M&A Basics | Can I Sell Part of My Business?

Executive Summary

I’m talking to a potential buyer who is interested in buying my business. We have talked about him purchasing the manufacturing portion of my business while I retain the wholesale division.

Can you help us create a deal structure and asking price for each division separately? I’m not sure if this is the best plan, but I’m considering it and would like help formulating a strategy.

Selling a business is not 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 about 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 market valuation increased to $400 billion from $14 billion.

While deciding upon the sale of your company, selling only a portion of your business may cross your mind. You may have questions about the process, such as whether it’s wise or common.

Many business owners have all of their wealth tied up in their company, even though doing so is risky. Selling a piece of your company allows you to create liquid assets while still maintaining complete control of the remainder of your business. It also allows you to focus your talents on a division that you think has the greatest potential.

These are the questions we address in the following article:

• Why do businesses divest divisions of their company?
• Should you consider selling a portion of your business?
• What are the operational implications of selling a portion of your business?
• What are the legal implications of selling a portion of your business?
• How do you determine an asking price for a division of your business?

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. To learn more, read on…

Why Businesses Sell Part of Their Companies

The sale of a portion of a business is called divestiture. This typically happens when a company’s management decides they no longer want to operate a business unit or asset.

So, why do businesses sell part of their companies?

First, divestiture is a strategy of focusing on the core competencies of the company by spinning off non-core divisions. In other words, a business may divest divisions that are not part of its core operations to allow the entire company to focus on what it does best.

A company’s strategic development plan may involve divesting or spinning off non-core businesses while strengthening core operations through a series of disciplined acquisitions.

Second, companies sometimes make bad acquisitions and later divest those investments to correct their mistakes. The buyer may be too large, and the new company may get lost after the acquisition and suffer from a lack of attention. Sometimes, poor management decisions lead to a need to divest non-performing business units. Selling a weak division is a straightforward management decision.

Third, selling non-core divisions could also be a way to raise funds. A divestiture generates cash at the sale, with that cash being invested in more promising opportunities that can yield higher returns. Also, a company’s individual components are sometimes worth more than the company as a whole. Therefore, breaking up the company and selling its pieces can yield more than if the business were sold in its entirety.

So, Should You Sell a Portion of Your Business?

The truth is, as a business owner, 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 company, allowing you to generate additional funds for your retirement or provide you with growth capital to invest back into your business.

As the owner of a small or mid-sized company, the decision you face may not be as straightforward as it is for the management of large companies like General Electric or the Hewlett-Packard Company.

In deciding whether to sell the whole company or only a portion of it, you should first examine the overall value of your business and then the individual value of each division. It may be possible to sell your business in pieces to extract the most value.

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

• Selling a percentage of your company: This option involves selling a certain percentage of your entire company, usually structured as a percentage of your stock. This type of sale is often called a recapitalization and is commonly used by business owners looking to retire in stages. These business owners may just want to take some cash off the table.
• Selling a division or unit: This structure involves selling a division, unit, or category of your business. Many companies are bought for strategic purposes. A buyer may see tremendous value in one division of your company while seeing little value in your other divisions. If this happens, you may consider a spin-off of one division.

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 dramatically increasing its value as well.

Many owners have a significant portion of their personal wealth concentrated in their business. Selling a segment or division of your business allows you to create liquidity while still maintaining complete control of the remaining portion. It also allows you to focus your talents on a division of your business with the most significant potential, or that you most enjoy, or that offers you the greatest work-life balance.

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

Splitting your company in two 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.

Why? Because few buyers possess the skills and knowledge necessary to be successful in multiple domains, such as in both retail and online realms. Most buyers’ skill sets are concentrated in one domain.

If your business consists of two segments but can only be sold as a whole, the buyer may view one segment of your business as excessively risky if they lack experience in that segment, and the valuation will therefore be lower. If both the online and retail divisions can be sold separately to buyers who have a strong background and experience in each domain, the risk will be lower for each buyer, and you will potentially receive a higher purchase price as a result of the reduced risk.

Many companies develop additional product lines as a part of their overall corporate growth strategy. In the process, many business owners create product lines that 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 that case, selling the product line can make sense.

Additionally, many buyers search for strategic acquisitions and have specific criteria regarding which businesses they will consider. They may be interested in just one component of your business and may not pursue your business as a whole because your other divisions do not align with their strategy.

Recent, popular divestitures include the decision of Hewlett-Packard CEO Meg Whitman to spin off and merge its 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 small businesses can benefit from splitting up their companies into separate divisions and selling them individually. For instance, some businesses require special licensing, and splitting the business into two divisions may be prudent, as some companies may only be interested in the 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 have considered the strategic elements of the decision should you consider the tactical components, or the “how to’s,” which are addressed next.

Consider the Operational and Legal Implications

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.

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? The answers to these questions should be considered 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 operationally.

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

If the division is likely to be run as a stand-alone entity by the buyer, you should run it as a stand-alone business with a separate P&L for as long as possible before beginning the sale process. Doing so will make the business easier to sell and will simplify the process of valuing each division separately. This will also increase the chances of the buyer being able to obtain third-party financing for the transaction. The more stand-alone the division is run prior to putting it on the market, the easier it will be to sell. The more integrated the two divisions of your company are, the more difficult they will be to sell.

Legal Implications

There are two general deal structures from a legal standpoint when selling a division — asset sale or a stock sale.

If your business is one entity (e.g., corporation, LLC, etc.) with two segments, 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. The Asset Purchase Agreement is sometimes called the Definitive Purchase Agreement — the name simply indicates that the agreement is definitive or the final agreement is signed at closing.

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 an asset sale via an APA. 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 is no need to transfer the assets separately.

You also have the option of selling a percentage of your company (i.e., a portion of your shares in your entity), but this defeats the purpose of focusing on your core competency because you will still own both divisions post-closing. This type of sale is often called a recapitalization or “recap” for short and is commonly used by business owners contemplating retirement but who aren’t ready to completely retire.

A recap allows a business owner to take some cash off the table and diversify their risk. Recaps are most commonly funded by financial buyers (i.e., private equity firms), in which they purchase a minority position in your business. The catch is that they expect you to use a significant portion of the equity injection as growth capital in the company.

Private equity firms have a limited time horizon and are counting on you to grow the firm and achieve a second exit in a three- to seven-year time frame. Recaps, or minority investments, are also made by corporations, but this is less common than those made by financial buyers. Recaps are best for business owners who want to take some money off the table now while simultaneously receiving the support of a sophisticated investor with deep pockets who is willing to inject some growth capital into the business. The result is a double exit — one minority exit now and a second majority exit in three to seven years.

Regardless, the decision to sell a division should begin with your long-term goals. If you wish to focus on your core division, a recap is likely not for you. If, on the other hand, you want to diversify your risk and take some money off the table, and are willing to continue operating the business for another three to seven years, a recap may be a sensible strategy for you.

Determining an Asking Price for a Division

How do I determine an asking price for a division or segment of my business?

The asking price for a division is determined using the same methods used to value a business as a whole. In essence, you are selling a cash-flow stream. To properly value the cash-flow stream, one must first measure it. And here is where it gets tricky.

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

If the businesses are not being run as stand-alone units, a pro forma must be prepared. However, any errors in the pro forma will be magnified by the multiplier.

For example, if you overstate income by $500,000, and your business is valued at a 4.0 multiple, then your business will be overvalued by $2,000,000 ($500k x 4.0 = $2 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 of any inter-division transactions must also be considered on revenue. When allocating expenses, you must also decide how to allocate fixed expenses.

For example, if your facility costs are currently $20,000 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, marketing, etc.

An alternate method, if you can get away with it, 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), then 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, and therefore 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 (e.g., two clothing lines).

Ideally, the divisions should be valued based on the net profit that each division generates. However, doing so involves numerous assumptions that are prone to error. A back-of-the-envelope method for obtaining a ballpark valuation for each division is not difficult, but such a ballpark estimate is unlikely to suffice for most buyers. A ballpark estimate should only be used for internal planning purposes.

If a buyer is looking to obtain a division of your company for strategic purposes, different valuation methods should be considered.

In such a case, you should prepare a pro forma P&L based on your division being integrated into the buyer’s company. It’s likely that certain functions for the division, such as HR, legal, and accounting, will be centralized by the buyer, which will reduce expenses and increase income for the business, and therefore increase its value.

While a reduction in expenses is considered a safe bet, buyers are less likely to pay for revenue synergies than synergies resulting from reduced costs. Even in the case of operational synergies (i.e., reduced costs), you must aggressively negotiate to receive value for these.

This is compounded by the fact that buyers rarely provide you with their financial models or pro formas, so the best you can do is prepare an estimate and negotiate to receive as high a percentage of the synergies as possible.

Selling a Division is a Strategic Decision

In some cases, it only makes sense to sell your business as a whole. In other cases, the wisest course of action is to sell your divisions separately. Your decision depends on a number of factors that a professional can help you evaluate.

You should first examine the overall value of your business and the value of each division separately. Once you have done this, you should clarify your long-term objectives and determine if selling a division or selling a portion of your company via a recap will help you best meet your goals.

Regardless, 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 help increase my focus?
• Knowing what I know now, would I start both divisions again?
• Which division produces the most profit for me?
• 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 is the potential value of each division?
• What is 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 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, as well as the previous operational and legal questions, you can determine the best way to move forward with your decision about selling a portion of your company.

Business owners sell portions of their companies for many reasons. Yes, it can be wise to sell just part of your business. It is a fairly common practice, and it can free up cash for you to use as you see fit.

Nonetheless, you should have a professional examine your business so that they can give you advice about the best way to proceed.

It may make more sense to sell your business as a whole. It depends on several factors that a professional can help you evaluate, 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 for your business. Either way, a professional should be able to assist you with selling your business in the way you want to do it, so don’t be afraid 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.