How a Tax Strategy Is Key to Divestment Success

Commonly, value is lost when sellers identify tax risks in the early stages, but then fail to act to clarify and potentially mitigate those risks
Vincent RyanAugust 8, 2019

The ebbs and flows of the global economic climate mean that pressure from shareholders has created a new normal of frequent and disciplined portfolio reviews. As a result, companies are actively identifying assets for disposal. Divestment can be an important business strategy, but increasingly, shareholders are finding that divestments are not meeting their timing or price expectations, largely because of last-minute tax implications or hurdles.

Avoiding divestment completely is not the answer. A more proactive and strategic alternative is getting trusted tax advice at the beginning of the divestment process, providing decision-makers with insights to help mitigate potential tax risk and avoiding the kinds of unintended consequences that could undermine the ultimate value.

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Even with the challenges, the intent to divest remains at record levels. In the recent EY Global Corporate Divestment Study 2019, we found that 84% of companies planned to divest an asset within the next two years, holding steady with last year’s record of 87%. Despite uncertainty from tariffs, trade wars, desynchronized growth, and geopolitical concerns, the market offers sellers a resilient yet competitive environment.

In the same study, we found that 66% of respondents cited lack of preparation in dealing with tax risks as being the biggest cause of value erosion.

Commonly, value is lost when sellers identify tax risks in the first stage of preparation, but then fail to act to clarify and potentially mitigate those risks before the process starts.

Bringing tax into the divestment strategy earlier can allow sufficient time to undertake an open assessment of the business through the eyes of a buyer, address issues identified, and only then commence diligence. It is not only how a vendor sees tax risk and opportunities that is important, but how a buyer would look at them from the outside in — which is easier said than done.

Negative value adjustments can occur where a seller underestimates the tax perspectives from a widening pool of buyers, including private equity and cross-sector. Preparing for these conversations may require sellers to review historical tax advice and the trail of why positions were taken. That can help provide the reassurance and granular data a purchaser requires — in some cases resulting in pre-sale tax authority clearances and negotiations.

Simply put, value is being left on the table, predominantly because tax implications and issues are being considered too late.

Divestment can take many forms. Although a carve-out sale is the most common, other deal structures such as joint ventures, tax-free spins, or full enterprise sales can sometimes support a greater return to shareholders or align better with the long-term goals for the organization. Each has its own tax implications that need to be considered at the outset. And this means your tax team needs to be involved from the beginning, guiding the strategy and not just reacting to it.

From a business perspective, it is paramount to understand the variables and options about the approach and possible structures of a divestment early on, including how tax applies to the divestor.

Once the deal is on the table and has been reviewed by investment bankers and lawyers, however, it is difficult and expensive to go back and adjust for tax permutations.

One of the critical success factors related to enhancing tax value and minimizing the tax downside is also in thinking early on about the likely buyers of a divested asset – who they are and what their priorities may be. For example, a private equity buyer will have different considerations from those of another corporate, so it is important to build flexibility into the structure and allow for options that are appealing to a wide range of buyers.

The EY divestment study bears out that point: 57% of companies responding said that the lack of flexibility in the sale structure caused value erosion. Evaluating structures and building in greater flexibility allows room to optimize according to market conditions and greater tax efficiencies, which helps maximize value.

Once the deal is on the table and has been reviewed by investment bankers and lawyers, however, it is difficult and expensive to go back and adjust for tax permutations.

Actual value is, arguably, the most visible of the impacts but not the only one that can result from leaving tax out of the conversation. Sales processes often stall when sellers fail to recognize that potentially skeptical buyers may have a completely different view of the risks associated with legacy tax-efficient structures implemented historically.

Delayed closings pose operational and administrative burdens to sellers post-close and often postpone their receipt of cash. They can also impede the buyer in implementing the changes required to achieve value-capture goals. Issues like these are both inconvenient and avoidable for buyers and sellers.

Part of the challenge is that people “don’t know what they don’t know.” Although a board of directors may see a good opportunity for divestment, they might not be fully considering the tax implications or the different ways to approach it. With more and more tax authorities sharing information with one another, and with rapidly changing legislation across multiple jurisdictions, the hazards increase exponentially.

And at a global level, the majority of respondents in the EY divestment survey said they expect an increase in tax challenges as they execute deals and try to avoid value erosion in the year ahead.

The question is, then, what should divestors be asking? Even at the most basic level, here are the top five questions that should be on their minds:

  1. How should the transaction be structured to minimize tax exposure on the deal?
  2. What does the most efficient tax operating model look like for the carve-out business?
  3. How do we manage the potential tensions between tax efficiency on exit for the seller and the ongoing tax profile of the carve-out business for the buyer?
  4. Can we build a forecast model that underpins this work with hard data?
  5. How can we start executing tax structuring changes to accelerate exit while minimizing tax costs?

This is a critical time for business leaders to think more strategically about tax, not only as a central component to any intended carve-out, but also as part of the general portfolio review process from year-to-year.

Kate Barton is EY’s global vice chair of tax.

The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.

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