2.10 Formation of Joint Ventures and of Equity Method Investments

For a number of reasons, investors (often referred to as “venturers”) form joint ventures rather than undertake business activities on their own. A joint venture is a common form of a business enterprise that possesses specific attributes and is characterized by the presence of joint control among the venturers.

Upon the formation of a joint venture, registrants must consider their SEC reporting obligations. They must also consider the continuing SEC reporting requirements for significant equity method investments under Regulation S-X, Rule 3-09 (see Deloitte’s Roadmap SEC Reporting Considerations for Equity Method Investees).

According to Rule 3-05(a)(2)(ii), a business acquisition for SEC reporting purposes includes “the acquisition of an interest in a business accounted for by the registrant under the equity method or, in lieu of the equity method, the fair value option.” See Section 2.1 for further discussion of the types of acquisitions that may constitute a business for SEC reporting purposes.

A registrant that contributes assets or a business in exchange for an equity interest in a joint venture (referred to as an exchange transaction) is transferring a percentage of interest in its assets or business in exchange for an ownership interest in the joint venture. For SEC reporting purposes, the formation of a joint venture in this manner consists of two events that must be separately evaluated:

The disposition of a business or assets.
The acquisition of an equity method investment.

The sections below discuss considerations related to determining the SEC filing requirements for an exchange transaction.

2.10.1 Disposition of a Business — Registrant Contributes a Business in Exchange for Its Interest in a Newly Formed Joint Venture

A registrant that contributes a business, as defined in Rule 11-01(d), in an exchange transaction must file a Form 8-K, as required by Item 2.01 of that form, if the significance of the business disposed of exceeds 20 percent. As discussed in the highlights of the March 2011 CAQ SEC Regulations Committee joint meeting with the SEC staff, significance should be determined on the basis of the portion of the business disposed of, not the entire business.

Historical financial statements of the business to be disposed of are not required in a Form 8-K; however, unaudited financial statements of the business must be provided in proxy statements if the registrant’s shareholders are required to vote on the transaction. Pro forma financial statements depicting the significant disposition must be filed in a Form 8-K within four business days of the disposition. The 71-calendar-day grace period for providing separate financial statements and pro forma financial information applicable to business acquisitions does not apply to business dispositions. However, when the disposition is related to the formation of a joint venture in which both the acquisition and the disposition are significant, the initial Form 8-K need only include a narrative description of the disposition. The pro forma information reflecting both the disposition of the business and the acquisition of the equity method investment should be provided when the acquiree financial statements are subsequently included in an amended Form 8-K. See Chapter 4 for more information about pro forma financial information requirements.

2.10.2 Disposition of Assets — Registrant Contributes Assets in Exchange for Its Interest in a Newly Formed Joint Venture

A registrant that contributes assets that do not meet the definition of a business for SEC reporting purposes (see Section 2.1) in an exchange transaction must file a Form 8-K if the registrant’s share in the net book value of the assets disposed of (i.e., assets contributed to the joint venture) or the amounts received for the assets exceed 10 percent of the registrant’s total assets. Under Form 8-K, Item 2.01, registrants must disclose (1) the date of completion of the transaction, (2) a brief description of the assets involved, (3) the consideration exchanged, and (4) the identification and nature of the relationship of the person(s) to whom the assets were sold. In addition, Form 8-K, Item 9.01, requires registrants to provide, in accordance with SEC Regulation S-X, Article 11, pro forma financial information that reflects a significant asset disposition or business disposition.

2.10.3 Acquisition — Registrant Acquires an Interest in a Newly Formed Joint Venture

Upon the formation of a joint venture, there are no historical operations; accordingly, the financial statements required in an exchange transaction are those of the business contributed by the other party, if significant, and not the financial statements of the joint venture. A registrant has four business days after the consummation of a significant business acquisition to file the initial Form 8-K and, unless it is a shell company, generally has an additional 71 calendar days to file an amended Form 8-K that includes the required financial statements of the significant business acquiree (i.e., the business contributed by the other party) and pro forma financial information. If the other party contributed assets that do not meet the definition of a business for SEC reporting purposes, Rule 3-05 does not apply.

Example 2-42

Registrant A and Company B separately own 100 percent of several automobile dealerships. They each contribute five dealerships to form a new joint venture, Joint Venture X. In exchange for contributing the dealerships, A and B both receive 50 percent of the equity in Joint Venture X.

Registrant A must consider the SEC reporting requirements for (1) the disposition of the 50 percent interest in the dealerships it contributed to X and (2) the acquisition of a 50 percent interest in the dealerships contributed by B.

2.10.4 Performing the Significance Tests for an Acquired or to Be Acquired Interest in a Newly Formed Joint Venture

The significance of an acquired or to be acquired interest in a joint venture should be based on a comparison of the acquired percentage of the other venturer’s business with the registrant’s historical financial statements. Such amounts are generally for the registrant’s most recently completed fiscal year that is required to be filed with the SEC and should not be adjusted for the disposition of the assets or business contributed to the joint venture, if any.

When a registrant acquires an equity interest in a joint venture, it should perform the following three tests of significance:

Investment test — Compare the consideration transferred (i.e., the fair value of the consideration given up or the consideration received, whichever is more reliably determinable) with the registrant’s AWMV. Significance should be determined on the basis of the registrant’s interest in the business acquired, not 100 percent of the business acquired. If the registrant does not have an AWMV (e.g., the registrant is undertaking an IPO), compare the consideration transferred with the registrant’s total assets.
Asset test — Compare the registrant’s share of the total assets of the business contributed by the other venturer with the registrant’s total assets.
Income test — The income test consists of an income component and a revenue component:
- Income component — Compare the registrant’s share of the pretax income from continuing operations of the business contributed by the other venturer with the registrant’s pretax income from continuing operations.
- Revenue component — If both the registrant and the business contributed by the other venture have material revenue in each of the two most recently completed fiscal years, the revenue component is calculated by comparing the registrant’s share of the revenue of the business contributed by the other venturer with the registrant’s revenue. If either the registrant or the business contributed by the other venturer does not have material revenue for each of the two most recently completed fiscal years, only the income component should be used.

Example 2-43

Registrant A and Company B both have December 31 fiscal year-ends. They each contribute five restaurants to form a new joint venture, Joint Venture X, on March 31, 20X8. In exchange for contributing the restaurants, A and B both receive 50 percent of the equity in X. The fair value of the restaurants contributed by B is $1 million. The total assets of the restaurants contributed by B is $0.8 million.

Registrant A’s total assets as of December 31, 20X7, are $10 million, and its AWMV is $20 million, which is based on the average of the last five trading days of February 20X8, the most recently completed month-end before the announcement date of the transaction. In addition, A’s revenue and pretax income from continuing operations for the year ended December 31, 20X7, are $12 million and $3 million, respectively. The revenue and pretax income from B’s continuing operations for the year ended December 31, 20X7, for the restaurants contributed by B are $6 million and $0.9 million, respectively.

The investment test calculation is as follows:

The asset test calculation is as follows:

The income test calculation is as follows:

Income Component

Revenue Component

On the basis of the tests above, A concluded that the transaction is not significant in accordance with Rule 3-05 since no test result exceeds 20 percent. While the revenue component is greater than 20 percent, the income component is not.

Registrant A must also consider the SEC reporting requirements for the restaurants that were disposed of (i.e., contributed to the joint venture).

Confidential and Proprietary — for Use Solely by Authorized Personnel

This SEC Reporting Interpretations manual provides comprehensive guidance; however, the manual does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.