The most common way of divesting a business is a sale transaction in which a business is “carved out” and sold to a buyer.
From the seller’s perspective, the sale of a business can provide needed cash, and often has less onerous SEC filing requirements than other options, such as a spinoff or split-off transaction.
From the buyer’s perspective, the purpose for acquiring the business may vary. Strategic buyers often purchase a business because it complements an existing business or offers operational synergies. Financial buyers, such as private equity firms, typically purchase a business with the intent of increasing its value through further development or restructuring with the plan to divest the acquired business via sale or initial public offering in a specific timeframe.
Financial statement requirements are principally driven by the acquirer’s due diligence, financing (including offerings under 144A), or SEC reporting requirements. Specifically, an acquirer may be required to file a Form S-4
or a Form 8-K
which includes the carve-out financial statements for the business being acquired. The requirements of Form S-4
with regard to target disclosures are more extensive than those required for an acquired business reported on Form 8-K
Divestiture transactions may be subject to reporting requirements by the acquirer if the parts to be divested meet the definition of a business as defined in Regulation S-X Rule 11-01(d)
. For example, if a registrant acquires a business and certain significance thresholds are met, a Form 8-K
will need to be filed that includes financial statements in accordance with Regulation S-X Rule 3-05
or Regulation S-X Rule 8-04
While many divestiture transactions will meet the definition of a business, certain transactions will not. SEC Regulation S-X Article 11-01
(d) defines a business.
Regulation S-X Article 11-01(d)
For purposes of this rule, the term business should be evaluated in light of the facts and circumstances involved and whether there is sufficient continuity of the acquired entity's operations prior to and after the transactions so that disclosure of prior financial information is material to an understanding of future operations. A presumption exists that a separate entity, a subsidiary, or a division is a business. However, a lesser component of an entity may also constitute a business. Among the facts and circumstances which should be considered in evaluating whether an acquisition of a lesser component of an entity constitutes a business are the following:
(1) Whether the nature of the revenue-producing activity of the component will remain generally the same as before the transaction; or
(2) Whether any of the following attributes remain with the component after the transaction:
(i) Physical facilities,
(ii) Employee base,
(iii) Market distribution system,
(iv) Sales force,
(v) Customer base,
(vi) Operating rights,
(vii) Production techniques, or
(viii) Trade names.
The SEC guidance includes a presumption that a legal entity or division is a business. However, a component can also be a business if any of the criteria above are met. The SEC’s definition of a business is not consistent with the FASB’s definition of a business in ASC 805
, Business Combinations.
As a result, it is possible different conclusions may be reached for accounting purposes. If the transaction is a business under the SEC definition, financial statements may be required to be filed with the SEC even though for accounting purposes the acquisition will be accounted for as an asset acquisition rather than a business combination.
of the SEC’s Financial Reporting Manual (FRM) provides additional guidance around the determination of whether a transaction constitutes a business.
SEC FRM 2010.3 An investment accounted for under the equity method -
The staff considers the acquisition of an investment accounted for under the equity method to be a business for reporting purposes.
SEC FRM 2010.4 A working interest in an oil and gas property -
The staff considers the acquisition of a working interest in an oil and gas property to be a business for reporting purposes. Refer to Section 2065.11 "Unique Considerations for Acquisitions of Oil and Gas Properties – General." (Last updated: 10/20/2014)
SEC FRM 2010.5 Bank branch acquisitions -
The assumption of customer deposits at bank branches may constitute the acquisition of a business if historical revenue producing activity is reasonably traceable to the management or customer and deposit base of the acquired branches, and that activity will remain generally the same following the acquisition.
SEC FRM 2010.6 Insurance policy acquisitions -
Acquisitions of blocks of insurance policies by an insurance company or the assumption of policy liabilities in reinsurance transactions may also be deemed the acquisition of a business because the right to receive future premiums generally indicates continuity of historical revenues. The degree of continuity between historical investment income streams and the assets acquired to fund the acquired policy liabilities should also be considered.