Navigating CFO Challenges in Divestitures

Introduction

Divestitures present numerous challenges for Chief Financial Officers (CFOs). This blog post outlines common pain points encountered during the divestiture process, focusing on finance and accounting organizations, and suggests effective ways to address them. These insights are drawn from our experiences as financial executives who have successfully navigated these complex transactions.

1.        The Valuation Process

Pain Point: Accurately valuing the part of the organization to be divested, which can lead to financial losses or missed opportunities if done incorrectly.

Addressing the Challenge:

CFOs should begin with a comprehensive due diligence process to gather all relevant financial and operational data. This forms the foundation for adjusting financial statements to reflect the unit as a standalone entity. A multi-faceted approach to valuation is crucial, involving the application of various methods such as Discounted Cash Flow, Comparable Company Analysis, and Precedent Transactions. It's essential to consider synergies that may be lost or gained and factor in current market conditions and industry trends.

Engaging valuation experts early in the process ensures that methodologies and assumptions are robust and defensible. These experts can provide invaluable insights into industry-specific valuation nuances and help navigate complex areas such as the allocation of shared costs, estimation of future performance without parent company support, and quantification of intangible assets.

Proper documentation of all valuation decisions is essential for audit purposes and to support the valuation in potential negotiations. This documentation should clearly outline the rationale behind key assumptions and methodologies used, providing a transparent and defensible basis for the valuation.

2.        Financial Statement Preparation

Pain Point: Carving out historical financial data specific to the divested unit, which often requires significant time and resources and may involve complex judgments and estimates.

Addressing the Challenge:

The preparation of carved-out financial statements is a multifaceted process requiring careful attention to detail and a strategic approach. The size and scope of the divested assets or business will determine the extent of separate financial statements required and the level of detail needed.

CFOs should begin by assessing the significance of the divestiture relative to the Company and understand the buyer’s financial reporting requirements as a result of the acquisition. This assessment will guide the level of financial reporting required, ranging from limited disclosures to full carve-out financial statements, and determine the type of assurance the buyer may seek from the seller. For smaller divestitures, a review of the financial information or agreed-upon procedures might suffice. However, larger or more significant divestitures may require a full carve-out audit. These requirements should be discussed with auditors and legal advisors early to ensure compliance with regulatory standards and buyer expectations.

If full audited financial statements are necessary, the ensuing clip level for substantive audit testing can significantly impact the process. As the new business may represent only a fraction of the whole, sample sizes for testing can be quite large, potentially straining existing personnel. Throughout this process, the level of detail and the extent of financial statement preparation will be guided by the size and significance of the divested assets or business. CFOs should work closely with their audit teams to determine the appropriate level of assurance required, whether it's a review, agreed-upon procedures, or a full carve-out audit. This tailored approach ensures that the financial reporting meets both regulatory requirements and buyer needs while efficiently allocating resources based on the materiality of the divestiture.

CFOs should start by identifying all relevant transactions and balances, which often involves dealing with incomplete or inconsistent record-keeping. This process may require the finance team to dig deep into historical records and collaborate with various departments to piece together a complete financial picture.

Allocating shared costs and corporate overhead is another critical aspect. This requires developing a fair and defensible allocation methodology that accurately reflects the true cost of running the divested unit as a standalone entity. CFOs should work with operational leaders to understand how shared services are utilized and develop a rational basis for cost allocation.

Adjusting for intercompany transactions is crucial for presenting an accurate standalone picture of the divested unit. This involves identifying all intercompany transactions and balances, determining arm's length pricing for goods and services, and unwinding complex intercompany financing arrangements. It's important to consider the tax implications of these adjustments and work closely with tax advisors to ensure compliance.

Recasting financial statements to reflect the unit as a standalone entity requires estimating costs for functions that were previously shared and adjusting for economies of scale that may be lost. This process often involves making informed assumptions about how the business will operate independently, which should be clearly documented and substantiated.

Ensuring compliance with accounting standards and regulatory requirements is paramount. CFOs should work closely with their auditors and legal advisors to identify all applicable standards and regulations, address any differences in accounting policies between the parent and divested unit, and ensure proper disclosure of the divestiture in financial statements.

When a clean system break cannot occur immediately, CFOs must negotiate Service Level Agreements (SLAs) with the buyer. These agreements outline the terms for continued provision of certain services or systems access during the transition period. Key considerations include service duration, scope, performance metrics, pricing, data security, and exit strategies. Effective SLAs ensure the continuity of critical services while protecting both parties' interests.

When applicable, reporting discontinued operations adds another layer of complexity. This is where clear communication lines and strong connections between the divestiture project team, the RemainCo reporting team, and investor relations become crucial. These clear lines of communication are essential for several reasons:

a)        Accuracy and Consistency: Discontinued operations reporting requires precise tracking of financial data related to the divested unit. Clear communication ensures that all teams are working with the same set of numbers and assumptions, reducing the risk of inconsistencies or errors in financial reporting.

b)        Timely Updates: The status of a divestiture can change rapidly, potentially affecting how it's reported. Strong communication channels allow for quick dissemination of updates, ensuring that all teams can adjust their reporting and analyses promptly.

c)        Regulatory Compliance: Reporting discontinued operations has specific regulatory requirements. Clear communication helps ensure that all teams understand these requirements and can provide the necessary information to meet them.

d)        Stakeholder Communication: Investor relations need accurate and up-to-date information to communicate effectively with stakeholders. Strong connections between teams help ensure that investor relations have the latest information on the divestiture's financial impact.

e)        Decision Making: Clear communication facilitates informed decision-making by providing all relevant parties with a comprehensive understanding of the divestiture's financial implications.

Preparing pro forma financial statements to show the impact of the divestiture involves developing assumptions for future performance, reflecting the impact of transition service agreements, and estimating one-time costs related to the divestiture. This forward-looking view is critical for potential buyers and stakeholders to understand the full financial implications of the transaction.

Clear communication and strong connections between the divestiture project team, the RemainCo reporting team, and investor relations are crucial throughout the financial statement preparation process. This ensures accuracy, consistency, and timely updates across all teams, facilitates regulatory compliance, effective stakeholder communication, and informed decision-making. Regular coordination meetings help align efforts, address discrepancies, and ensure all teams work towards the same goals in terms of financial reporting and stakeholder communication.

3.        Separating Integrated Financial Systems

Pain Point: Ensuring data integrity and security during the separation and setting up new financial systems for the divested unit.

Addressing the Challenge:

The separation of integrated financial systems requires meticulous planning and execution. CFOs should identify all relevant systems and data, determining which systems will be transferred versus replicated, often collaborating closely with IT teams and external IT specialists.

For example, consider a multinational corporation divesting a regional subsidiary. The CFO might need to:

• Identify which ERP modules are shared and which are standalone

• Develop a plan to replicate shared modules for the divested unit

• Ensure data migration without compromising security or integrity

• Set up new interfaces between the replicated systems and remaining corporate systems

• Provide training on the new system configuration to the divested unit's finance team

Implementing robust data security measures, such as setting up new firewalls and access controls, is essential to protect sensitive information and maintain compliance with data protection regulations. Establishing new interfaces between systems ensures smooth post-separation operations, which may involve creating APIs, modifying software, or implementing middleware solutions.

Furthermore, providing comprehensive, phased training on new systems for all employees helps ensure a smooth transition and minimizes operational disruption. If the divested unit is merging with another entity, conducting a thorough systems audit and developing a detailed integration roadmap is crucial. Temporary solutions may be necessary to ensure business continuity during the transition, but with careful planning and execution, the process can be managed effectively.

4.        Maintaining Business Continuity

Pain Point: The divestiture process can disrupt day-to-day operations, leading to potential inefficiencies and productivity losses.

Addressing the Challenge:

Maintaining business continuity during a divestiture is critical for the divested unit to preserve its value and ensure a smooth transition. To achieve this, it is essential to work closely with operational leaders to establish a dedicated transition team equipped with a detailed plan, clear timelines, and defined responsibilities.

Conduct thorough risk assessments to identify and mitigate key operational risks and develop contingency plans to address potential disruptions. Ensuring uninterrupted supply chain operations and maintaining key customer relationships are vital; this can be managed by assigning dedicated account managers and forming special project teams to focus on critical areas.

Clear communication protocols must be set up to keep all stakeholders informed throughout the process. Arranging temporary service agreements for shared functions will help ensure a smooth transition. Careful planning of asset separation, including technology, intellectual property, and physical assets, is necessary to avoid operational disruptions.

Maintaining transparent communication with employees, customers, suppliers, and investors is essential to manage expectations and sustain confidence throughout the transition. This transparency helps mitigate uncertainty, maintain productivity, and protect the divested unit's reputation and relationships, ensuring that all parties are aligned and informed during the divestiture process.

5.        Balancing Divestiture Activities with Business-as-Usual for RemainCo

Pain Point: While managing the divestiture process, the remaining company (RemainCo) must continue its regular operations without disruption, which can strain resources and attention.

Addressing the Challenge:

Form a dedicated divestiture team to focus on the separation, allowing other employees to concentrate on day-to-day operations. Implement robust project management to track tasks, identify resource constraints, and manage timelines effectively. Regularly reassess and adjust priorities, possibly putting non-critical initiatives on hold to free up resources for the divestiture.

Communication is crucial to managing this balance. Maintain open lines of communication with all stakeholders, including employees, customers, and suppliers, to manage expectations and minimize disruptions. Clear and consistent messaging about the divestiture process and its potential impacts can alleviate concerns and maintain trust.

Ensure clear and consistent communication between the divestiture and RemainCo teams, especially where interdependencies exist due to external reporting requirements. Regular updates and coordination meetings are essential to align efforts, address any cross-team dependencies, and meet regulatory obligations. Temporary resources or consultants can be strategically deployed to support either divestiture activities or ongoing operations, depending on where the greatest need lies.

Pay close attention to employee morale and workload in RemainCo, implementing support mechanisms such as additional training or temporary job rotations to help manage increased responsibilities or changing roles. These measures support the immediate needs of the divestiture and contribute to the long-term resilience and adaptability of RemainCo's workforce.

6.        Managing Employee Retention and Morale

Pain Point: Divestitures can create uncertainty and anxiety among employees, affecting morale and productivity.

Addressing the Challenge:

Effective communication is key. Collaborate with HR to develop a clear, consistent, and frequent communication strategy explaining the divestiture, its implications, and the timeline.

Retention incentives such as financial bonuses, accelerated stock vesting, or guaranteed positions can help maintain stability. Offering career development opportunities within the new structure can alleviate job security concerns.

Address job security, benefits, and cultural changes through one-on-one meetings, town hall sessions, and regular updates. Engage employees in the transition process to help them feel more in control and invested.

Provide support services like counseling and career coaching to help employees navigate the transition. If merging with another company, address cultural integration early to smooth the transition and reduce anxiety.

7.        Managing Dual Responsibilities of Key Personnel

Pain Point: Employees involved in divestiture activities typically also have day-to-day responsibilities, leading to potential burnout, decreased productivity, and increased stress.

Addressing the Challenge:

Address this challenge by first assessing and redistributing roles and responsibilities, identifying critical tasks and deprioritizing less crucial ones. Implement flexible work arrangements and maintain clear communication of expectations and priorities. Bring in additional resources like temporary staff or consultants to support either divestiture activities or day-to-day operations. Offer support and training in time management and stress management and provide access to productivity tools. Recognize and reward employees for their extra effort, and regularly monitor their well-being to detect signs of burnout early. By taking this comprehensive approach, CFOs can manage the complexities of dual responsibilities, ensuring the success of the divestiture while maintaining employee engagement and productivity.

Conclusion

Successfully navigating the divestiture process requires CFOs to address key challenges head-on. These include ensuring accurate valuation, preparing comprehensive financial statements, managing system separations, maintaining business continuity, balancing divestiture activities with regular operations, retaining talent, and managing dual responsibilities. By proactively tackling these pain points and leveraging proven strategies such as early preparation, engaging the right expertise, and maintaining clear communication, CFOs can guide their companies through successful separations. Remember, successful divestiture is less about rigid adherence to a plan and more about creating an adaptive framework that can respond to the inevitable challenges and opportunities that arise during this complex process.

Enjoyed this perspective? We share periodic insights like this through Kebla Insights — short, practical updates drawn from real work with finance and operations leaders. Subscribe here

The information provided on this blog is for general informational purposes only and should not be construed as professional advice. Please consult a qualified professional before making any decisions based on this information.