Divesting a business unit creates value when other owners can extract more value from it than the current owners can. This is known as the “better owner” principle. Often, new owners change the operating model of both the divested business and the parent company because large companies frequently impose mismatched operational requirements on diverse business units. For example, high-growth, high-margin businesses may require operating models that are different from those of low-margin, mature businesses.1 Breaking up the business units can help both entities develop a fit-for-purpose operating model.
Moreover, divesting noncore business units can help free up management attention and allow for better resource allocation decisions within the core businesses. Finally, divestments can improve capital allocation decisions while making it easier for the divested entity to raise capital as a pure-play company, versus competing for funding with all other lines of business.
The value created in a divestment for a parent company is the price received minus the value forgone minus separation costs incurred by the parent. The value forgone is the value of the divested business, as operated by the current management team, plus any synergies it has with the rest of the parent’s businesses. This forgone value represents the cash flow that the parent company has given up by selling the business. The costs of separation include the costs the parent incurs to disentangle the business from its other businesses, plus the so-called stranded costs of any assets or activities that have become redundant after the divestment—costs that, as we will see, can often be substantially mitigated by restructuring central and shared services in the parent company.
This article, an excerpt from the eighth edition of our book Valuation: Measuring and Managing the Value of Companies (Wiley, May 2025),2 discusses these synergies and costs. It also examines practical challenges relating to legal and regulatory issues, as well as pricing and liquidity of the businesses.
Lost synergies and stranded costs
When a company divests a business unit, it may lose with it certain synergy benefits that come from having that business in its portfolio, even if the company isn’t the best owner of the business. For example, a business unit may have cross-selling opportunities with other units. Likewise, a corporation may bundle its procurement for various businesses globally so that it enjoys significant discounts. In other cases, the divested business may have to give up access to shared resources like innovation centers and engineering teams that foster knowledge sharing, promote best practices, and drive efficiencies across business units.
Divestments could also lead to the loss of nonoperating synergies related to taxes and financing, although these tend to be relatively small. For example, an integrated electricity player that divests its (regulated) transmission and/or distribution network business and keeps a portfolio of generation and supply units will have a higher risk profile after the divestiture and, consequently, a lower debt capacity and corresponding value from tax shields.
One-time disentanglement costs
Depending on the extent to which a business unit is integrated within an organization and its operations, disentangling it can incur substantial expenses. These are one-time costs such as expenses for legal and advisory fees, information technology (IT) system replacement or reconfiguration costs, relocation costs, and retention bonuses. Disentanglements can be more complex than the integration processes of large M&A deals.
Taxes triggered by the divestment depend on the details of a proposed deal structure, but they too can have real impact on post-deal economics. Differences in fiscal regimes also play a role. In many European countries, gains on the sale of business units are to some extent exempt from corporate income and withholding taxes. In the United States, however, capital gains from divestitures are often subject to taxes unless the unit is spun off and meets certain tax requirements. Depending on the fiscal regime, executives may therefore prefer different types of transactions, including spin-offs, split-offs, carve-outs, and IPOs.
Stranded costs
Stranded costs can be hard to accurately estimate and harder still to fully address. These are (corporate) costs for assets and activities associated with the business unit but ultimately not transferred with it. Stranded costs can relate to shared services, such as procurement, marketing, and investor relations. They can also refer to IT infrastructure and shared production assets—for example, when a single manufacturing facility consists of production lines of products from different business units. And they can relate to general overhead costs that are allocated to businesses, such as costs for the board of directors, legal counsel, and corporate compliance.
In our experience, divestments often bring to light excessive corporate overhead that cannot be transferred to the divested business unit and is subsumed under stranded costs. Large companies tend to have many layers of management and communication. This easily leads to redundancy and unnecessary costs. For example, sizable business units often have managers in human resources, strategic planning, or financial controlling functions whose primary job is to coordinate and communicate with their counterparts in the corporate headquarters. After a divestiture, such intercompany transaction costs can be largely eliminated in both the parent company and the divested businesses. In fact, successful sellers often use divestitures as a catalyst to reduce overhead and improve efficiency in the remaining business.
Real stranded costs from divestitures take considerable time and effort to unwind. Some stranded costs are fixed and difficult to reduce, as in the case of shared IT systems. Others can be more readily managed over time—for example, by head count reductions in shared service centers. McKinsey research has found that it often takes up to three years for the parent company to recover from stranded costs, leaving it with substantially lower profit margins during this period.3
Legal and regulatory barriers
The divestment process may be complicated by legal or regulatory issues. These are typically not large enough to distort the value creation potential, but they can seriously slow down the process and add to the amount of work to be done, thereby increasing the time and resources required to come to closure. For example, pharmaceutical companies are required to have a so-called marketing authorization to sell an individual product in a specific market, typically a single country. If a pharmaceutical company decides to sell a particular product portfolio (for example, oncology, respiratory, or vaccines) to another pharmaceutical company, it needs to apply for a transfer of the marketing authorization for each individual product in each specific market. The process is time-consuming and requires additional expenses. Asset transactions can be especially complex, because they require extensive documentation and contracts with respect to all the different categories of assets involved.
Contractual issues often come as unpleasant surprises that typically surface after companies have started the divestiture process. Procurement contracts, long-term contracts with customers, and loan agreements, for example, often require the creation of transitional service agreements between buyer and seller to guarantee continuity of the business unit. Or they may include change-of-ownership clauses activated upon divestiture that render the existing contract or agreement invalid when ownership in the business transfers.
Pricing and liquidity
Market valuation levels are generally in line with intrinsic value potential in the long term but can deviate in the short term. A near-term divestiture would seem to be a good idea if the market would price a business above management’s estimate of its intrinsic value. The reverse holds as well: Siemens, for example, delayed the spin-off of its lighting business OSRAM for several years because of adverse market conditions, eventually completing the transaction in 2013.
Although external market factors may lower potential proceeds from a divestiture, management should balance this against the (hidden) costs of continuing with the status quo. Alternatively, management could look into transaction types that do not generate cash proceeds and thereby do not lock in an exit price for the company’s shareholders. For example, as the credit crunch unfolded in 2008, Cadbury decided against a planned trade sale (in cash) of its American beverages business. Instead, it opted to spin off the business to its shareholders. This left Cadbury shareholders with the option to hold the shares of the American beverage business and sell at some later stage when prices might be higher.
There is no guarantee that divestitures will create value. The best divestitures indeed outperform the market, but those at the bottom fall even further behind. To increase the chances of a successful divestiture, executives should thoroughly identify the implications for the economics of the remaining businesses and consider these implications when structuring the divestiture agreement. Executives should also take care not to underestimate the time and effort required to complete a divestiture.
This article is excerpted from Valuation: Measuring and Managing the Value of Companies, 8th Edition, by Tim Koller, Marc Goedhart, David Wessels, and McKinsey & Company, in agreement with Wiley. Copyright © 2025 McKinsey & Company.
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