Assessing Potential Value from Divestitures  623 Lost Synergies When a company divests a business unit, it may lose with it certain synergy benefits of having that business in its portfolio, even if the company isn’t the best owner of the business. For example, a business unit may give cross- selling opportunities to other units. Likewise, a corporation may bundle its procurement for various businesses globally so that it enjoys significant dis- counts. Thus, divestment can result in lower discounts and higher costs for the remaining businesses, as well as for the divested business unit itself, when volumes decrease. 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 sup- ply units will have a higher risk profile after the divestiture and, consequently, a lower debt capacity and corresponding value from tax shields. Disentanglement Costs Depending on the extent to which a business unit is integrated within an or- ganization and its operations, disentangling it can incur substantial expenses. Examples of such expenses include legal and advisory fees, information tech- nology (IT) system replacement or reconfiguration costs, relocation costs, and retention bonuses. Disentanglements can be more complex than the integra- tion 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. Dif- ferences in fiscal regimes also play a role. In many European countries, profit (including capital gains) distributions from subsidiaries to parents are to some extent exempt from corporate income and withholding taxes. In the United States, corporations do not enjoy this so-called participation exemption for capital gains on divested subsidiaries. Depending on the fiscal regime, execu- tives may therefore prefer different types of transactions (see discussion later in the chapter). Stranded Costs Stranded costs can be real but are easily overestimated. These are (corpo- rate) costs for assets and activities associated with the business unit but ul- timately 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 624  Divestitures to businesses, such as costs for the board of directors, legal counsel, and cor- porate compliance. In our experience, divestments often bring to light excessive corporate overhead that cannot be transferred to the divested business unit and is sub- sumed under stranded costs. Large companies tend to have many layers of management and communication. This easily leads to redundancy and un- necessary 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 re- duce 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 ex- ample, 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 re- cover from stranded costs, leaving it with substantially lower profit margins during this period.15 A seller could therefore consider including transitional service agreements for the divested business. This could help cover the costs for central and shared support services, at least in the near term. But sellers should be careful that the transitional agreements do not diminish the pres- sure on the organization to reduce the stranded costs in the longer term. How to handle stranded costs will vary with the type of buyer. A strategic buyer may be able to absorb the divested business unit without all the corporate support services or even production facilities; a financial buyer may be more interested in acquiring the business with these services and facilities included. 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 mar- ket, typically a single country. If a pharmaceutical company decides to sell a particular product portfolio (e.g., oncology, respiratory, vaccines) to another 15 D. Fubini, M. Park, and K. Thomas, “Profitably Parting Ways: Getting More Value from Divestitures,” McKinsey on Finance (Winter 2013): 14–21.