On-Demand: Real Estate SPAC Life Cycle--IPO & Pre-Merger

June 10, 2021

In Part II, we discussed the SPAC lifecycle, from the formation of a SPAC (IPO) to the operation of a SPAC prior to the merger with its target.


Transcript

Laurie Grasso:Good afternoon. Welcome. Thank you so much for joining us for session number two. Especially those that were here for session one, that means we must have done well and we've kept you interested and thank you for joining us again. And so happy to be doing this together with our good friends at EisnerAmper. And so would love to take a chance to introduce the panelists to you.

I'm Laurie Grasso. I am a partner and co-head of the Global Real Estate team at Hunton Andrews Kurth. Where we see a lot of real estate transactions and a lot of interest from our real estate clients with respect to SPACs, hence the reason for putting together this wonderful webinar for all of you.

Lisa Knee, who is my good friend and the partner and co-leader of the National Real Estate team at EisnerAmper, who's not here with us today. But we'll be back for session three, which hopefully you all come back for and we'll give you more information on that a little later. And then I have two of my wonderful partners on the corporate team who are seeing SPACs on a day-to-day basis.

First Taylor Landry, who's a partner in our corporate team and then Mike O'leary, who's a partner and co-head of our corporate team at Hunton Andrews Kurth. And then I'm just so excited that I've had an opportunity to get to know Michael Torhan, who is a partner in the tax group at EisnerAmper. And Angela Veal, who's the managing director at EisnerAmper.

And we've spent a lot of time putting together this program for everyone, and we hope that it's informative. The only way it can really be helpful to you is if you do put in questions, ask us anything as we're going along. Some of the questions that we're going to talk about today related to feedback that we got from session one.

So when we do session three, we'll also use some of the feedback from this session to talk in session three. So I think we have our first polling question. And so these polling questions help us. We get to know who's listening and also will inform future webinars. But also I think it's interesting for all of us to see who's listening in. 

I'm going to turn a quick question over to my Hunton colleagues. One of the questions we got from the first session was, whether or not there was a marketplace, like a brokerage or some suppository where people could go. To consider where they could locate potential target companies, in order to consider a future merger together. Is there any such marketplace available to people? And I'll turn that either to Mike or to Taylor to respond.

Mike O’Leary: Yeah Laurie, this is O'leary and there's not a marketplace per se that you go to, but what target companies that are considering a potential strategic current action. Whether it's with a SPAC or whether it's with a strategic, will typically engage a financial advisory firm, investment banking firm, who will help them market the company.

That will have contacts with other financial advisory firms that are working with SPACs among others to target. And so that's typically the way it's done. Some target companies may know executives at SPACs, and can reach out to them directly. But obviously depending on what your target operating company is, what you want to do is find one that's actually looking in your particular sector.

Be it real estate, or some other sort of business. So you either have to do your own homework or you engage your financial advisor, who does that work for you, that legwork for you. And it ends up contacting different SPACs to seeing if they might be interested and want to sign a confidentiality agreement, non-disclosure agreement with you and begin doing their diligence.

LG: So we're going to move on to the SPAC lifecycle.

Angela Veal:Thank you Laurie. I'm excited to be back on this platform to discuss a topic that has continued to intrigue many in the marketplace. SPACs have been around since the 1990s, but they made a stunning comeback last year with a total of 250 SPAC IPOs, and 83 billion capital raised. This was five times that of traditional IPOs as well.

One well-known real estate SPAC transaction would be that of WeWork merger, with the SPAC to become public. This year, SPAC transaction started off strong, but came to a halt amid some pressure from the SEC and Congress. For those of you who did not join us last week for the first part of this series, we previously discussed the history and background of SPACs, and the pros and cons.

You can find the link to the archived version at the end of this presentation slide deck as well. To level set quickly for everyone, SPAC stand for special purpose acquisition companies, and they are sometimes known as blank check companies. The three key players include the sponsors, investors and target companies.

The sponsors would raise money from the public market investors, with the objective of merging with the target company in the near future. At a high level, the lifecycle of a SPAC consists of four phases, namely the formation and IPO, pre-merger, de-SPAC, as well as post-merger after the de-SPAC transaction is closed.

You would also notice that the pre-merger phase would take place over 18 to 24 months, with two years as the max for SPAC successfully consummate a merger with the target company after the SPAC's IPO. There's definitely a lot of on tech capital out there, looking for the right company to acquire at this moment.

Once the target company is identified, it only has anywhere between a few weeks to five months to become public company ready, and to merge with the SPAC. You would also hear the term de-SPAC a lot throughout this presentation. And this is basically another term for the merger of the SPAC and the target company.

Today's session, we'll touch on the first two phases. And the next session on June 15 will be on the last two phases itself. We will share some practical insight on what people should be considering in terms of legal, accounting and taxation. With this, I will hand it over to Mike or Taylor to talk through the activities relating to the formation and IPO of the SPAC, as well as their take on the legal implications.

Taylor Landry:Thank you. All right. So first you have the potential sponsor meeting with the potential underwriters, to determine the likely liability of forming the SPAC. That process, frankly the lawyers are not particularly involved that early on.

We usually get brought in a little bit after that phase, but once that is determined to be a go, they'll select an underwriter, underwriters, oftentimes it's just one, maybe two banks. As far as the legal documents and agreements go, on the front end you're usually getting together a letter of intent where it's going to include all of the terms of the arrangements between the sponsor, and the company and the underwriters.

And then once you get that LOI sorted, typically what people are doing is they're filing a draft registration statement with the SEC, a confidential submission. We'll get more into the contents of that later but, it's shorter than what you see in a typical non-blank check company. Like a company that would have operations, it's a lot more abbreviated so you can expect fewer comments from the SEC.

And as far as getting the S-1 buttoned up as between sponsor, underwriters, and their respective councils, it can move pretty quickly. And once you get the DRS, the draft registration statement on file, it takes 30 days to hear back from the SEC. Typically, the comments shouldn't be very heavy because there's not a lot of content in the draft registration statement.

Count the respective councils, the sponsor, and the management team will work through the comments. And then oftentimes what you see is doing what's called flip public. So they'll then file the S-1 publicly with the SEC. And once you do that under the Jobs Act, you have to basically cool off for 15 days and let people see that document on file. And then you would technically be in a position to launch.

Now honestly once you file your S-1 publicly, you're going to have a number of exhibits that we'll get into a little bit later. That are going to be the underwriting agreement, business combination, marketing agreement, things like that. So typically your public filings, you would put those in there. And obviously you're also making concurrent filings with FINRA as well.

Once you've cleared SEC comments, then you're going to get to the road show. In a typical company and non-SPAC IPO the road show is what it sounds like. You've got people on a jet flying to LA, Chicago, New York, Minneapolis, whatever they've determined to be the major markets. And it can be six, seven, eight days before they finished that and then price the IPO.

In a SPAC IPO, it's a little bit more abbreviated and then obviously with COVID and everything, presumably a lot more is being handled virtually and over Zoom. Once you price the comfort letter and the underwriting agreement are delivered at pricing, then typically it's going to be a T post two. So two days later you would close.

And once you sell the units, which are comprised of common stock and fractional interest in warrants, the proceeds from the IPO are placed in a trust.

MO: So I'm going to add a couple of things on top of that. One of the important gating events that the company wants to SPAC ideal is that they have to engage their auditors. Because even though there's no operations per se, it will have basic financial statements that have to be included in the S-1. And that engagement of the big four accounting firms, they don't represent SPACs because they tend to represent the operating companies and they don't want the conflict.

So there are a few auditing firms that specialize in SPAC engagements, and you needed to get in there too because they're very busy. Even with the slowdown that's going on with the SEC, those firms have been very busy. They've had all the restatements they had to do for the existing SPACs that had warrants that needed to be treated as liabilities.

And then they also got all the new SPAC IPOs that have been filed in a public out there. So that's one consideration you really need to factor into your timing. Because the onboarding takes time that they at the accounting firms. Included with the filing of your S-1 you've got, in addition to the exhibits that Taylor mentioned, you've got other agreements have to be there.

You've got your charter and bylaws for the SPAC that have to be because you're going to have a couple of classes typically of stock, which we're going to address in a bit. You've got to make sure those are baked to your charter documents. You're going to have the warrant agreements, both the public warrants and the private warrants.

You may have a forward purchase agreement, in some cases that are part of the equity capitalization of the SPAC, those need to be prepared and filed. And then you're going to have just like all public companies, you've got a lot of policies you're going to have. You're going to have charters for your different committees, which they won't have a lot of committees, but they will have some.

So there's documentation that has to be prepared to put these companies to have them up and running and an in place. So those were the things that I just wanted to address, that also need to be part of factored into the timing. That's why it takes generally from the time the underwriters and the sponsors have come to an agreement on what the structure's going to be, and that they're going have the green light to start work on the S-1, it takes probably 45 days to get it done.

Even though it's a given structure, there's not a lot of changes that happen. It's just a lot to pull together all at once, to get on file. So sorry, I was just going to address there in terms of the S-1, there are a couple of things that the SEC has really focused on in particular. And that SPACs need to consider or addressed in your S-1.

And that is the inherent conflicts in the structure. As we mentioned in the first session last week, the sponsor typically gets 20% of the equity, basically for little or no investment that's their incentive for forming the SPAC and then identifying a favorable acquisition opportunity. And at the end of the day after the 24 months, and can't identify a target and get it approved by the stockholders, all the money that's been put in the trust, goes back to the public holders.

And that 20% equity stake is working. It creates an inherent conflict. Many SPAC have also in the past been giving some of the sponsors have given some of the independent directors some of that class-based off. As opposed to having to pay them cash, they've been giving them stock, and that's created conflicts as well.

If that's going to be how they're compensated, you need to make sure that's disclosed. There've been several commentators out there who have been talking about the SPAC market, and they're recommending that either there be no such equity given to the independent directors, or just a little equity given to the independent directors.

Because at the end of the day, if there's a conflict involved and there is an inherent conflict in that that equity is going to be worth either zero, or it's going to be worth a significant amount of money, if the de-SPAC transaction gets done. And it's a binary choice at the end of the day, and it creates a conflict that needs both disclosed.

And if there've been some SPAC, these clear transactions that have been with related parties. And the SPAC then looks to its independent directors as a separate committee to approve that transaction. And if they're rewarded in their equity, it does create an inherent conflict and both needs to be disclosed and the council to that.

And then the committee needs to factor that in the process that the committee undertakes to evaluate and approve the transaction. And also the complex need to address the disparity, between the treatment of the public stockholders and the sponsor. As you've heard before, there's a redemption right at when the public is deciding whether or not to approve the business combination, they can vote for it or against it, they typically vote for it.

Then they also have the right to tender their stock for redemption by the company, and get the money back out of the trust. So that 20% equity stake that the sponsor started off with, can significantly grow if there's a high number of redemptions. And what some people have been doing is requiring that the sponsor give back some of this equity.

If in fact there was a high level of redemptions to keep it at the 20% level. And even when that hasn't been an embedded part of the SPAC terms, some of the target operating companies with their financial advisors have been negotiating that in fact, if redemptions exceed a certain level, the sponsor will surrender some of its equity to keep that stake in at, or around the 20% level. That's all I got.

LG:So question for you. So two things I guess. The 20% level, is that just market-driven or is that regulatory in some way? How did the 20% interest come about?

MO: No, Laurie. It's not regulatory, the tradition. And it's a hybrid of the private equity world, where they get 20% sharing in their private equity funds. It's just the market as this SPACs are coming out they just took that as a level that investors. Particularly since these are hedge fund investors and many of their hedge funds give a stake to the hedge fund management of about 20% of the returns. And so it just sort of banked on based on that.

LG: Okay.

MO:And some of the more recent ones have had a lower equity stake than we tend to our 10%.

LG:Okay. And then the give back concept is becoming more market to you would say. And is that like a formula or how does that play out?

MO:It's not formulaic and it's typically just a function. If it's driven by the target operating company, then it's just a function of the negotiations between the target operating company and the SPAC management, and or sponsor. In terms of what they think is reasonable. You can expect some redemptions.

And so the issue is okay above what level, or is that a high level of redemptions and should some of the equity be given back? And if so, how much of the equity should be given back? Sponsors are reluctant to give up what they don't have to give up, and so it's just negotiation.

LG: Okay. All right. That makes sense. Thank you Mike. Okay. So Taylor, I think this was a question when we got on the first session and I know the answer if so, but I'm going to ask you anyway, I'm learning here. Can a target company be identified before a SPAC does its initial IPO?

TL:This may be the shortest answer you get all day. No, it cannot make. In the IPO prospectus, in the S-1, some of them will give a really broad mandate, other ones that'll be like a team with a ton of tech experience. Some of them will say, "We're chasing tech deals." But it doesn't even mean that they end up going that route.

But nonetheless, they really shouldn't start turning the gears of the machine to get the search going until they've got the IPO done. In order to be a SPAC, you really shouldn't have a business identified out of the gate. But you are seeing that recently some of these, the minute they closed their IPO, it's a matter of weeks or months before they're in the process, they're getting it going, they're getting NDAs. It can move pretty quickly.

While they have like an 18 to 24 month clock, if you look at a lot of the recent deals, these people they're doing an IPO and then once later they're announcing entry into a business combination agreement.

LG: So a follow on to that before we go to the results, Josh put in the Q&A, we talked about the advisory role of banks or investment banks. So he's asking how do banks underwrite, if the targeted company for the SPAC is not yet determined?

MO:It's just based on the business plan and the strength of who the sponsors are, and their background. And so what they're really marketing is that management team, or that sponsor, and their track record in whatever industry, whatever sector they're targeting, or just generally. Some of the private equity firms have done these.

And where they've got a history of having formed companies and identified target companies, they're basically marketing that background of theirs and their ability to identify the targets for acquisition. But it's a good question, but it's really you're just marketing it.

TL: I was just going to add one thing to what Mike was saying. With respect to the underwriting arrangement, also the way that underwriters are compensated on these transactions is different. They're not taking the traditional gross spread off of the IPO. They take it's usually 2% on the front when they get the IPO done.

And then there's deferred underwriting compensation on the backend of usually three and a half percent, where they get paid upon a business combination. So everyone is aligned in trying to get a business combination done. I just wanted to raise that as it relates to underwriting.

LG:Okay, we're going to move on to accounting and reporting.

AV:Sure. Thank you Laurie. Yeah. So the SPAC IPO phase would take place over just a span of a few months. So this process is definitely faster than a traditional IPO. However, this would also mean that the SPAC team has a limited timeframe to get everything ready to be that of a public company.

So even though the SPAC's assets consists of mainly cash from the IPO proceeds, and therefore the financial statements are less complex, there are certain nuances that we would like to remind everyone as well. Namely, the equity structure and founder shares, SPAC warrants, financial reporting, and disclosures, and lastly selecting accounting resources and the audit firm.

So first off, we would just want to walk everybody through at a high level what the equity structure of a SPAC is. So during an IPO, a SPAC would typically issue units to investors at $10 per unit, and each unit consists of one common share, also known as the class A share. And one warrant or a fraction of such warrant, to purchase an additional common share in an exercise price of $11.50.

And these are also known as the public warrants, and the public warrants typically cannot be exercised until a business combination event, or at least a year after the SPAC's IPO. Through a private placement, the SPAC's sponsor or founder may concurrently purchase the warrants at a price of usually $1.50 per warrant, and these are the private placement warrants.

Private placement warrants are essentially have the same rights as the public warrants, except that they do have some transfer restrictions. And also they're usually not redeemable by the company like public warrants. And last but not least, founders are also issued a separate class called the class B shares, at a nominal or very affordable consideration of usually $25,000 when the SPAC is formed.

And these are sometimes known as the founder shares or the promote. So we're going to elaborate a little bit more on the SPAC warrants and founder shares on the next two slides. And also one thing to note is that following the IPO, the units, the public class A shares, and whole warrants would be listed and traded separately on the security exchange.

Okay. So moving on to a very hot topic on SPAC warrants, we have received a lot of questions on that. So for this session, we're just going to talk about this at a very high level and feel free to reach out if any other questions. So this, we anticipate that this topic is going to revolve for a while and many people in the community have been actively tackling this topic as well.

And some SPACs are also consulting with the SEC to obtain further clarification on this topic. We have published an FRAQ relating to accounting, taxation and valuation implications on SPAC warrants. And this link is found on the article here. Also we have a podcast, if you would like to get a quick rundown on what SPAC warrants are, while running your daily errands.

So to summarize SEC issued a statement on April 12th, 2021, relating to the accounting and reporting considerations for SPAC warrants. And now existing SPACs would need to reevaluate the accounting position for their warrants. So instead of being classified as equity which has been done historically, they might now need to classify their warrants as liabilities.

And as liabilities, the warrants have to be fair valued, every reporting period with the change going through the income statement. The change in classification of SPAC warrants may also be considered a material misstatement, that requires a restatement of the financials. Pre-IPO SPACs would also need to review their draft warrant agreements, to address certain nuances and be comfortable with the ultimate accounting position.

We have also been receiving questions on specifically what features should SPACs look at when reviewing their warrant agreements, and whether this has any impact on the valuation piece of the SPAC warrants itself. So some key provisions that they should be looking out for would include, tender offer provisions and also settlement provisions that would differ based on holder characteristics.

For example, for certain private placement warrants, the clause would say something like, the characteristics of the warrants would stay the same as long as they are held by the sponsor, and their permitted transferees. So since the holder of the instrument is not an input into the valuation, such a provision would preclude the warrants from being indexed to the SPACs common stock.

And the warrants would end up with a liability classification. In terms of valuation, definitely a lot to talk about as it gets really complex. But one thing to note is that for public warrants they are publicly traded. So if they have observable pricing, they will use those pricing as their valuation. But if the public prices are not readily observable, the fair value of public warrants is usually derived using the Monte Carlo simulation method.

And for our private placement warrants, typically you'll be using option pricing models such as the Black-Scholes model itself. Next, we'll move on to the founder shares, receive a lot of questions on this as well. Actually, most of the questions on founder shares. So as a quick background, SPAC sponsors may be private equity or venture capital first, or they are made up of individuals with a strong M&A background.

Investors rely a lot on the experience on the sponsor team, while making their investment decisions. The sponsors are basically responsible for most of the activities during the SPAC lifecycle. However, they typically do not have an employment agreement with the SPAC, and are not permitted to receive compensation for their services.

So instead, they are granted class B shares for around $25,000 typically, and these shares would make up 20% of the SPAC's outstanding common stock after the SPAC's IPO. However, the founder shares are not entitled to any cash in the trust, that's holding the IPO proceeds. They also do not have any redemptions rights prior to the dispatch or a liquidation.

And if they fail to close a deal, the equity stake basically becomes worthless. However, if there's a successful de-SPAC, thus the shares themselves will be automatically converted to public shares. And in recent years, investors have been expecting sponsors to have a skin in the game. So sponsors have more recently been purchasing additional founder warrants in a private placement as well.

And lastly, sponsors may also provide funding to the SPAC and they will receive a promissory note that is convertible into an equity upon the de-SPAC closing. Therefore, real estate SPAC investors should be aware that sponsors may have preferential rights as compared to them. Next, we'll move on to the last slide here, just to talk a little bit on the overall accounting and reporting considerations for phase one.

So even though the financial statements of a SPAC is not as complex, SPACs should not underestimate the amount of preparation that goes into the S-1 filing and preparing the initial financial statements. And the disclosures would also include capitalization and dilution tables. And they should also note that the audits would need to be completed by a PCAOB registered public accounting firm, who is independent under the SEC and PCAOB independence rules.

Then you also want to make sure that all of their books and records are kept in place and ready to be audited. And as a public company, the SPAC should definitely be ready to respond to SEC comments on a timely basis. With that, I'm going to hand it over to Michael to elaborate on the tax considerations relating to founder shares and warrants, as well as other considerations for phase one.

MT:Thank you Angela. So from a tax perspective, I'm going to focus on two key considerations, one being tax considerations for the founders of the SPAC. As Angela mentioned, the founders are receiving founder shares when they start and create the SPAC. So certainly, the founders want to consider what are the tax implications for them, as well as from the entity standpoint itself, right?

So the SPAC will be a legal entity, a tax reporting entity. So the entity’s considerations surrounding tax and how it may report, or what jurisdiction it might be in, are certainly important to consider as well. So beginning with the founders as Angela mentioned and as many of you are aware, the founders do get these founders shares and possibly warrants when the SPAC is created.

And further like Angela was saying, generally they're purchased by the founders for a nominal amount. But if the SPAC is successful and the successful merger, the founders essentially own 20% of the company after the de-SPAC merger transaction. So clearly, there could be some tremendous value in those founder shares.

So the tax consideration becomes, is that purchase of the shares upfront for a nominal amount, is there some kind of tax event at that point? If there's significant value in those shares when they're purchased for a smaller amount, could that be some disguised compensation? It's actually called the cheap stock issue, and essentially it's this potential risk for there being some kind of a disguise compensation.

Right, clearly if you're buying something for a nominal amount then if there's tremendous value, is that difference between the value and the purchase amount of some kind of compensation to you. So with that said based on some relevant case law out there, typically what has been done is these founder shares are generally issued as soon as possible.

Because once the founders really start performing activities, once they start raising capital, identifying targets there's clearly some value they start creating in the shares. So typically, those founder shares have been issued as soon as possible, to try to mitigate some of those tax implications. But since there is a risk of there being some kind of compensation to the founders, Section 83 of the Internal Revenue Code needs to be considered.

So that section relates to property that's transferred to a taxpayer in connection with services. And essentially 83(a) states that income is recognized in an amount equal to the excess of the value of the property… so here it would be the value of the shares, over the amount paid for the property. And the transfer is deemed to occur when there's no substantial risk of forfeiture.

So if there's some kind of vesting in place, once the property is vested, that's when the income would be subject to recognition. So clearly there's a consideration. There is some uncertainty out there regarding how these founder shares would be treated. Again based on timing, usually they're issued as soon as possible so as to eliminate as much as possible, any kind of built-in gain or inherent gain for this purpose.

And Section 83, it just needs to be considered because that is one of the main tax code sections that speak to transfers of property in connection with services. So let's speak a little bit about the entity. From the entity's perspective, we're clear the entity has to incorporate somewhere, whether it's domestically in the US or in a foreign country.

The key consideration there is, where will the target entity be located? Is the target going to be a domestic company? Is the target going to be a foreign company? Unfortunately, that's generally not known when the SPAC is being formed, right? As my colleagues from the Hunton team and Angela have mentioned, generally the target is identified throughout the process.

So the consideration is, where does the SPAC intend to search for a target? If a SPAC expects to acquire a domestic target, generally a domestic SPAC would be formed. And on the other hand, if a foreign target is expected to be identified, you'd want to set up a foreign SPAC. And so why is that? If you're going to be acquiring or merging with a US target, you want a US SPAC because there's favorable US corporate rules regarding mergers and reorganizations.

And so those can drive tax efficient mergers when you have a US SPAC and a US target. What happens if you have a US SPAC where you find a foreign target? So there's a couple of inefficiencies that can be generated from that. First of all, if you're a US company and you acquire a foreign target, income from that foreign target maybe subject to US taxation.

There's rules out there including CFC rules, which are controlled foreign corporation rules. So you may have income from a foreign jurisdiction that's now being subject to US tax. Likewise, certain distributions to foreign shareholders might be a subject to US withholding. So clearly not a tax efficient result.

So what happens if you started with a US SPAC, if you identify a foreign target. So there the domestic SPAC may attempt to do a domestic to foreign reorganization, something that's called a domestic to foreign F reorg. However, there's rules that are called anti-inversion rules. We're not going to get into all those rules for this session. We could speak about them for hours, but in general there are certain rules out there that even if you attempt to do this reorg from a domestic to foreign entity, under the anti-inversion rules, that SPAC may still be considered a US corporation. It would be a failed attempt to reorganize. But certainly there's some structuring and planning considerations that should be considered.

So that was if you had a US SPAC and you found a foreign target, let's talk about the converse. If you started out with a foreign SPAC and if you were targeting a foreign target, why is that a good result? All of the SPAC's income in that instance may not be subject to US income taxation. You have a foreign SPAC that merges with a foreign target.

Likewise if you're making distributions to foreign shareholders, you can mitigate some of the US withholding taxes on those distributions. So clearly there's more tax efficiency. When you have a foreign SPAC and a foreign target just like we spoke about, are you a SPAC with a foreign target? Let's talk a little bit about what happens if you start out with a foreign SPAC, and you find a US target.

Again, here you have a US target that's merging into a foreign company. Payments from that US entity to the foreign parent, let's call it, those payments may be subject to US tax withholding. Inversion rules, may actually prevent the acquisition outright of the US target by the foreign corporate parent.

So whereas in the other scenario we had anti-inversion rules, here we have inversion rules that needs to be considered. So what do you do? If you formed a foreign SPAC, but you end up finding a US target. There are ways to re-domesticate that foreign SPAC into a US entity. Any of your shareholders could be subject to a tax on any existing earnings and profits of that foreign SPAC.

But like we'll talk about later, while it's just the SPAC, usually the only income you have is some interest income that might not be that significant. What happens if you don't do that? Your foreign SPAC, here's where we get into, there's like PFIC rules, PFIC stands for “passive foreign investment companies.”

Again, we're not going to go into the details just based off of the time limitations today. But certainly things to consider, PFIC rules or QEF elections. Just from a high level you want to think about where your targets might be and that really is going to be one of your driving considerations for where you choose to form your entity.

Whether it's domestically, for example, in Delaware, or if you choose a foreign jurisdiction.

LG: While they're considering that question Michael, what is, as you were talking through the tax and legal implications of what the target may be and foreign versus domestic. I mean, what is the current appetite with respect in the real estate world for hard real estate assets as opposed to prop tech? We think prop tech is sexy and it's what we hear about.

But I think a lot of the people listening are pure real estate players owning hard assets. And so if you have a luxury hotel development, or you have a portfolio of multifamily residential buildings, what's the practical reality there?

MT:So this is a great question. And as you know for anybody that was on the webinar last time I went through a whole series of examples of what real estate types of targets have been out there. And again I think like you mentioned PropTech, when you search through real estate SPAC on Google PropTech is probably the first hundred results, right?

PropTech has been out there as one of the key targets. But there are other targets out there that aren't just PropTech. Like I mentioned in the earlier session, there's targets out there that focus around industrial, there's targets out there that focus around even hospitality resorts. I think Laurie the key consideration here is, where is there value to be generated?

SPACs and the investors… they're really looking for companies that are going to grow tremendously, and generate a lot of value. They're really looking for companies that are going to turn into an Amazon or a Tesla. And if you think about some traditional, stabilized real estate asset, that's just generating some annual yield; those are generally out there and they're priced efficiently.

The appetite or, what the market thinks is going to happen with real estate, is that the hard assets out there that are connected to some kind of transformative industry. So let's think about a cold storage that has been out there. Last mile distribution centers. Those are the types of real estate, hard assets that are really going to prosper. That's what the expectation is. So it's those real estate assets that are connected to some kind of evolving sector of the industry. So certainly those are going to be the clearest targets, but it remains to be seen. I don't think there's been any wildly known deals where it's just a real estate portfolio.

Generally there's a story behind the real estate. I think that's the driving theme in a lot of these deals is what's the story behind the real estate.

AV:Okay. So phase two relates to the operation of a SPAC after the IPO and before the de-SPAC merger. So during this phase, the SPAC would seek a target company and conduct the relevant due diligence procedures. And other activities also include the ongoing SEC reporting maintenance for the 10-Ks and 10-QS, related officer's certifications.

And tracking the triggers from 8-K, which is basically a form of notifying the public of certain events, such as acquisitions and resignation of directors. The SPAC would conduct financial and operational due diligence on target companies. Investors should be aware that even if the prospectus may state a certain target on industry, this may not necessarily be the case.

On the real estate target company side, we also see them trying to seek an optimal SPAC acquirer and performing sell site on financial due diligence, such as quality of earnings, to help with the deal price negotiations as well. During this phase, the clock is definitely ticking since the period given for this process from the SPAC IPO through the successful commercial merger of the de-SPAC with the target company is usually between 18 to 24 months.

However, it is important to still strike a balance between meeting the deadline, and finding a strong target company that will still perform well after the merger. Upon the identifying an opportunity, the SPAC would negotiate an acquisition agreement with the target during this phase two as well. And the SPAC may also arrange for committed debt or equity financing, such as a private investment in public entity, or pipe commitment to finance a portion of the purchase price.

Then the SPAC would announce on both the acquisition agreement and the committed financing, and then thereafter a shareholder would vote to approve of the business combination, and the business combination itself will be consummated. So we'll elaborate all of this, the activities with this on our next session on June 15.

And also the sponsor would typically commit at the time of the IPO to vote any founder shares held by them, and any public shares purchased in favor of de-SPAC. As a result, at least 20% of the SPAC's outstanding shares will be committed to vote in favor of the merger. And with recent SEC statement on SPAC warrants, during this phase two itself, hundreds of existing SPACs out there are now currently revisiting the accounting position and also evaluating if their financials would need to be restated.

And they should be ready to address any SEC comments. And as Mike and Taylor had mentioned earlier, if the SPACs are not able to consummate a successful de-SPAC at the end of the two years, the SPACs would be liquidated and the proceeds will be returned back to the investors. For phase two in terms of accounting and reporting, just wanted to touch on three key pillars to highlight to everyone.

The first is the day-to-day maintenance of the periodic SEC filings and ensuring that you have the proper books and records and working with the audit firm to get the audits and reviews done on time. At this point, the SPACs should also have an experienced team of financial, legal, taxation, accounting, and strategic advisors to help them along the process.

And cutting costs in this area may lead to a bumpy road, so they need to make sure that they have an experienced team helping them. There are also many public company disclosures that're applicable and are required on the 10-Ks and 10-Qs that SPAC should be aware of as well. The second pillar relates to the documentations, or formal documentations of the accounting policies and positions relating to SPAC warrants and any other complex areas.

And they should also monitor cash to ensure such a sufficient funding for a future merger. And from an investor standpoint, we have received a lot of questions on pipe commitments, such as a hedge fund investing in a pipe commitments issued by de-SPAC. This, there are alternative views in the industry right now, and you should definitely stay tuned to any updated views from the AICPA investment companies expert panel.

At a high level pipe commitments, are commitments to acquire shares of the common stock of the merged entity at a fixed price subject to certain contingencies, such as shareholders approval. And then when the merger happens, the investors would then fund this commitment when the contingencies are met. So at a high level pipe commitments should be recognized when the commitment is legally binding.

And there are also a lot of valuation considerations there as well. And also determining how to account for this pipe commitments, when the contingencies are met. And the last pillar relate to financial and accounting due diligence work. So other than looking at the business of a potential target, SPACs should also ensure that these targets have a strong management team.

Because they are often the ones who stay on to become the management of the new combined entity upon a de-SPAC. And they should also perform a comprehensive gap analysis on the current accounting and internal controls of the potential target, before committing to an acquisition agreement. And like I've mentioned earlier, the real estate target company would need to be ready as a public company in just in a couple of months.

And also get the financial statements reordered it under the PCAOB standards. We'll definitely elaborate more on this as well on our next session. Next Michael, is going to share some interesting insight on the tax complexities associated with phase two. Michael?

MT:Great. Thank you. So just to walk through a couple of key considerations, once a SPAC is formed and before the de-SPAC or a merger transaction, which we'll talk about on the next session, once the SPAC is formed, you do have a legal tax reporting entity. So management will want to consider your general federal and state filing requirements.

You'll want to consider state nexus and registration requirements. SPACs will really need to evaluate where activity is being performed by management, contractors, key personnel … to determine which states that may require filings. Similarly, if you have an offshore structure, you have to consider any kind of tax laws of the foreign jurisdictions.

 While you're incurring costs, and the startup/introduction and investigation phase, a lot of those costs will be capitalized. Start-up costs are capitalized until a trader business is started. Then those are amortized over 15 years. Likewise, many transaction costs, especially those that are facilitative in nature will be capitalized.

In terms of income, generally the SPACs will only be generating interest income on the cash that they've raised. So you will have some income, you really won't have deductible expenses outside of some filing fees or franchise reporting fees. You will have some taxable income. And finally, if a target is not acquired and the SPAC does not become successful, you will have accumulated all of these deal costs.

Those deal costs would be deductible in the final year of the dissolution and liquidation. So just moving it along to some of the legal considerations from the Hunton team, Taylor and Mike.

MO: I'll address that very quickly. The M&A process for a SPAC proceeds very much like any other M&A process. The SPAC will sign a nondisclosure agreements with target operating companies and decide that it might be interested, and they'll do their diligence to decide whether or not they want to proceed, with a potential transaction and submit an offer.

And one of the most important aspects obviously is the diligence that gets done on the targets. That's been a focus of both Congress and the SEC, particularly on the projections that some of these companies have. And the highlight right now is I think there are five electric vehicle company de-SPAC transactions that are target of investigations, because they're all pretty money.

And the SEC and Congress are very focused on that. What may happen? I don't know. But at the end of the day, when the SPAC and the target company reaching recent agreement, they sign definitive agreements, there's an announcement. And then the race is on to work on the S-4 for the target company to begin, to get ready to the public they typically don't have the staff. They've got to staff up.

They have an awful lot of work themselves in a position to be a public company, and I'll leave it there.

Transcribed by Rev.com

About Angela Veal

Angela Veal is a Managing Director in EisnerAmper. She has over 20 years of experience in both public and private accounting, with focus on financial services, SPACs, IPOs as well as mergers & acquisitions.

About Michael Torhan

Michael Torhan is a Tax Partner in the Real Estate Services Group. He provides tax compliance and consulting services to clients in the real estate, hospitality, and financial services sectors.

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