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Divestiture can help your company manage its best assets. Bankrate explains.

What is divestiture?

Divestiture is when a company sheds or reduces assets or business units that are not performing well or supporting the company’s overall mission. It may help restore a company’s profitability, reduce its investment risk, and streamline its business operations. When a company divests, it can recoup funds from financial loss by selling an underperforming asset to another company, or it may opt to simply eliminate the asset.

Deeper definition

A company will divest a particular unit when it’s obsolete or no longer a beneficial part of a company. If you’re in the printer business but you also sell ink, you may decide that it’s more strategic to focus on just printers. You might sell the ink division to another company – perhaps one that only sells ink. Or you may shrink the ink division if your revenue from ink is exceeded by the cost of maintaining the ink department. If the cost of ink becomes too volatile but printers remain stable, your company might better appeal to investors if the ink asset is divested.

In each of those scenarios, the goal is to maximize profitability. Divestiture helps manage a company’s investments by drawing back from those that didn’t pay off or have run their course. Sometimes a company’s mission is better served when it’s leaner, but divestment also helps a company settle its debts. A divested asset might even become its own separate company, which is sometimes called a spin-off.

Divestiture often follows after a merger or acquisition when redundancies occur or the new owners feel like an asset doesn’t meet the new company’s strategic goals. When divestitures are not carefully planned, they may often be forced by bankruptcies.

Divestitures have also been used to improve an organization’s public image. Recently, environmental activists have succeeded in getting many universities to divest their investments in fossil fuel companies, in the hope of fighting climate change.

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Divestiture example

In one important case, divestiture was initiated by the U.S. government. By the middle of the 1970s, AT&T controlled almost all telephone service in the country through its ownership of the Bell System monopoly. The Department of Justice filed an antitrust lawsuit against AT&T, and in 1982, rather than lose the case, AT&T divested its local operations and the Bell System was broken up into seven regional companies called Baby Bells.

AT&T was allowed to hold onto its telephonic equipment company, Western Electric, but it was eventually forced to divest of that as well when it proved less profitable in the wake of the settlement.

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