Selling a Part of Your Business

Selling a business isn’t always an all-or-nothing proposition. Just ask Jack Welch.

General Electric CEO Jack Welch was well-known for divesting businesses as a way of “pruning” the company to give way to the growth of the remaining business units within GE. In his first four years as GE’s CEO, he divested over a hundred business units accounting for approximately 20% of GE’s assets. Welch eliminated over 100,000 jobs through layoffs, forced retirements, and divestitures. During Welch’s 20-year reign, GE’s profits grew to $15 billion from $1.5 billion, while the market valuation increased to $400 billion from $14 billion. 

Many owners have a significant portion of their personal wealth concentrated in their business. You may consider selling a division of your business, which can enable you to generate liquidity while still maintaining control of the remaining portion of your business. It also allows you to focus your talents on a division with the most significant potential, that you most enjoy, or that offers you the greatest opportunity for work-life balance.

Publicly owned companies, which are usually under intense pressure to meet projected quarterly earnings, commonly sell non-core divisions. And so can you, even if you’re no Jack Welch. 

Why Businesses Make Divestitures

A divestiture is a strategy of focusing on the core competencies of your company by spinning off non-core divisions. In other words, you can divest divisions that aren’t part of your core operations to allow your entire company to focus on what it does best. 

Sometimes, poor management decisions lead to a need to divest non-performing business units. For large companies, selling a weak division is a straightforward management decision.

Selling non-core divisions could also be a way to raise funds. A divestiture generates cash upon a sale, creating an opportunity to invest those funds into more promising divisions or ventures that can yield higher returns. A company’s individual components are sometimes worth more than the company as a whole. Therefore, breaking up the company and selling the pieces can often yield more in the aggregate than if it were sold in its entirety.

Learn More

If you’d like to learn more about what goes on behind the scenes in deciding to sell a business unit, listen to Advice From a $5 Billion Business on Selling Your Company With Russell Iorio on the M&A Talk podcast at morganandwestfield.com/resources. I discussed this decision-making process with Russell, the former Senior VP of Corporate Development at Leggett & Platt, a $5 billion diversified manufacturer with 15 business units in 18 countries, where he was in charge of divesting the company’s business units. 

Selling a segment or division of your business allows you to focus your talents on a division with the most significant potential, that you most enjoy, or that offers you the greatest opportunity for work-life balance.

Deciding To Sell a Division

You don’t need to sell your entire company should you decide to retire or cash out. With proper strategic planning, you can often sell just a piece of your business, allowing you to generate additional funds for your retirement or provide you with growth capital to invest back into the company.

In deciding whether to sell your whole company or only a portion of it, first examine the overall value of your business and then determine the individual value of each division. Once you’ve performed this analysis, you may realize that it would be prudent to sell your business in pieces to extract the most value.

You have two primary options in selling a portion of your business:

1. Selling a Percentage: Selling a piece of your entire company is usually structured as a percentage of your stock. With this strategy, the business owner typically just wants to take some cash off the table. 
2. Selling a Division: This structure involves selling a division, unit, or category of your business. Many companies are acquired for strategic purposes. A buyer may see tremendous value in one division of your company while seeing little value in your other units. If you encounter such a buyer, you may consider a spin-off of one of your divisions. 

Selling a Division Is a Strategic Decision

Selling a portion of your business doesn’t necessarily mean giving up something – it only means letting go of a “part” to enable the “whole” to thrive. The cost of keeping a non-performing or non-core division could be much higher than the returns that could be generated by selling that division. This strategic decision could free up your time and energy, allowing you to focus on your core operations, potentially increasing the overall value of your business in the process.

A common example I encounter is a business that originally started as a single retail location and gradually evolved to a business with multiple retail outlets on a national basis and a significant online presence. Splitting the business into two divisions – an online division and a brick-and-mortar division – may make the company easier to sell and potentially maximize its value. Many buyers have a strong preference for online-based businesses and a strong aversion to brick-and-mortar businesses, or vice versa. Selling the divisions separately solves this problem.

Splitting your company may make it easier to sell, increase its value, and ultimately increase the final selling price. Value is directly related to risk. The higher the risk, the lower the value – and the lower the risk, the higher the value. By splitting the business into two, you potentially reduce the level of risk for the buyer. 

Many companies develop additional product lines as a part of their overall corporate growth strategy. In the process, many business owners create product lines they later regret pursuing. The product line may not fit with the overall operations or may make the business owner lose focus on their core business. In such instances, selling the product line can be a wise course of action.

Many buyers search for strategic acquisitions and have specific criteria regarding which businesses they’ll consider. They may be interested in just one component of your business and may not pursue your company as a whole because your other divisions don’t align with their strategy.

Popular divestitures in the past include the decision of Hewlett-Packard CEO Meg Whitman to spin off and merge HP’s non-core software assets with Micro Focus, a British company. This transaction was valued at about $8.8 billion, significantly less than the $11 billion it spent to acquire the division five years earlier. 

Even middle-market owners can benefit from splitting their companies into separate divisions and selling them individually. For instance, some businesses require special licensing, so breaking the business into two divisions may be prudent, as some companies may only be interested in divisions that don’t require special licenses.

Regardless, the decision should first be considered from a strategic standpoint, and you should ask yourself if selling a division will help you accomplish your long-term objectives. Only after you’ve considered the strategic elements of the decision should you consider the tactical components, or the “how to’s,” which I address next.

Operational and Legal Implications 

The decision should first be considered from a strategic standpoint – ask yourself if selling a division will help you accomplish your long-term objectives. 

When deciding to sell a division, there are two important aspects to take into consideration – operational and legal. Let’s examine them both.

Operational Implications

You must first be sure that your business can be divided in two, from an operational standpoint, before considering the legal implications of doing so. Some divisions are so intertwined that it’s impossible to separate them, or doing so could prove too costly. Businesses that are most conducive to being sold as divisions can be easily split in two from an operational standpoint.

When determining if your business can be split in two, consider the following questions:

• Do you have a separate website, phone number, and facility for each division? 
• Can costs be accurately allocated between divisions? 
• Do you have employees who share duties for each division? If so, which division would they remain with? 

Consider the answers to these questions as early as possible to determine how practical it is to separate the divisions from an operational standpoint. In many cases, significant work needs to be done to separate divisions so they can be operated independently.

Few buyers will be willing to take the risk of creating a separate website, hiring new employees, and completing the dozens of other tasks that are required unless you’re selling a division that can easily be integrated into another company, such as a product line. 

If the division is likely to be run as a stand-alone entity by the buyer, it’s ideal to run it as a stand-alone business with a separate profit and loss statement for at least one year before beginning the sale process. Doing so will make the business easier to sell and will simplify the process of separately valuing each division. The more integrated the division is with your primary operations prior to putting it on the market, the more difficult it will be to sell.

Legal Implications

From a legal standpoint, there are two general transaction structures when selling a division – asset sale or a stock sale. Here are your options for structuring the transaction from a legal perspective:

• One Entity: If your business, including the division you wish to sell, is legally structured as one entity, such as a corporation or LLC, your only option is to structure the sale of one of the divisions as an asset sale. In an asset sale, your entity sells the individual assets of the division to the buyer via an asset purchase agreement (APA), and the assets are listed and transferred separately in a bill of sale. 
• Separate Entities: If each division is a separate entity, the sale can be structured either as an asset sale or a stock sale. For example, if “Division A” is “Acme Incorporated” and “Division B” is “Summit Incorporated,” you can structure the transaction either as a stock sale via a stock purchase agreement (SPA) or as an asset sale via an asset purchase agreement. In a stock sale, you sell the shares of the entity that owns the division and its assets. Because the entity owns the assets, there’s no need to transfer the assets separately.
• Selling a Percentage: You also have the option of selling a percentage of your company, but this defeats the purpose of focusing on your core competency because you’ll still own both divisions post-closing. 

Regardless, the decision to sell a division should begin with a consideration of your long-term goals. If you wish to focus on your core division, selling a percentage of your entity, or stock, is likely not for you. If, on the other hand, you want to diversify your risk and divest the division so each division operates as a separate legal entity, then you can structure the sale as a stock or asset sale.

Valuing a Division

The asking price for a division is determined using the same methods used to value a business as a whole. In essence, you’re selling an income stream (i.e., EBITDA). To properly value the income stream, you must first measure it. And here’s where it gets tricky. 

If the two segments are closely interwoven, it may be difficult to calculate the income for each division separately unless the divisions are being run as stand-alone units. 

If the divisions aren’t being run as stand-alone units, a pro forma must be prepared for each division. But, be aware that any errors in the pro forma will be magnified by the multiplier. For example, if you overstate income by $1 million, and your business is valued at a 6.0 multiple, then your business will be overvalued by $6 million ($1 million x 6.0 = $6 million).

Preparing a pro forma for a division can be tricky due to the difficulty of properly allocating expenses between divisions. While revenue may be easier to allocate than expenses, the impact on revenue of any inter-division transactions must also be considered. When allocating expenses, you must also decide how to allocate fixed expenses. For example, if your facility costs are currently $100,000 per month for both divisions, what would a reasonable rent be for each division separately? The same idea goes for allocating other forms of corporate overhead as well, such as salaries, insurance, professional fees, advertising, and marketing.

Assigning Weights to Each Division

An alternate method, if you can make it work, is to value the business as a whole and then assign weights to each division based on the revenue that each division generates. For example, if your company generates $20 million in revenue and is valued at $10 million, and “Division A” generates $12 million in revenue (60% of total revenue) and “Division B” generates $8 million in revenue (40% of total revenue), Division A would be worth $8 million ($10 million x 60%). 

While this may seem to be a reasonable computation, some buyers may not be willing to accept such a calculation. That’s because you’re likely to understate the amount of fixed expenses and therefore overstate income or margins, meaning profitability may differ significantly between divisions. Such a calculation would only be reasonable if the two divisions have similar margins and expenses, such as two similar product lines.

Ideally, the divisions can be valued based on the income each division generates. But doing so involves numerous assumptions that are prone to error. A back-of-the-envelope method for obtaining a ballpark valuation for each division isn’t difficult, but such ballpark estimates are unlikely to suffice for most buyers. A ballpark estimate should only be used for internal planning purposes. Or for valuing ballparks.

The asking price for a division is determined using the same methods used to value a business as a whole. In essence, you’re selling a cash flow stream. 

Questions to Consider

The decision to sell a division or segment of your business is a strategic one and should be based on your long-term objectives. Consider the following questions when deciding if selling your company as a whole or in parts makes better sense:

• Would I be happier if I simplified operations and focused solely on my core business?
• Have I spread myself too thin? If so, would selling a division improve my focus?
• Knowing what I know now, would I start both divisions again?
• Which division is the most profitable?
• Which segment of the business is most suited to my skills and strengths?
• How hard would it be to sell each segment separately?
• Is it practical to sell each segment separately?
• What’s the potential value of each division?
• What’s my number one bottleneck now? 
• Do I need growth capital to significantly grow my business? If so, would selling one of the divisions free up my capital and energy to focus on my core competence?
• If I sold one of my divisions, could I reinvest the money in the remaining division and significantly boost revenue and income?

Once you consider these questions and the operational and legal implications, you can determine the best way to move forward. Business owners sell portions of their companies for many reasons. It’s a fairly common practice and can free up cash for you to use as you see fit.

But you may decide it makes more sense to sell your business as a whole. This is where an M&A advisor, or investment banker, can help you evaluate the host of different factors that come into play, including how much stake you want to have in the future of the company. Also, having your business valued as a whole and in pieces can help you decide what makes the most financial sense in the long run. Either way, an M&A advisor or investment banker should be able to assist you with selling your business in a way that aligns with your long-term objectives, so don’t hesitate to seek professional advice. Remember that selling a portion of your business doesn’t mean giving up something – it only means letting go of a “part” to let the “whole” thrive. After all, the cost of keeping a non-performing or non-core division could be much higher than the returns.

Conclusion

Planning your exit starts with weighing your exit options. Your exit options can be broadly categorized into the following three areas:

• Involuntary
• Inside
• Outside

If you’re reading this book, I assume you want to maximize the price. If so, an outside exit option is the only guaranteed way to do just that. 

Finally, examine if it’s sensible to break your company into pieces and sell them individually. In some cases, doing so can yield a higher value. If you’re unsure, consult with an M&A advisor to help you determine the most prudent course of action that will help you maximize not only your price, but also your level of well-being and happiness.