Scott Norris
While SPACs have their advantages and can be an attractive alternative to the traditional IPO process, there are certain key considerations to be aware of before jumping in.
Often called “blank check companies,” Special Purpose Acquisition Companies (SPACs) are essentially shell corporations — they don’t actually engage in any commercial operations, and usually exist as a means for raising money to acquire other, existing private operating companies.
In short, SPACs are used as an alternative to the traditional IPO process. The sponsors of a SPAC use the entity to raise capital from investors, and then target a specific company they want to acquire, thereby taking it public and bypassing the cumbersome IPO process.
SPACs have been around for decades but have seen record growth in 2020, according to Spacinsider.com which lists 243 for 2020 compared to just 59 in 2019.
While SPACs have their advantages and can be an attractive alternative to the traditional IPO process, there are certain key considerations to be aware of before jumping in.
Clock is Ticking
A SPAC generally has two years from the date of its IPO to acquire a target (based on its charter documents). Additionally, the U.S. Securities and Exchange Commission (SEC) has specific age requirements on the financial statements to be provided for companies utilizing the SPAC process in lieu of a traditional IPO process. It is imperative that companies be aware of the age requirements so that the financial information doesn’t become stale and require more recent quarterly financial information to be resubmitted — a resource-intensive process. It is advisable that financial reporting teams speak with the entity’s auditors to lay out a well-defined timeline with set milestones and deadlines as well as those dates that trigger additional financial reporting requirements.
Augmenting Financial Teams
Typically in private companies that are SPAC targets, accounting and financial reporting processes are scaled-down or performed by a small team. In addition, there are a number of complex accounting matters to evaluate, such as determining the accounting for the merger (business combination or reverse merger with a recapitalization), which drives financial statement presentation and potentially fair value considerations. Also, quarterly financial information, typically not prepared for private companies, will need to be prepared, bringing an additional level of effort from the accounting and finance team.
These requirements and complexities will likely stress the target entities’ financial reporting and accounting departments, and they may need time to scale-up the number of resources or potentially consider obtaining external advisors to augment the internal accounting team at the private company.
Another key consideration: increasing the frequency of calculating tax provisions. While private companies are only required to perform their income tax provisions on an annual basis, that process will need to be done quarterly. SPAC targets will need to be prepared for that increase in frequency along with potential complexities in tax preparation.
Doublechecking Auditing Process
Coordination and upfront planning with the auditors are critical. The SPAC target’s auditor likely performed prior audits in accordance with the guidelines set out by the American Institute of Certified Public Accountants (AICPA) and those audits will also need to be performed in accordance with the auditing standards of the Public Company Accounting Oversight Board (PCAOB). Another matter to consider is if the existing auditor is not independent under PCAOB rules if they had, for example, prepared the SPAC target’s income tax provisions. Further, there is the possibility that the existing audit firm is not an independent registered public accounting firm with the PCAOB and thus cannot perform the PCAOB audit.
To avoid delays, as soon as a SPAC transaction is contemplated, a conversation with the current auditor of the target should take place to understand the dynamics that will be driving the auditor’s behaviors and ensure that the auditor is completely aware of the requirements, deliverables and timelines.
Playing MD&A Catch-Up
Management discussion and analysis (MD&A) is a section of a public company’s annual or quarterly financial statements. Generally, it’s where the company’s executives and leadership team discuss the company’s financial performance, risk analysis, future plans, compliance, and more. These sections can provide investors with valuable insight into past financial results and other critical factors management must consider.
However, private companies are not required to include MD&As in their financial reports — something that will need to change when a private company is being targeted by a SPAC to go public. As a part of the SPAC merger process, a target company will need to prepare MD&A disclosures for all years and time periods presented in its financial statements. These disclosures often require extensive effort and significant data analysis.
Navigating SEC Comments
As a part of the merger process, the SPAC will need to prepare and file a proxy statement with the SEC. This document contains many sections, including a petition to seek shareholder approval of a proposed merger, the financial information of the target company, the aforementioned MD&As, and pro forma financial information. Once the proxy is filed, the SEC will generally get back to the SPAC within a month with questions and comments on the document.
Addressing and responding to SEC comments is often a comprehensive and time-consuming process involving a number of parties and potentially threatening key deadlines. Entities can benefit from consulting with an expert to successfully navigate through SEC comments.
Carve-Out Caveats
In some cases, a SPAC transaction can be completed through a carve-out — a process in which the SPAC acquires a portion of a minority stake of a target, and takes the target public. If this is the SPAC’s strategy, it’s important to be aware that the carve-out will need to be audited as part of the due-diligence process, and there can be special rules, in accordance with regulatory and compliance requirements, that need to be followed to successfully complete the transaction.
Completing a SPAC transaction is, again, an increasingly popular and available method for taking companies public.
However, a SPAC transaction is still a complicated, methodical process. Failure to take a holistic view of the process could cripple a potential SPAC transaction, leaving investors and stakeholders high and dry.
