Divestiture Definition: What Is Divestiture in Business?

Growing a small business is rarely a straight path toward success. There are plenty of unavoidable twists, turns, and backtracking that takes place—and in most cases, these events end up being for the best even if they don’t feel like they’re beneficial in the moment. A company divestiture, by definition, is one of these kinds of bumps in the road for a business. Divestiture may not be fun, foreseen, or welcomed, but it’s a vital concept to understand as a small business owner, as it can affect your business finances.

The divestiture definition actually encompasses several different actions. Each pertains to a different kind of action one might have to take in order to make their business more financially viable. In some cases, this means closing locations that are underperforming. In others, it might mean abandoning some product lines in order to focus on those that are more profitable. These are two pretty divergent examples of a divestiture, with plenty of other examples still left on the table. 

Since the definition of divestiture is pretty broad, it’s worth going into more specifics to see if one or more of the usual uses of the word might apply to your business case. Familiarizing yourself with the divestiture definition may help you take the first step toward reorganizing your business so you can take on the next chapter with confidence.

Essentially, divestiture is merely the selling or shuttering of some component of a business. Divestitures are usually the result of a change in a business or its finances: If your business takes off and a prospective buyer enters the fray, you’d consider divesting in order to cede control to the new owner. Or, on the other hand, if your new brick-and-mortar location isn’t driving enough sales, you might want to cut your losses and shutter the store.

Divestiture Examples

We’ve talked about a few kinds of divestitures so far, but there are even more instances to review. There’s a lot of ground to cover, and plenty of typical divestiture types out there that might apply to your business interests. Here are the most common kinds of divestiture, as well as some hypothetical examples to provide more context.

Selling Underperforming Business Assets

Not every part of your business is going to be equally successful. Sometimes a brand doesn’t fly off shelves, or a component of your company has profit margins that aren’t strong enough to make it sustainable for the long haul. In this case, you might want to pursue a divestiture of the particular asset that isn’t breaking even (or isn’t generating enough revenue to make it worth the effort to keep).

Selling a Business

It’s not always an easy decision to sell your small business. Sometimes it’s a no-brainer if you get an offer you simply can’t turn down, or if you’re looking to exit the company before finances go from bad to worse. No matter the reason, selling a business can count as a divestiture as you’re divesting your financial interest in the company. 

Selling a Business Subsidiary

Instead of selling your business outright, you might be interested in entertaining offers for a subsection of your company. This is particularly true if you have subsidiaries or brands that could be spun out from your organization easily. Selling a subsidiary business is a potentially lucrative kind of divestiture depending on your specific case and the conditions of the sale.

Closing a Location

Divestitures also include the closing of a business location, as we touched upon earlier. If you’re looking to downsize an unprofitable expansion, this too counts as a kind of divestiture. In this case, you may not necessarily be looking to sell the business or get rid of stock, but merely want to scale down the size of your organization and its physical footprint to save money. This can be a great way to use divestiture to reorganize your company and pursue a new business strategy.

Licensing Equipment or Intellectual Property

A small business’s best asset can be its trade secrets or proprietary products. That’s not just true in terms of generating income by offering something unique, either. Licensing products and equipment can be a quick way to boost cash reserves for a limited (or indefinite) period of time. If you have machinery you don’t need to use for a while, or can afford to license out technology you own, you can help shore up cash reserves in exchange for these items.

Bankruptcy

No one wants to deal with a small business bankruptcy, but unfortunately these things happen. When they do, you’ll likely have to sell off major components of your business (or, as is even more likely the case, the entirety of the business’s holdings, assets, and property). The most common example of a divestiture that requires the full sale of a business is Chapter 7 bankruptcy, whereas Chapter 11 can allow for more wiggle-room during a company’s reorganization.

The Benefits of Divestiture

There are plenty of upsides to divesting from your business, so long as it isn’t due to bankruptcy or other unavoidable circumstances. Every business’s needs are somewhat unique, so the upside to divestiture will likely be different than someone else’s. In some cases, divestiture can help companies bulk up on cash. In others, it can help businesses streamline and re-tool their operations to be leaner and more lucrative. 

Even though the reasons for divestiture vary between unique cases, there are a few major reasons why some small business owners might want to divest from all or some of their stake in a business, its assets, or its subsidiaries. Here are a few of the most common reasons why you might want to consider divestiture.

Increased Cash Reserves 

Divestiture can give your company a boost in its cash reserves, which might be a better option for you than a small business loan. Loans are a worthy option to consider (particularly if you’re a good candidate for an SBA loan), but are likely to require good credit and a longstanding track record of success for your business. Not every company has those things in hand, which can preclude them from getting approved for all but the most expensive loans with fast repayment terms and high interest rates.

If this sounds like your company, divestiture can provide an alternative means of getting cash quickly. If you license your equipment, technology, or intellectual property to another business, you can help put your assets to work for you in terms of generating capital. Divesting from subsidiaries can be trickier, however, because you run the risk of selling a portion of your company that would have otherwise generated revenue down the road.

Streamlined Operations

Entrepreneurs are usually geared toward growth. Many want to expand as quickly as possible, too. This doesn’t always work out as intended though, which may put you in a position where you need to scale back your operations and retool your business strategy. Divestiture lets you cut your losses on underperforming parts of your business, rather than subjecting you to sunk costs in keeping portions of your company operational in the hopes that they’ll eventually turn around. 

Even if you started your company off on the right footing with a robust business plan, it’s more than likely that you’ll have to retool as you go along. Streamlining what you sell, and where you sell it, can make it easier for your company to pivot. You can always expand and grow with a new strategy in place; divesting allows you to do so in the best way possible. 

Avoiding the Sunk Cost Fallacy

You may have heard about sunk costs as they pertain to your business. These are typically expenses that you can’t recoup and have to either write off or otherwise discount as you assess your company’s finances. There’s more to sunk costs than merely writing off spent money, however. There’s also the sunk cost fallacy—the idea that people are averse to cutting their losses because of the investment they’ve already made in them.^[1] This is often known as “throwing good money after bad,” wherein a business owner makes more of an investment into something that is a lost cause.

You can avoid falling prey to the sunk cost fallacy by divesting from parts of your business that have no real chance of succeeding. This can take the form of an unsuccessful business branch, an unprofitable line of products, or other efforts that aren’t panning out as you’d hoped. In this case, the sooner you divest, the sooner you can cut your losses.

How Divestiture Affects Your Business

Given the usual circumstances under which you would consider divestiture, it’s clear to see that there are pros and cons that come with doing so. In some cases, divestiture can be a great option for small business owners who need to retool their business or scale down in order to grow later on. In other cases, however, divestiture might be an unwelcome consequence of financial woes or declining business. 

Divestiture Pros

Divestiture can mean right-sizing your business for future trends, or finding ways to cut costs to make your business more efficient. It’s never easy to decide whether or not divestiture is the way forward, but it can be a savvy option for businesses that know they need to make changes in order to thrive. Better still, if you’re considering divestiture because of a potential sale of the business or its components, you might be at the brink of an opportunity to cash in on all your hard work. These examples demonstrate when and how divestiture might be a good fit for you, and why it’s not always something done out of adversity.

Divestiture Cons

There are also less-than-rosy reasons to consider divestiture as well. One might argue that there are more cons than pros. First, divesting from a part your business may signal problems ahead. Lenders might ask you why you’re reducing your investment in the business, and could possibly see this as a risk factor when deciding to approve or reject a future loan application. Divestiture can also preclude you from potential revenue and growth down the line if you’ve cut out a part of your daily business operations. You won’t necessarily be able to predict whether or not an underperforming business activity could pick up in the future, however.

The Bottom Line

Opting to divest from your company is not an easy decision. After all, it’s hard to decide what to cut, sell, or part with when you own your own business. Shuttering a store means laying off staff; giving up on a product line means sacrificing the costs involved in getting it off the ground. If your market conditions and business activities make it such that divestiture is your best way to cover expenses or right-size your business, it can be the right (if still painful) decision to make. Alternatively, if divestiture means selling your business and taking advantage of the hard work you put in to make it successful, then divesting can mean the realization of a dream come true. It all comes down to your own scenario and perspectives.

Article Sources:

1. BehavioralEconomics.com. “Sunk Cost Fallacy“