Last week, we discussed the board’s role in M&A activity. Now we shift our focus to another type of strategic transaction: divestitures.
Regularly espoused by shareholder activists, divestitures provide a variety of tactical benefits beyond just “removing a piece of your company.” Whether to focus on core capabilities, to mitigate key risks, or to raise capital for acquisitions or innovation, companies can offload or reposition pieces of their business in ways that unlock significant value for shareholders.
This week, PwC’s Governance Insights Center published a comprehensive roadmap to divestitures, also published in the Harvard Law School Forum on Corporate Governance and Financial Regulation. In this resource, PwC’s Paula Loop (a familiar face on our weekly webshow) details everything a board would need to know about divestitures, from the consideration stage to post-deal operations:
- What is the goal of the divestiture?
- What kind of divestiture should we consider?
- How important is timing?
- How are we handling talent?
- What should our board watch out for after a deal is done?
In this blog, however, we hone in on Loop’s insights for the post-deal planning (i.e., once the divestiture is complete). In doing so, we highlight four critical elements that boards must consider before a transaction takes place. Let’s discuss:
Key Considerations for Divestiture Success
The considerations below pertain to divestitures other than a trade sale—such as a carve-out IPO, spin-off, joint venture, etc.—where the parent company maintains an interest in the subsidiary. For more information on the various types of divestitures, see PwC’s resource for boards, When a Piece of Your Company No Longer Fits: What Boards Should Know.
1. Are you striking the right balance with post-deal changes?
Divestitures (including carve-out IPOs, spin-offs, and joint ventures) often allow companies to focus more aggressively on their core capabilities and long-term strategy. Beyond the transaction, however, the board must ensure that management has positioned both companies on the road to long-term profitability and growth. In outlining the strategy for each company, the board must be sensitive to the nature of these adjustments, lest they be too aggressive or too conservative.
If the new entity and parent company make only slight adjustments in strategy and operations, they run the risk of simply being smaller versions of the formerly combined company, with stranded costs and few, if any, new advantages. But if the two entities make drastic shifts, it could make the divestiture process even more complex and overwhelm the companies, leaving them fumbling as they set off in separate directions.
In all cases other than a full sale, it’s the board’s responsibility to engage management on the divestiture plan in order to ensure that strategy adjustments are appropriate and competitive market positions are maintained. Which brings us to the next consideration…
2. Will the divestiture create vulnerabilities that competitors can capitalize on?
In the case of highly publicized or complex divestitures, competitors may “see an opportunity to disrupt customer relationships and grab market share,” says Loop. The board must ensure that management anticipates these vulnerabilities during the planning process.
Depending on the nature of the deal, companies should consider outlining a detailed communication plan with both reactive and proactive elements: (a) this is how the company will respond to potential or likely attacks from competitors, and (b) this is how the company will protect areas of weakness by communicating beforehand to customers, shareholders, etc. The board is responsible for ensuring that these risks are assessed by management and a counteractive strategy is in place.
3. How will the cost-mitigation plan be communicated to shareholders?
After a divestiture, the new entity will likely incur short-term costs associated with establishing processes and personnel required to run the new company. If not communicated properly, these early inputs could pose a threat to shareholder confidence.
“If the new entity had been tightly integrated with the parent company, those costs could be high,” said Loop, “especially in the early months, before profit growth can offset the expense.”
Prior to a divestiture, the board must ensure there’s a cost-mitigation plan in place; that plan should not simply be duplicated from the parent company, nor should it be overly aggressive. Most importantly, the board must communicate to shareholders how these upfront costs will be neutralized over time:
Maintaining focus on the value being created through the divestiture against the short-term costs is vital for shareholder confidence. Directors should understand how the divestiture may create opportunities for long-term value in both companies—whether it’s exiting an unprofitable line of business, making major capability enhancements or even changing a culture.
4. How will the new company’s board of directors be structured?
In the case of a carve-out IPO, spin-off, split-off or joint venture, the new entity will likely need its own board of directors. The parent company board will need to assess the structure and composition needs of the new board, among many other considerations (e.g., To what extent should the governance policies between the two boards overlap?).
“Depending on the focus of the new entity,” says Loop, “it could make sense for some of the parent company’s directors to join the new entity’s board.”
This was the case for the 2015 spin-off of TEGNA and Gannett, where three board members transitioned to the new company to ensure continuity. In the episode below, board member Susan Ness explains the board’s process for assessing the strategic needs of both companies and ultimately building a board of directors from the ground up:
Click here to access PwC’s roadmap to divestitures, When a Piece of Your Company No Longer Fits: What Boards Need to Know About Divestitures.