Instead of using IPOs to raise capital, private operating companies (POCs) are increasingly turning to SPACs. In fact, SPACs in the US have recently set a new record of $26bn being raised in January 2021.
In this article we take a look at US SPAC transactions in rather more detail.
What’s a SPAC transaction?
A Special Purpose Acquisition Company (SPAC) is a term for a newly-formed company that raises cash via an Initial Public Offering (IPO) and uses that cash or the equity of the SPAC, or both, to fund the acquisition of a ‘target’ (normally a POC). In the UK this is the equivalent of what’s commonly referred to as a ‘cash shell’.
After a SPAC IPO, the SPAC’s management looks to complete an acquisition of a target (the transaction). If a transaction can’t be completed within the period specified in its governing documents, e.g. 24 months, the cash raised by the SPAC in the IPO must be returned to investors and the SPAC is dissolved.
What to consider before getting involved
When a US SPAC merges with a POC (the ‘target’) the POC’s Financial Statements become the predecessor of the combined public company (PubCo). During the process a target will therefore need to devote a considerable amount of time and resource to technical accounting and reporting issues.
Here are some of the key considerations:
The US Public Company Accounting Oversight Board (PCAOB) and The Securities and Exchange Commission’s (SEC’s) requirements.
As the SPAC’s shareholders are required to vote on the transaction, the SPAC must file a Proxy or Registration Statement, which is commonly done through Form S-4 (or the equivalent Form F-4 for foreign filers, i.e. those located outside the US). This document must include the target’s Financial Statements for the previous two or three years (this depends on a number of factors including the type and size of the target). The Financial Statements must be prepared in accordance with public company disclosure requirements as well as the SEC’s rules and requirements and a PCAOB registered auditor in accordance with PCAOB standards must audit them. During the course of the transaction, the Form S-4 (or other equivalent) will go through the SEC’s review process that’s as stringent as for traditional IPOs.
This was emphasised in a public statement issued by the SEC’s Acting Chief Accountant in March 2021 that also highlighted the following five areas as key to preparing for a successful SPAC transaction:
Market and timing – Ensuring the target is prepared for its people, processes and technology to meet the SEC’s filing, audit, tax, governance and investor relations needs after the SPAC transaction;
Internal control – The target must have internal controls over financial reporting and disclosure controls and procedures in place after the SPAC transaction;
Corporate governance and Audit Committee – It’s imperative that both the Board and Audit Committee have oversight over the SPAC transaction and PubCo;
Auditor considerations – Generally, auditing to comply with the PCAOB’s and the SEC’s audit and independence standards requires additional audit procedures; and
Financial reporting – There are various complex areas of financial reporting and accounting which must be fully considered.
Common issues raised by the SEC
Identifying the accounting acquirer
In a SPAC transaction, one of the combining entities must be identified as the accounting acquirer. This may be the same as the legal acquirer but in many cases it isn’t. This is especially true in a scenario whereby a POC arranges for a SPAC to acquire its equity interests in exchange for the equity interests of the SPAC.
The following factors should be considered when identifying the accounting acquirer:
The relative voting rights in the combined entity after the business combination;
The existence of a large minority voting interest in the combined entity;
The composition of the governing body of the combined entity;
The composition of the senior management of the combined entity;
The terms of the exchange of equity interests; and
The relative size measured in, for example, assets, revenues, or earnings of the combining entities.
In most cases it’s clear after considering these factors which of the combining entities is the accounting acquirer, however it can be complex and requires careful consideration. The SEC typically expects the disclosures in the Financial Statements to explain the facts and circumstances that the entity considers most pertinent in their assessment of the accounting acquirer.
Accounting for warrants
There are a number of arrangements that entities enter into in the formation of a SPAC or at a later date before the SPAC completes a transaction in which warrants are issued. Accounting for such warrants has become a hot topic since the SEC released a statement in April 2021 on accounting and reporting considerations for warrants issued by SPACs.
The most common ways that a SPAC issues warrants to investors as part of units sold in their IPOs (public warrants) and also to their sponsors in a private placement at the time of their IPOs (‘private placement warrants’ and, collectively, with the public warrants, SPAC warrants). SPAC warrants have generally been classified as equity instruments – both prior to and following transactions. The SEC statement challenges this accounting treatment by concluding that certain common features in SPAC warrants require the warrants to be classified as liabilities at fair value through profit or loss for financial statement purposes rather than as equity.
In practice, what we’re seeing is that the standard SPAC warrant agreements are being changed to allow the warrants to be classified as equity instruments. It’s important that an entity carefully considers the equity versus liability accounting treatment when preparing for a SPAC transaction to avoid an unnecessary restatement.
How can PKF help?
We’re a PCAOB registered auditor and have experience auditing financial statements in compliance with the SEC’s rules and requirements. We’ve worked on a number of SPAC transactions and understand the key issues that arise. Our proactive approach in tackling key issues as early in the process as possible, means that there are no unnecessary surprises. If you’re planning a SPAC transaction, please get in touch with us to discuss how we can help.