Divesting Redundant Assets in Preparation for a Sale

Redundant assets, or non-operating assets, are those assets that are not specifically required to generate cash flow and earnings of a company’s core business.  They can be either fixed assets such as real estate or working capital assets such as inventory.  When valuing a business, the net realizable value of the redundant assets is added to the value of the operating business to give an enterprise value.  In circumstances where redundant assets make up a significant part of the enterprise value and the owner is planning to sell the business, some prudent pre-sale preparation can go a long way to help ensure an acceptable outcome.

Often buyers will not pay full market value for a business that has significant redundant assets as they are only interested in the core business and its future cash flow.  Sometimes a seller can easily carve out the redundant assets to retain post-sale, but it can also complicate the deal and the negotiation process.  The best option may be to divest redundant assets before marketing the business for a sale.

Strictly speaking, real estate can be considered redundant, when the company does not engage in real estate as part of its core operations. Pre-sale divestiture of non-operating real estate can be to an outside party, to a shareholder, or a related entity.  Selling to a shareholder or setting up a related entity to acquire the company’s non-operating real estate allows the seller to take a disciplined approach to obtain its fair market value when it is time to sell or retain it for long-term appreciation.

While the carve-out for retention or pre-sale divestiture of real estate holdings not used in the operating business can be straightforward, owned real estate used by the business can be a little trickier, particularly if its book value is substantially less than its market value.  In this situation, it may be best to explore a sale-leaseback in advance of a sale of the business.  A sale-leaseback is where a company sells an asset, such as its real estate, to either a related entity or a third party, then leases it back at market rates on an arms-length basis.  The cash it generates can be distributed to shareholders through a special dividend or used for operations.  This approach could have significant tax implications and therefore obtaining expert advice from a tax specialist familiar with sale-leasebacks is critical.  It will also undoubtedly impact the business’s earnings, as a new lease payment based on the market value of the property may be higher than the depreciation it replaces.  This may mean the business is worth less but the combined value, net of taxes, should be higher.

Separating the real estate through a sale lease-back to a related entity or shareholder can also unlock more value in a couple of other ways.  First, it may generate more interest by a larger set of potential buyers, when there is flexibility on the part of the seller.  Some buyers may want to acquire both the real property and the business, while others may be interested in the business only.  More potential buyers can mean higher values in a well-run competitive process.

Second, asset-light businesses can attract higher multiples, as they are in higher demand.  A study by Ernst and Young found that companies that transitioned to asset-light models were more likely to generate higher Total Shareholder Return (TSR) than their asset-intensive competitors and 17% more likely to exceed shareholders' expectations of value when sold.
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Taking this concept further, there may be instances where the pre-sale divestiture of a division or product line can unlock further value.  According to a Harvard Business Review article, a disciplined approach to divestiture can not only sharpen a business’s focus on its core strengths and strategy, it can also create almost twice as much shareholder value (based on a twenty-year study by Bain and Company).

Finally, almost every business has a list of assets that are fully depreciated and underutilized.  Perhaps there is production equipment that is used as a backup or only used periodically that can be sold.  Selling these types of assets before a sale will likely be advantageous for the seller as buyers would normally expect all operating equipment on the books to be included in the purchase price. The same principle could be applied to any excess, written-down, or non-core inventory.  There also may be receivables that a buyer will not want to assume or will use to negotiate a late-stage purchase price adjustment.  Selling receivables to a factoring company beforehand may be a more disciplined way to generate maximum value.
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The key to maximizing the value when it is time to sell the business is to plan and to think through the best options for your specific situation; which among other things, may mean the pre-sale divestiture of redundant assets, or even a product line or business unit.

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