SPACs: Considerations for Accountants of Sponsors, Target Companies and Investors
March 10, 2021
By Angela Veal
Special purpose acquisition companies (“SPACs”) have been a hot topic in many business conversations since last year. Despite the COVID-19 pandemic, SPACs made up half of the IPOs in 2020, with IPO deals in 2020 actually doubling that of 2019. At the beginning of 2021, numerous SPACs have undergone IPOs and many more are in the works.
SPACs are not a new concept. Yet due to their rising popularity, the SEC’s Office of Investor Education and Advocacy issued an interesting investor bulletin on December 10, 2020 to educate investors on investing in SPACs.
What are the interesting facts about SPACs?
- A SPAC is a “blank check company” that raises capital through an IPO from investors in order to finance a future merger with a target company that has yet to be identified.
- IPO proceeds are placed in a trust that earns interest.
- The merger generally needs to happen within 18-24 months of the IPO.
- If the merger does not materialize, the SPAC will be liquidated and the IPO proceeds will be returned to the investors.
- SPACs are often viewed as more advantageous than a traditional IPO in that the timeline is accelerated, the IPO documents received historically fewer SEC comments due to the less complex nature of the financial statements, and flexibility is provided to investors who can redeem from the SPAC if they are not in favor of the target company.
- The process of merging with a target company is sometimes called a “de-SPAC” transaction.
Who are the key parties involved?
- Sponsors – The SPAC management team that pays for the offering expenses and receives founders’ shares in return. Sponsors are usually private equity firms.
- Target companies – Small to mid-size private operating companies based in either a U.S. or non-U.S. jurisdiction, looking to raise capital from the public but preferring not to go through the time-consuming traditional IPO route. They are the legal acquiree and typically receive a mix of cash and stock from the SPAC. Very often, targets can be deemed the “accounting acquirer” pursuant to a business combination accounting analysis (ASC 805 below) required under GAAP.
- Investors – They invest in the SPACs and hold various financial instruments such as common stock, warrants, backstop commitments, forward purchase agreements, and private investments in public equity (“PIPE”) commitments. Investors also include investment funds.
What is the “10,000 foot-view” for the accountants of sponsors, target companies and investors?
- Business Combinations (Accounting Standards Codification (“ASC”) 805, Business Combinations (“ASC 805”))
It is a critical step to determine who the accounting acquirer is under ASC 805, which involves a high level of judgement. The conclusion in turn drives the presentation of financial statements and whose financial statements that are required to be reported at fair value.
For example, if the target operating company is determined to be the accounting acquirer (often the case even though it is the legal acquiree), the process is considered a reverse merger and typically is accounted for as a reverse recapitalization if the only pre-merger asset of the SPAC is cash. The target company will account for this as a capital transaction and any seller transaction costs will be recorded against the equity proceeds.
However, if the SPAC is the accounting acquirer, it would apply push-down accounting by recognizing the assets and liabilities of the target company at fair value under ASC 805. Any buyer transaction costs would be expensed.
The recommendations would be to a) analyze the preliminary deal documents prior to closing to ensure the company is comfortable with the accounting conclusion on who the accounting acquirer is and the resulting accounting treatment; and b) confirm the preliminary conclusions with the SEC where deemed necessary.
2. Consolidations (ASC 810)
In certain structures, consolidation analysis under ASC 810 can be complex and it is also one of the initial items to consider when determining who the accounting acquirer is under ASC 805. This involves consideration under both the variable interest equity (“VIE”) and voting interest models.
3. Share-Based Compensations (ASC 718)
This may not be a significant area but should be considered if share-based compensations (e.g., profits interests, restricted stock units and options) are issued to the target companies’ employees as part of the acquisition.
4. Adoption of New Accounting Standards for Public Companies
The adoption dates of new accounting standards required to be filed by public business entities may be accelerated for the merged entity. There may be instances where the company has either not adopted the new accounting standards or has already adopted such standards as a private company. As the adoption of new accounting standards may take time and require certain process changes, the SPAC should consider the related impact and timing of such changes when searching for a potential target company. Some of the more complex new accounting standards include Leases (ASC 842), Revenue Recognition (ASC 606) and Current Expected Credit Losses (ASC 326).
5. SEC Reporting and Filing Requirements
The SPAC needs to ensure its Form 10-Qs and Form 10-Ks are filed timely. Non-timely filings may trigger the need for more complex future filings. Additionally, Form 8-Ks are required for certain events, including (a) a “super 8-K”1 at the merger, (b) an 8-K for the change in auditors; and (c) 8-Ks for other significant events among others.
The target company has to, within a relatively tight timeframe, ensure the audit of its financial statements under AICPA standards is being converted to an audit under Public Company Accounting Oversight Board (“PCAOB”) standards. The audit is required to be completed by a PCAOB-registered public accounting firm which 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 (“PCC”) standards. The target company also needs to upgrade its internal controls, processes and the documentation thereof to ensure compliance with Sarbanes-Oxley 404 rules.
Investments in Financial Instruments
Investment funds often invest in a number of financial instruments issued by SPACs. These instruments include different classes of stock of varying rights and preferences, preferred stock, warrants, forward purchase agreement, backstop commitment as well as the PIPE commitment.
The PIPE commitment is a common financial instrument used by SPACs. It relates to the commitment by the investor to acquire shares of the common stock of a merged entity at a fixed price, subject to certain contingencies such as shareholder approval and capital raise. PIPE commitments are a vehicle used by a SPAC when investors in the SPAC redeem their shares before the merger takes place, resulting in the SPAC having to secure additional funding for the SPAC merger. The investment fund would then fund the commitment upon the merger and when the contingencies are met.
It is critical for the investment fund to identify all the commitments entered into, especially those with SPACs, which often include PIPE commitments. PIPE commitments should generally be recognized by the investment fund when the contract is legally binding. When recognized, the unfunded commitment should be fair valued on the balance sheet and re-measured every reporting period.
The valuation process can also involve significant judgment pertaining to the inputs used for the valuation model. Examples of inputs to be considered include the expected timing of the merger event and certain contingencies.
U.S. shareholders may often invest in a SPAC that is formed in other jurisdictions, such as the Cayman Islands. Certain tax implications relating to passive foreign investment companies (“PFICs”), qualified electing funds (“QEFs”) and mark-to-market elections are complex and should carefully be evaluated by the investors.
U.S. SPACs that are closely held corporations should also assess if the personal holding company (“PHC”) rules would apply. A SPAC could be a PHC if at any time during the last half of the taxable year more than 50% in value of its outstanding stock is owned, directly or indirectly, by or for five or fewer individual shareholders. The SPAC would then need to carefully evaluate if this results in additional tax liability.
This is a very complex area, and this article is not meant to serve as a comprehensive discussion. Please consult with your accountant and tax preparer for discussions on specific facts and circumstances.
1 This is a special Form 8-K that a SPAC is required to file within four business days following completion of a de-SPAC transaction. It contains all the information that would be required in a Form 10 registration statement as well as target company’s financial statement information.
Our Current Issue: Q1 2021
- SPACs: Considerations for Accountants of Sponsors, Target Companies and Investors
- Are Investment Advisors Sleeping on Interval Funds?
- ESG-Driven Amendments to Europe’s Fund Regulations and their Impact on U.S. Managers
- Treasury Giveth and Treasury Taketh Away – The Business Interest Expense Limitation and Trader Funds
- SEC Modernizes Framework for Registered Fund Valuation Practices Under Investment Company Act
- Impact of the COVID-19 Pandemic on Goodwill -- Impairment Considerations (ASC 350)