Divestment - Meaning, Strategies, Examples in India

Divestment, in very simple words, can be called the opposite of investment. Divestment is the method that business owners can adopt if they wish to dissolve investments that are no longer aligned with their goals. 

This blog provides details of this important business concept. Read on. 

What is Divestment? 

The term ‘divestment’ refers to the process of selling off a business or an asset class that is consistently failing to meet the expectations of investors and other stakeholders. It is also known as divestiture. 

Reasons Behind Divestment Strategy

Deciding to divest a subsidiary company or an asset class is not an easy decision. Some of the reasons why a company may opt for divestment are as follows: 

• Emphasis on Primary Business 

Nowadays, it has become common for businesses to sell off non-related units and focus solely on their primary business and its operations. Gone are the days when larger organisations would take over smaller and unrelated businesses. 

An example would be Ford Motor Company selling off some of their businesses to focus on their core operations. 

• Source of Funds 

Companies don’t prefer to invest in subsidiaries or non-performing units during financially distressful times. It’s much better to sell off the assets and save money to prevent insolvency. 

• Better Opportunities to Invest 

Divestment of a not-for-profit unit can also take place if a company wishes to invest in a unit that holds the potential to generate higher returns at the same investment amount. One must not forget the main purpose of any business is to generate profits. 

• Preventing Monopoly 

There have been instances when governments have made divestment mandatory for maintaining fair trade practices and avoiding a monopoly. Companies have followed it to play by the rules. 

• Political or Social Reasons 

It's common for companies to divest from countries/regions going through civil strife or socio-political tensions. It leads to the outflowing of cash from war-torn countries. Divestment can even lead to major political changes, such as changes in the central government. 

This can be best illustrated by what happened in Myanmar in 1990. Established companies like Macy's, HP, and PepsiCo became vocal against the military government in Myanmar, and they were actively encouraged by the opposition parties. 

What is a Divestment Strategy? 

The management of a business needs to be sure of the fact that they want to opt for divesting because it's a crucial step. Choosing the right type of divesting is also quite important. Here, one must say that adopting a systematic and structured process is equally important while choosing an appropriate divestment strategy. 

Companies should hire skilled professionals to carry out a divestiture. Business owners should not overlook the customers as their satisfaction plays an important role in the success of a venture. The management should be able to convey their strategies to the customers easily as it helps to build stronger relationships. 

Lastly, another important requirement for divestment is patience. The people involved in the divestment process must hold their patience for a year or more to make a deal a success. 

What are the Types of Divestment? 

Below are the different types of divestment: 

• Equity Carve-Out 

In equity carve-outs, the company launches an initial public offering (IPO) to proceed with the sale of a portion of its subsidiaries, business sectors, or divisions. But, there's an important factor to take into consideration. The parent organisation will have complete control and will remain the most important shareholder in the business unit that has been divested. 

• Demergers 

Demerger is another type of divestment. Splitting up of an organisation leads to the creation of two or more independent corporations. It also dissolves the identity of the parent company very gradually. Companies can also opt for the spin-off method of divestment, where the business entity gets subdivided into multiple subsidiaries, but the parent company continues operating. 

• Sell-Offs 

When a company sells off a few of its business units, divisions, or subsidiaries, it's known as a sell-off. Some of the reasons behind this type of divestment are the poor performance of a subsidiary unit, failure of a business division, a lot of capital requirements, and non-alignment with core business operations. 

Examples of Divestment in India 

A few years back, in 2018, to be precise, Tata Power divested a few of its non-core assets and came up with a plan for the growth and expansion of the next 10 years. 

The company planned to lay more emphasis on renewable power and services businesses. The officials of Tata Power stated that the growth and expansion of the business would take place in conventional power generation. 

Advantages of Divestment

• Divestment is a source of funds from non-business operations, and it helps in facilitating business expansions and lets people focus on core niches. 
• This is a great opportunity to unload debts. 
• Divestment helps business owners to eliminate business entities that are headed toward failure. 
• This method helps businesses invest funds in ventures holding the potential for more profits. 
• An important benefit of divestment is that it leads to higher shareholder returns. 

While divestment carries many benefits, it would be wise to know its disadvantages as well: 

• If the divestment strategy is not disclosed properly, investors might feel it’s an indicator of the company’s poor financial health. As a result, they might withdraw their funds from the company. 
• Valued customers, vendors, and other stakeholders can lose trust when a company disinvests and might just shift to its competitors. 
• Divestment is also an expensive process because the company needs to pay for various transaction costs, including fees for professional experts, asset transfer charges, and employee severance pay. 

Differences Between Divestment and Disinvestment

Divestment or divestiture is the process of selling off business divisions, units or subsidiaries, assets, and other investments that have consistently failed to perform well. In divestments, the restructuring of a business entity takes place while its operations remain unaffected. 

On the other hand, when it comes to disinvestment, the capital assets of a company undergo significant reduction when it faces a major loss. However, a firm may willingly sell off assets such as equipment and buildings to raise the money required for paying lenders and shareholders. 

In divestment, companies can easily reinvest the funds they receive in more profitable options. However, this isn't the case in disinvestment. The company, in the latter case, does not have the option to reinvest the funds. 

Conclusion

Summing up, divestment is an important business concept that one must know if one wishes to understand the financial performance of a business adequately. It's the process by which businesses sell off their assets to maximise value. Considering that it frees up a lot of funds, it can be called a turning point in a company's trajectory.