Search within this section
Select a section below and enter your search term, or to search all click Carve-out financial statements
Favorited Content
1.3 Common exit strategies
Publication date: 31 Oct 2023
us Carve-out financial statements guide
Corporate exit strategies seek to maximize shareholder value. Common exit strategies include the sale of a business (see CO 1.3.1), spinoff (see CO 1.3.2), split-off (see CO 1.3.3), and initial public offering (see CO 1.3.4). The reasons why a reporting entity may pursue a particular strategy are discussed in the referenced sections.
1.3.1 Sale of a business
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.
Section 2010.3 through 2010.6 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.
1.3.2 Spinoff
A spinoff typically refers to the pro rata distribution of a subsidiary’s stock (the SpinCo) to the parent company’s shareholders. The effect of this transaction is to “dividend off” or “carve out” a piece of the company to its existing shareholders. Thus, the SpinCo becomes a stand-alone company with its own equity structure. These transactions may be referred to as “one-step spinoffs.” ASC 505-60-20 defines a spinoff.
Definition from ASC 505-60-20
Spinoff: The transfer of assets that constitute a business by an entity (the spinnor) into a new legal spun-off entity (the spinnee), followed by a distribution of the shares of the spinnee to its shareholders, without the surrender by the shareholders of any stock of the spinnor.
SEC reporting companies typically use spinoff transactions to enable the separate businesses to more readily pursue individual long-term strategic goals. Additionally, companies often use spinoffs as a tax-free mechanism to unlock value for shareholders. A spinoff transaction does not raise capital for the parent or the spun off entity. A parent might raise debt in SpinCo’s name prior to, or in conjunction with, the spinoff and retain the cash as a way to monetize its divestiture of SpinCo; however, this is a separate transaction preceding the spinoff. After the spinoff, the shareholders own shares in two entities, and the overall value held by the shareholders typically does not change immediately. Although a spinoff is not a sale of securities, the SpinCo’s newly-issued shares are registered with the SEC. This is typically accomplished by filing a Form 10 for the SpinCo, which generally includes historical stand-alone, carve-out financial statements for the SpinCo and other required historical and pro forma financial information.
A “two-step spinoff” occurs when a parent offers securities in the SpinCo through an initial public offering prior to executing a pro rata distribution to the parent's shareholders. Companies use these transactions as a way to build brand value and to fund the working capital requirements prior to the separation from the parent entity. Two-step spinoffs are typically undertaken to monetize value in a subsidiary while still retaining control and an interest in its future value. Frequently, the initial public offering is for a less than 20% ownership interest in the SpinCo in order to achieve a tax-free spinoff in accordance with Internal Revenue Code Section 355. The first step in a two-step spinoff (the initial public offering) is an offer of securities to the public requiring the filing of Form S-1 with the SEC. The second step is the distribution by the parent of its holding of the subsidiary shares to the parent’s shareholders.
In unique circumstances, the substance of a spin-off transaction does not match its legal form, such that the new legal spinee will be the continuing entity. In this type of transaction, known as a reverse spin-off, the determination of the accounting spinee and spinnor can become quite complicated, such that specific attention and significant judgment is required to determine the appropriate financial statement presentation.
1.3.3 Split-off
A split-off is a transaction in which the parent entity gives its stockholders the opportunity to exchange some (or all) of their parent entity stock for an interest in one of its subsidiaries (i.e., the carve-out business). This type of transaction is described in ASC 845-10-20.
The principal difference between a spinoff and a split-off is that after completion of a split-off, the subsidiary's stock is held by the parent’s stockholders on a non-pro rata basis. Some stockholders may hold only parent stock; others may hold only subsidiary stock; and others may hold both.
Some companies may choose a split-off over a spinoff because a split-off gives stockholders an option to participate. This flexibility may be important when stockholders holding a significant interest express a preference for one stock over the other.
Exchange offers typically require the filing of a Form S-4. Like a one-step spinoff, the split-off transaction is not a capital-raising transaction. Similar to a two-step spinoff, a split-off can also be preceded by an initial public offering of securities of the carve-out business to the public (typically no greater than 20%).
1.3.4 Initial public offering
In an initial public offering, a parent company may carve-out a portion of itself to create a new company to be traded on a public exchange. This exit strategy allows a company to raise capital quickly from numerous public investors. This cash can then be used for various purposes, including to reinvest in the company, settle outstanding debt, or generate capital for future growth.
The typical filing requirement is a Form S-1, which requires up to three years of audited financial statements. Financial reporting requirements are reduced if the business qualifies as an emerging growth company or a smaller reporting company.
1 References herein are based on a domestic filer. Foreign private issuers would file the applicable form (e.g., F-4) with the SEC.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
Link copied
