A once seldom-used liquidity alternative, SPACs’ popularity has boomed in recent years. A SPAC, or a special purpose acquisition company, is a “blank check” company that raises money from investors through an initial public offering (IPO ) with the sole purpose of acquiring a target company that has not been identified at the time of the SPAC’s IPO. Around since the 1990s, SPACs began garnering greater attention between 2017 and 2019 before booming in 2020, due in part to volatility in the IPO market and increasing interest from sophisticated financial sponsors and management teams. Coupled with greater acceptance among the small and midsize private companies that have historically been SPAC targets, the momentum from 2020 has poured into 2021, with the influx of interest leading SPACs to begin outpacing traditional IPOs.
Expertise With Fair Value Measurement of SPACs
The lifecycle of a SPAC includes its formation and IPO, search for a suitable acquisition target, vote by shareholders to approve the acquisition, and finally the merger with an acquisition target.
A SPAC is typically formed by an experienced management team or sponsor, who capitalize the SPAC by contributing nominal capital in exchange for founder shares that often comprise 20% of the shares of the company after the IPO, with the remaining interest held by public shareholders through units offered in the IPO. Each unit typically comprises one share of common stock plus a warrant to purchase a fraction of one share of common stock in the future. The warrants, intended to compensate holders for investing their capital in the SPAC before it acquires an operating company, become exercisable shortly after the SPAC acquires an operating company and are issued with a strike price that is out of the money (publicly traded shares are commonly priced at $10, with warrants maintaining an $11.50 strike price). Proceeds from the IPO are placed in a trust account until a future transaction is consummated or the SPAC is liquidated. Importantly, at the time of IPO, the SPAC cannot have identified an acquisition target and must also state in its registration statement that it has not identified any target.
Once formed, SPACs ultimately provide for a fixed 18 to 24 month period to identify and complete an initial business combination transaction. If it fails to do so, the SPAC must dissolve and return to investors their pro rata share of the assets in escrow.
After its formation and IPO, a SPAC has no other business purpose except to find a company to acquire or merge with. Similar to a typical merger and acquisition (M&A) transaction, the sponsor and management team will proceed to vet potential acquisition targets. Given the defined period to complete an acquisition, the due diligence process might move at an accelerated pace.
Once a SPAC has identified and reached an agreement with an acquisition target, SPACs are typically required to send a proxy to shareholders (after filing with the SEC and responding to comments) before holding a shareholder meeting and corresponding vote. Importantly, when a SPAC proposes to acquire a specific target company, the SPAC’s public shareholders have the right to redeem their shares for a pro rata portion of the proceeds held in the trust account if they do not wish to invest in the proposed target (though the warrants received as part of each SPAC unit in the IPO remain outstanding regardless).
As a result of shareholder redemptions, it is possible that additional capital may be required to complete the transaction. Private investment in public equity (PIPE) deals involving affiliates of the sponsor or institutional investors purchasing common stock are a frequent source of capital in such situations. Other potential sources of capital include preferred equity investments from affiliates of the sponsors or institutional investors, the sale of additional common stock to public investors, or the issuance of debt.
Upon the close of the SPAC merger (often referred to as “de-SPACing”), the sellers of the target company may receive cash, equity in the SPAC, or a combination thereof. In many cases, the sellers of the target company will retain some ownership in the merged entity. The post-merger combined entity moves forward as a publicly traded company.
SPACs have garnered greater acceptance among companies of all sizes and across industries, and for good reason: SPACs offer a number of valuable benefits for the private companies they acquire.
Once a SPAC identifies a target, the SPAC then prepares a proxy statement to solicit shareholder approval for various aspects of the SPAC merger transaction. The financial statement requirements and related SEC review process for a SPAC transaction are largely consistent with the requirements for a traditional IPO. As the SPAC merger process with a target company might be completed in as little as three to four months, a target company must accelerate public company readiness well in advance of any SPAC merger. In light of the compressed timeline, it is critical to engage a reputable advisor to efficiently and accurately assist in addressing key financial reporting and other public company readiness issues.
While the targets of SPACs are usually privately held companies, they need to provide financial statements that comply with the form and content requirements of Regulation S-X and the U.S. GAAP requirements of a public business entity for use in the proxy statement. This may be particularly impactful for target companies that have historically elected private company accounting alternatives (“Accounting Alternatives”), as they are required to retrospectively revise their financials from the date the Accounting Alternatives were elected before including them in a proxy statement.
Unwinding the Accounting Alternatives can significantly increase the time needed to produce audited target company financial statements; thus, engaging a suitable valuation advisor is vital.
In addition, as a public company there are additional accounting issues (e.g., segment reporting, earnings-per-share) that will need to be addressed, documented, and reported.
Stock options and other forms of stock-based compensation are frequently issued to company officers and key employees in start-up or early-stage companies in order to preserve cash and to align the incentives of key employees and investors. Commonly referred to as “cheap stock” issues, the SEC is on the lookout for stock-based compensation grants that are substantially below fair value in a pre-IPO period, as well as inadequate disclosures of the grant-date fair values. Target companies issuing stock-based compensation are well-served by coupling equity grants with a comprehensive valuation of the securities in order to meet financial reporting requirements in accordance with FASB ASC 718, to avoid any unintended IRC 409A tax consequences, and to avoid delays in the SPAC merger due to additional disclosures, restatements, and added professional fees.
In addition to valuation-related work required for historical financial statements, de-SPACing itself may require substantial analysis, depending on whether the SPAC or the target company is determined to be the accounting acquirer in the transaction. Specifically, the accounting acquirer is the entity that has obtained control of the other entity, which might be different from the legal acquirer (which is generally the SPAC). If the target company is determined to be the accounting acquirer, the transaction will be treated similar to a capital raising event. However, if the SPAC is determined to be the accounting acquirer, acquisition accounting in accordance with FASB ASC 805 will apply and the target company’s assets and liabilities will require a valuation to be stepped-up to fair value. In determining the accounting acquirer, consideration should be given to the guidance detailed in ASC 805-10-55-11 through 55-15.
After de-SPACing, the combined entity moves forward as a publicly-traded company subject to ongoing SEC reporting obligations. Early in its quest to be acquired by a SPAC, it is valuable for the target company to engage an advisor to determine whether the people, processes, and systems are in-place for the company to begin life as a public company. Key items to assess include (but are not limited to):
Engaging an advisor to perform this assessment early in the SPAC pursuit will allow for a smoother process and provide ample time to remedy any areas that might need addressed in advance of becoming a public company.
SPACs offer a potentially quicker and cheaper path to the public markets for private operating companies while also avoiding stock market volatility. However, companies considering being acquired by a SPAC must keep in mind the substantial financial reporting requirements these companies must meet and the accelerated timeline upon which they must be met. Engaging an appropriate advisor will be critical to ensuring a smooth and successful transaction process.