Top 3 Considerations for Real Estate SPAC Target Companies

Last year saw a resurgence of special purpose acquisition companies (“SPACs”). This year started off strong, but SPACs have taken a pause in April amid some regulatory pressure from the Securities and Exchange Commission (“SEC”). (Refer to our article on the SEC’s recent statement relating to accounting for warrants). Despite this standstill, there is currently an immense supply of untapped capital looking for solid real estate firms in which to invest.

SPACs are “blank check companies” that raise capital through an initial public offering (“IPO”) in order to finance a future merger with a target company. The merger has to be successfully consummated within 18 to 24 months of a SPAC IPO. Many SPACs may be nearing the end of this time frame and are eagerly looking for targets that have been pandemic-proof and are expected to continue with their strong performance in the future. The process of a SPAC’s merger with a target company is known as a “de-SPAC” transaction.

If you are part of the management team of a private real estate company looking for a less time-consuming method of going public, merging with a SPAC may be a good way to go. When a real estate company gets identified by a SPAC and a letter of intent is executed, the amount of time to get public company-ready may be accelerated. This can range from a few weeks to a few months.

These are the top three considerations for a real estate company that is targeted in a de-SPAC transaction:

1. Have you selected the audit firm to perform the PCAOB audits?
   The audit of the real estate company’s financial statements under the American Institute of CPAs’ standards has to be converted to an audit under Public Company Accounting Oversight Board (“PCAOB”) standards. The audit can comprise of multiple years of financial statements and must be completed by a PCAOB-registered public accounting firm that is independent under the SEC and PCAOB independence rules. These financial statements need to be prepared under public company rules, including SEC guidance, which may include earlier adoption of new accounting standards and reversing the effects, if any, of adopting Private Company Council standards.
   
   
2. Do you have the resources to assist with accounting and reporting requirements?
   There should be adequate resources to address existing accounting positions and adopt required new accounting standards including those applicable to public companies. This process can be very time consuming because it involves revisiting past conclusions and taking a fresh look at LPAs, operating agreements, lease contracts and revenue contracts, among others. A public company’s financial statements are under more scrutiny by the SEC, and management should be ready to respond to SEC comments on a timely basis.
   
   The most common areas with nuances within the real estate industry include:
   • Conversion of financial statements from cash to accrual basis or from tax to GAAP basis.
   • New lease standard (gathering agreements, identifying embedded leases, assessing accounting from lessor and/or lessee perspective, determining appropriate discount rate).
   • Consolidations (many real estate companies have joint arrangements and special purpose entities).
   • Software costs (for proptech companies).
   • New revenue recognition standard (may result in transition adjustments).
   • Issuance of equity and debt instruments (understand warrants guidance as this may be a focal point for the combined company after a de-SPAC transaction).
   • Share-based compensations (issuance of stock options, profits interests, phantom stock and change-in-control bonuses).
   • Business combinations (purchase price allocation reports for past acquisitions, earn-outs and evaluating who the accounting acquirer is in a de-SPAC transaction).
   • Goodwill impairment.
     
     
3. Have you performed any gap analysis relating to your internal control environment and financial reporting processes?
   As a public company, the real estate firm would need to ramp up its internal controls, processes and the documentation thereof to ensure compliance with Sarbanes Oxley 404 rules. This is especially complex if you outsource your processes to external service providers (e.g., facility or property management and bookkeeping). You need to perform a thorough risk assessment to evaluate the strength of your internal control environment.
   
   There should be adequate documentation to support your assertion over the effectiveness of internal controls over financial reporting which is included on the filings. Form 10-Qs and Form 10-Ks also need to be filed timely. The preparation of the management discussion and analysis section of the Form 10-K may involve multiple parties including your legal counsel, banker, accounting and tax advisors, as well as your auditor. Non-timely filings may trigger the need for more complex future filings.