, the divestiture structure “all depends on the health and positioning of the company,” a panelist remarked. If the property is weak, “the use of structures other than cash tend to be driven by whatever it takes to get the property moved. When you make the decision that the most important thing is to get out, you have to be realistic and creative, and you ought to be thinking about what kinds of structures will work at the outset, not in the middle of the process.”

Seller beware: some common pitfalls in managing divestitures

“They used to call me the vice president of dead companies.”

Thus citing past experience with a former company as point person on a crash program of 15 divestitures over a three-year period, a panelist cited some of the key areas where companies with less experience might fall short in their own divestiture attempts. As he talked, other panelists contributed ideas as well.

• Wrong mindset. Senior managers unfamiliar with divestitures may not recognize the amount and nature of the work required to conduct a successful sale. As a result, they may not give it enough attention. “Upper management must set the tone for the divestiture right at the top,” the panelist said. “Sometimes there is a sort of let-down after the decision is made to divest. But you don’t want people saying, “If this divestiture is so important, why are there no meetings on it? No updates? Why is there no regular reporting system?” Similarly, board members must be properly briefed so their expectations are in line with reality.

• Lack of a formal process. Companies that infrequently engage in divestitures may not have formal processes for conducting them. These procedures can be developed almost as a mirror image of the steps taken for an acquisition, the panelist said. He stressed the importance of stringent due diligence performed by M&A professionals. “You need to do the kind of diligence you would do yourself as a buyer. You need to challenge the strategic assumptions about growth; you need to look hard for risks.” This is far different and much more intense than an operating review, he said, and it should be done “super early” in the process. Such reviews, however, are particularly difficult to do in many cases because digging too deeply into the unit’s operation is certain to spark rumors of an impending sale.

• Insufficient resources. Selling companies must commit as much corporate or outside resources to a divestiture as to an acquisition. Sometimes more resources must be committed, a panelist added, because “people tend not to be attracted to working on a property that’s going to go away.” Another panelist agreed, saying, “Often management’s tendency is to prefer that people invest in the future, so they hate to put talented people on a divestiture. But it’s a mistake to think that way.”

At least one company represented at the roundtable has taken this advice to heart: it has a team virtually dedicated to handling divestitures.

• No sense of urgency. Once the sale begins, it should be conducted as rapidly as possible. “The milk doesn’t get any better once it’s in the fridge,” the panelist said. “It only gets worse.” However, the seller should realize that the complexity of the deal varies directly with how embedded the business or product line is within the parent and this may affect how rapidly the unit can be disposed.

• Weak strategic positioning. Although the company being sold may not be a strategic fit for the seller, it is assumed to be one for the buyer. Frequently the offering materials fail to adequately develop this key point. It’s not enough to show sales projections that trend upward, the panelist said. The strategic rationale should be expressed as well. “If nothing else, it helps the other side make presentations to its board.”

• Poor back-end planning. Even successful divestitures contain what are sometimes called “trailing liabilities”— post-closing and transitional responsibilities that rest with the seller. In addition, totally unexpected conditions can occur after the sale. Many of these can be eliminated or anticipated with careful planning. “We have integration teams that go to work when we acquire a company,” the panelist said. “Why don’t we have disintegration teams that stay on the job after a company is sold?”

• No contingency plan. It’s only realistic for divestiture teams to develop a “Plan B” at the outset to cover the possibility that the deal might break down during negotiation. Part of developing Plan B is to think critically about the point at which you walk away from the table, and consider alternatives.

“You need to do the kind of diligence you would do yourself as a buyer. You need to challenge the strategic assumptions about growth; you need to look hard for risks.”

“Often management’s tendency is to prefer that people invest in the future, so they hate to put talented people on a divestiture. But it’s a mistake to think that way.”

“The milk doesn’t get any better once it’s in the fridge, it only gets worse.”

“We have integration teams that go to work when we acquire a company. Why don’t we have disintegration teams that stay on the job after a company is sold?”

 

• Poor back-end planning. Even successful divestitures contain what are sometimes called “trailing liabilities”— post-closing and transitional responsibilities that rest with the seller. In addition, totally unexpected conditions can occur after the sale. Many of these can be eliminated or anticipated with careful planning. “We have integration teams that go to work when we acquire a company,” the panelist said. “Why don’t we have disintegration teams that stay on the job after a company is sold?”


• No contingency plan. It’s only realistic for divestiture teams to develop a “Plan B” at the outset to cover the possibility that the deal might break down during negotiation. Part of developing Plan B is to think critically about the point at which you walk away from the table, and consider alternatives.


“You need to do the kind of diligence you would do yourself as a buyer. You need to challenge the strategic assumptions about growth; you need to look hard for risks.”


“Often management’s tendency is to prefer that people invest in the future, so they hate to put talented people on a divestiture. But it’s a mistake to think that way.”


“The milk doesn’t get any better once it’s in the fridge, it only gets worse.”


“We have integration teams that go to work when we acquire a company. Why don’t we have disintegration teams that stay on the job after a company is sold?”

Due diligence: What you don’t know can hurt you

Murphy’s Law famously states that if something can go wrong, it will. Over the years, a multitude of corollaries to Murphy’s Law have emerged, many of which are applicable to divestitures. For example, “Almost everything in the world is easier to get into than it is to get out of.”

Three different panelists, at different times during the roundtable, added their own corollaries:

1) “You always think you know more about the business you’re selling than you actually do.”

2) “The worst thing that happens is when the buyer surprises you by pointing out something negative you didn’t know.”

3) “There is no crystal ball for determining what those surprises will be.”

“The two biggest deal killers,” another panelist said, “are mismatched expectations and surprises that occur late in the negotiating process.”

The panelists discussed at length the importance — and difficulty — of discovering the skeletons in the cellar before they are unearthed by the buyer. The need to maintain secrecy presents a major obstacle to a thorough examination of the unit’s strengths and faults, but human nature also comes into play.

For example, one panelist said he was often frustrated in his attempts to persuade unit management teams to provide conservative projections for year-end results. “We try to drill into them up front that we don’t want what they promised the CFO. We want what they really think they are going to do. If the unit runs ahead of plan, I would much rather go to the buyer and say we’re ahead of outlook than have to tell him we’re behind.” But the managers find it hard to be conservative. “We’ve had situations where, one month after the conversation, the guy says, ‘Well, you know, I couldn’t come off what I promised my boss.’ And then suddenly you’re off track and it just drives you nuts!”

To audit or not to audit

The question of whether a seller needs to provide audited financial figures to a prospective buyer came up in this context, and the response was divided. While there was general agreement that financials prepared according to GAAP were essential, several panelists felt that in many instances it was sufficient to have these figures developed internally and that financials audited by an outside firm were unnecessary, especially on deals of less than $100 million.

“Getting stand-alone financials for a segment of a big company just takes forever when you do it internally, then having it audited requires all the more time and money,” a panelist said. “But the flip side is that if it’s not audited, you are going to have to make all kinds of representations and warranties. I think you have to make the decision, audited or not, before you start talking to potential buyers. You can’t start the process without the financials set.”

Size of the proposed transaction relative to each potential buyer is one of the determining factors in this decision- making process, the panelists said, and another factor is the potential buyer. An industry buyer familiar with the business might be satisfied with non-audited figures backed by warranties. A private equity buyer that intends to flip the property or take it public would likely need audited figures.

Audited figures had at least one champion. “On all the big deals we’ve done, we’ve done audited financials. We found that the deal went more smoothly and we got more value. If you’re doing $100-million deals there’s a huge payback to have a team that can put it together, package it and represent the company effectively to the buyer.” The auditing, he added, serves a due diligence function as well, “so you’re killing two birds with one stone. I’ve done 20 divestitures and there’s been an audit for each one. When our management does a deal they want to know where all the skeletons are. Then they want to close the deal and they don’t want to hear about it again.”

Another panelist argued for holding off on auditing until “we’re certain we can get the transaction done.” The reason is to preserve secrecy, the panelist said. “We know what our walk-away price is. We know what our expectations are. We want to float the idea with buyers but we don’t want our customers to know. We don’t want our employees to know. Even if it warrants audited financials, we won’t go down that route until we’re certain we can get the transaction done. The worst thing in our experience is putting things on the market and then taking them off.”

A panelist agreed that preliminary discussions can be held before financials are audited, “but there comes a point when you have to make the announcement and spend the two or three months working with unit management to audit the financials, do the due diligence, get the offering memorandum together.”

Yet another panelist stressed one of the abiding truths of M&A work: that the road you take depends on the situation. “We’re running a process right now where we’re very comfortable that we’re not going to have to do an audit because it’s a stand-alone business and we have enough strategic buyers who are going to play. We’re happy to make representations based on the internal audit.

But there were other times when we’ve learned to our great pain that you have to do an audit when you’re doing a carve-out and when you’re dealing with private equity guys who want to take the unit public right away.”

“Almost everything in the world is easier to get into than it is to get out of.”

“You always think you know more about the business you’re selling than you actually do.”

“The worst thing that happens is when the buyer surprises you by pointing out something negative you didn’t know.”

“There is no crystal ball for determining what those surprises will be.”

“On all the big deals we’ve done, we’ve done audited financials. We found that the deal went more smoothly and we got more value. If you’re doing $100-million deals there’s a huge payback to have a team that can put it together, package it and represent the company effectively to the buyer.”

“We’re running a process right now where we’re very comfortable that we’re not going to have to do an audit because it’s a stand-alone business and we have enough strategic buyers who are going to play. We’re happy to make representations based on the internal audit. But there were other times when we’ve learned to our great pain that you have to do an audit when you’re doing a carve-out and when you’re dealing with private equity guys who want to take the unit public right away.”

Step-by-step through a divestiture

Once the decision is made to divest a unit, what process should be used? What steps, taken in what order, are most likely to lead to success? The answer, of course, varies with every company and every situation, but here is an outline of key steps in the divestiture process described by one of the panelists. This manager has played a key role in 25 such efforts in the past five years as his company dramatically reduced its size to concentrate on core strengths. The divestitures have ranged in size from tens of millions to tens of billions of dollars.

The process described here, which is basically the same for deals of all sizes, assumes that a valuable property is being sold, and the hope is to spark an auction.

The sale of an impaired property would probably involve a more targeted approach with materials prepared for a single potential buyer.

• Deciding to divest. The request to sell a unit may be a strategic decision by management or the request by a business unit to jettison an operation. At this point, corporate development may conduct a preliminary analysis of the situation and its potential for sale.

• Determining sale value. Once the decision to sell has been made, the corporate development staff works with the business plan and key corporate managers “at a high level” to determine the potential value of the unit. Often, the unit for sale has strong growth potential, which could be realized only through additional capital investment. But “in a world of limited capital, management has decided to put its money elsewhere,” the panelist said. Thus, the “keep value” or “harvest value” of the unit (its value without new infusions of capital), is far less than its sale value, especially to a buyer willing to invest in its growth. “When the numbers work out this way, we feel we have a winner,” the panelist said.

• Getting the license to hunt. A two- to three-page memo describing the deal and its benefits goes up the chain of command to be approved by the CFO or chairman.

• Assembling the team. The team is typically composed of individuals from the 11-person corporate development staff along with a “virtual team” of experienced staff members from legal, control, tax, human resources and other departments, adding outside advisors as needed.

• Developing stand-alone financials. Since the unit being sold is usually a product line or a segment of a division, no financial statements exist. They must be developed in secrecy by the corporate controller’s office, working with finance people in the business unit. This can take up to three months and “has always been the most difficult part of the process,” the panelist said. “We won’t put this in front of potential buyers until we’re sure it’s right. The worst thing you can do is have to make changes along the way.” For this reason, too, the team tries to time the sale so that it closes within the current quarter to avoid having to produce another set of financials.

• Preparing the offer. As the financials are being developed, an offering memorandum and a “teaser” are being prepared. When completed, the memorandum will contain three years of historical financial data and an outlook for the current year. Projections for future years are not part of the offering memorandum, but will be revealed in the management presentation to be delivered later to a small group of serious buyers. Meanwhile, potential buyers are being identified, a data room is being set up (or simply downloaded into a CD if the material is not highly sensitive), and decisions are being made about the management presentation. Typically, the presentation will be made by unit leaders who will go with the unit to the buyer. All this is treated as top secret.

• The sale begins. With the materials ready, the sale begins with phone calls to potential buyers, most of whom are well known by the selling team. At the top of the list are the “strategics” — industry competitors who might be interested in the business to strengthen their own portfolios. Calls also go to investment bankers and private equity funds. Now, time is critical; you want a quick sale. If a party expresses interest, the “teaser,” or deal summary, is sent. If interest continues, a non-disclosure agreement is sent; if that is signed, the potential buyer receives the offering memorandum and a draft of the contract. Through this process, the panelist said, a universe of 25 to 30 potential buyers is whittled in stages. Perhaps 10 or more interested parties receive the non- disclosure agreement; of these, perhaps five or six receive the offering memorandum and contract draft.

• Keeping the lid on. Even after the unit is offered for sale, the company tries to maintain confidentiality, avoiding an announcement to the employees as long as possible.

• Getting the bids. The handful of potential buyers that receive the offering memorandum and the contract draft are told they have “two to three weeks” to perform their due diligence and attend a management presentation. The hope is that they will return a marked-up copy of the contract and a preliminary bid within six weeks. “We only want to deal with a group of people who seem willing to pay within our price range,” the panelist said. “The tension here is that the seller wants this thing over in a hurry and the buyer wants to take time to fully evaluate the deal.”

Another panelist added that his company has eliminated buyers based on the way they marked up the contract. “If the contract is marked up in a really negative way, we’ll discard the buyers or put them lower on the list.”

• Negotiating the sale. If things have gone well, the seller will now have preliminary bids and marked-up contracts from three potential buyers. At this point, negotiations are undertaken with the party that submitted the most attractive bid. Other bidders are put on hold; if the first deal falls through, the seller will turn to the next bidder. Price, the panelist said, is not the only factor in choosing the top bid. Many others items must be considered as well, including agreements for managing the transition period, the contingency payments and penalties demanded by the buyer and the ability of the buyer to sustain the quality of the business. In many cases, the unit being sold does business, and will continue to do so, with various operations in the selling corporation. Hashing out the “inter-company agreements” that govern these relationships and establishing values for them is often a wrenching process. “All these things have to be negotiated internally with our own business units as well as the buyer, and it’s always the internal stuff that nearly kills you,” the panelist said.

“That’s the ideal,” the panelist concluded. “A robust auction. You want the unit sold, you want it to be clean and you don’t want to live with a legacy of post-closing adjustments. You don’t always get that.”

Who’s your banker?

During a brief discussion on the use of outside advisers, the panelists described situations in which they turn to investment bankers for help.

For big deals. “They carry a lot of weight on big deals,” a panelist said. “They do the all the prep work, the modeling work, the offering memorandums. So you are outsourcing all that work and you are getting good advice.”

When it’s a tough sale. “I think there are times you might want to use an investment banker when you have an asset that is a difficult sell,” said another. “They can be helpful in gaining more interest for the asset.”

On small deals. Several panelists expressed concern about retaining investment bankers for smaller deals because “you can’t get the A team interested” in the relatively small fee. However, said others, there is a “whole universe of boutique firms” that thrive on deals in the $10-million to $20-million range. The problem, however, lies in selecting the right firm for the job.

“We only want to deal with a group of people who seem willing to pay within our price range. The tension here is that the seller wants this thing over in a hurry and the buyer wants to take time to fully evaluate the deal.”

“All these things have to be negotiated internally with our own business units as well as the buyer, and it’s always the internal stuff that nearly kills you.”

“That’s the ideal. A robust auction. You want the unit sold, you want it to be clean and you don’t want to live with a legacy of post-closing adjustments. You don’t always get that.”

In the aftermath, a variety of post-closing matters

Even in the best of times, the closing does not signal the end of the seller’s responsibilities. There are a whole host of matters that must be settled in the months that follow the signing. The panelists discussed many of these matters in detail. The overriding point seemed to be that contracts and other deal documents must be carefully crafted to avoid misunderstandings that could lead to litigation later on. “The lesson I learned some time ago is that you start negotiating post-closing adjustments on day one,” said a panelist.

Here are some of the topics covered:

Transition services. The two parties must agree on how to manage activities which can range from accounts receivable to treasury activities — until the unit is integrated into the new company. One panelist said his company attempts to limit this period to six months at the most and prefers buyers who have minimal transition services needs.

“Clawbacks.” Based on the seller’s warranties and representations, the buyer is permitted to recover (or “clawback”) amounts from the sale price. Buyers may demand that as much as 25 percent of the sale price be reserved for such claims. The term for making a claim might be limited to three months. The seller, of course, sees this as an open invitation for the buyer to demand money back. “I hate that,” said a panelist, clearly wearing his sales hat.

Working capital adjustments. Is there enough money at stake in the resolution of working capital agreements to justify the expense of the accounting and legal work involved? Yes, answered several panelists, because operating units don’t have experience in following the cash management rules in the negotiating documents and the unit for sale may overspend its budget while the deal is being negotiated. It was also pointed out that working capital adjustments may be required in international deals when sharp swings occur in the currencies involved.

“If the currency movement’s too great, it can be a brand new negotiating point and people have to come back and talk again,” said a panelist.

Inter-company allocations and charges. The panelists said their companies work hard, using somewhat different methods, to provide the data that potential buyers need to understand the costs of operating the unit under their own systems. “We have so many inter-company allocations and inter-company charges that we want the buyer to see what the thing will look like when it’s not part of our company,” said a panelist. “It’s very important to spell out non-recurring charges as well as allocations for items like supplies, warehousing and leases,” said another. “The buyer usually won’t have the same kind of corporate overhead we have.”

Pensions and retiree medical plans

Pension plans tend to be an afterthought in the disposition process but the values involved can often be significant—so careful planning is advisable. The first thing to understand is the historic pension expense that has been charged to the business being disposed. It will also be necessary to look at the current financial status of the pension plan and the relevant share of assets and liabilities that could be transferred under pension plan rules (Section 4044 of ERISA). This puts the Seller into a position to assess the various alternatives for pension transfer in the light of who the likely buyers might be. For example, a private equity buyer will be much less likely to accept a transfer of pension liability and may want to go forward with defined contribution plans only. This assessment of alternatives should include any curtailment or settlement pension accounting impact on the seller as well as the impact on buyer valuation. The preferred pension transfer approach can then be developed and the financial statements for the carved out entity should ideally reflect that approach. Remember that a well advised buyer will be seeking to identify value adjustments in the pensions area so it is wise to try to pre-empt the issues buyers may raise and prepare a counter argument.

The process for retiree medical plans is similar to pensions except that most buyers now are unwilling to continue providing retiree medical benefits. These benefits are rarely funded and the benefits do not vest until the employee is eligible to retire. By retaining the liability for retirees and not requiring the buyer to replicate these benefits, the seller can seek to benefit from the higher valuation suggested by earnings after retiree medical expense is stripped out and from the reduction in carried liability as the active employees will effectively lose their benefit.

While both these issues are highly emotive from the employee perspective, the general change associated with the disposition may represent the ideal opportunity to address them.

Haggling with the buyer after the sale — and perhaps going to arbitration — over details that should have been settled during negotiation is a painful prospect for M&A executives, the panelists said. The goal is a clean break, and even if there are no Lucite trophies in store, at least there’s the satisfaction of a job well done.

“The lesson I learned some time ago is that you start negotiating post-closing adjustments on day one.”

“If the currency movement’s too great, it can be a brand new negotiating point and people have to come back and talk again.”

“We have so many inter-company allocations and inter-company charges that we want the buyer to see what the thing will look like when it’s not part of our company. It’s very important to spell out non-recurring charges as well as allocations for items like supplies, warehousing and leases. The buyer usually won’t have the same kind of corporate overhead we have.”

Conclusion

It has become commonplace among large corporations to divest units that are underperforming or don’t meet strategic goals. The practice is likely to increase as the M&A market continues to heat up. Whether the market is hot or not, managing a divestiture successfully is a demanding activity, requiring strong support from senior management and a significant investment of time and money. Treating a divestiture like the poor cousin of an acquisition is a sure way to throw away value.

Divestitures, the panelists made clear, come with their own peculiar set of booby traps. The need to maintain secrecy can prevent the selling company from digging deeply enough into the financial and operational structure of the unit being sold — and the result can be an unpleasant surprise discovered by the potential buyer that upsets negotiation. Time, in many ways, is the enemy of a sale; yet thorough preparation is essential for success.

Experience pays. Many of the panelists have learned by trial and error the importance of a rigorous but flexible approach to selling a company. Knowing how to avoid the pitfalls is not an absolute guarantee of success, but it increases the odds tremendously.