Going public with a business is always a risky move, but you can execute strategies that ensure smoother sailing. One of these maneuvers is called SPAC and it’s a hugely successful trend on Wall Street.
What is a SPAC?
A SPAC (Special Purpose Acquisition Company) is a publicly traded company created for the sole purpose of acquiring (or merging with) an already-existing company that is ready to go public. The end goal of a SPAC is to help its acquired company save time and money by avoiding the IPO process and the complex, lengthy processes associated with going public.
Also known as a blank check company, SPACs have been around for decades. The process enables an operating company to merge with (or be bought by) the publicly traded SPAC and become listed. This is done in lieu of the operating business executing their own IPO. The operating company is the acquisition target and the SPAC handles the IPO process.
Although a SPAC is listed on the NYSE (New York Stock Exchange) it exists as a shell company and more so on paper. It helps organizations go public without the hassle of actually going public, as the SPAC company is taking all of the heat and risks associated with an IPO. It is the SPAC shares that are listed on the stock market, after all.
How is a SPAC created?
SPACs are typically formed by an experienced management team or a SPAC sponsor with nominal invested capital.
The agreement translates to approximately 20% interest in the SPAC IPO. This is commonly known as the “founder shares.” The remaining 80% is held by public shareholders through “units” offered in an IPO of the SPAC’s shares. Each of these units consists of common stock and a fraction of a warrant (1/2, 1/3, etc.)
Just like public shares, founder shares have similar voting rights. The exception is that founder shares typically have the sole right to elect SPAC directors. Institutional investors and warrant holders do not have those same voting rights, as only whole warrants are exercisable.
The SPAC timeline
SPAC acquisition is based on an investment thesis that’s focused on geography and business sector. For example, the intent to acquire a technology company in San Francisco. It can also be focused on a SPAC investor’s experience or background.
Directly following the IPO, proceeds are placed into a trust account. At this point, the SPAC usually has 18-24 months to identify and complete the merger with a target company. Another word for this is “de-SPACing.”
If, for any reason, the SPAC fails to complete a merger within that time frame, liquidation of the SPAC begins. The IPO proceeds are then returned to the public shareholders.
Once a target company is identified (oftentimes a startup or small business) and a merger is announced, the SPAC’s public shareholders may vote against the transaction and elect to redeem their shares. If the SPAC requires additional hedge funds to complete a merger, it may issue debt or additional shares. One example is a private investment in public equity (PIPE) deal.
The SPAC merger
Once a SPAC has been formed, it will need to solicit shareholder approval for a merger/acquisition. The management team will prepare and file a proxy statement.
If the SPAC intends to register new securities as part of the merger, it will need to file a joint registration and proxy statement on Form S-4. This document will lay out the various matters that need shareholder approval, including:
- A description of the proposed merger
- Governance matters
- Historical financial statements for the target company
- Management’s Discussion and Analysis (MD&A)
- Pro forma financial statements showing the effect of the merger
Once the SPAC merger is approved by shareholders and all regulatory matters are resolved, the merger closes and the target company becomes a public entity.
Within four business days of the closing, a Form 8-K (with data equivalent to what is required in a Form 10 filing for the target company) must be filed with the United States Securities and Exchange Commission (SEC).
Key considerations for SPACs
If a business chooses to go public via the SPAC route, there are some key considerations to keep in mind.
Public company readiness
The timeline for going public via SPAC is much shorter than a traditional IPO. When using a SPAC, the target company only has a few months for the same preparation as an IPO.
This can include:
- Due diligence
- Prospectus drafting
- Setting IPO price
- SEC engagement
- Roadshow
- Oversight
Before considering a share price or looking at tickers, a target company seeking to go public with a SPAC should examine cross-functional topics like:
- Finance effectiveness
- Human resources (HR) and compensation
- Accounting and financial reporting
- Treasury
- Financial planning and analysis
- Enterprise risk management
- Technology and cybersecurity
SEC reporting
In certain circumstances, the target company may qualify for reporting accommodations provided to a smaller reporting company (SRC) or an emerging growth company (EGC). Such relief can greatly impact the time and energy needed for the merger. Target companies should discuss these types of preparations early on in the process with advisors.
Financial statements
The target company should have a good track record of compliance with SEC reporting requirements.
Financial statement disclosure areas with substantial uplift include:
- Segments
- Adoption of new standards
- Earnings per share
- Quarterization
Pro forma
This type of financial statement provides a comprehensive overview of the SPAC merger. How this data is presented depends on the accounting treatment of the transaction.
It typically includes considerations for public shareholders’ redemptions, secondary transactions, and impact from any tax status change that the merger creates. Early coordination between all parties is crucial for a SPAC’s success.
MD&A
The target company is expected to prepare an MD&A disclosure for all periods presented in the financial statements. This is so underwriters, retail investors, banks, and any other entities involved have a better idea of the valuation and financial condition of the target company.
These documents typically require extensive analysis and contain sensitive financial and operating information about the target company.
‘Super’ 8-K
It’s critical that this form is filed with the SEC within four business days of closing. It has equivalent information to what you might find on Form 10.
Tax restructuring
A SPAC merger generally requires many steps for legal/equity restructuring that can greatly impact the tax status of a target company. Keep that in mind.
PCAOB audits
A target company’s interim and annual financial statements must be audited and reviewed based on the Public Company Accounting Oversight Board (PCAOB). This is a nonprofit corporation established in 2002 by the Sarbanes–Oxley Act to oversee all audits of public companies and other issuers.
This can add time and complexity to historical audits as compared to the American Institute of Certified Public Accountants (AICPA) standards.
Accounting acquirer
The accounting acquirer is the entity that has obtained control of the other (the acquiree), which may differ from the legal acquirer. If the target company is the same as the accounting acquirer, the transaction is treated similarly to a capital-raising event (for example, a reverse recapitalization).
However, if the SPAC is determined to be the accounting acquirer, purchase accounting will apply. In this event, the target company’s assets and liabilities require validation to move the merger forward. This must be done to be stepped up to a fair value.
Pros of a SPAC
A SPAC is a smart idea under certain conditions. This approach offers distinct advantages over a regular IPO. It creates more access to social capital, even when market volatility and other conditions are limiting liquidity options.
SPACs can also lower transaction fees and save a smaller company time and money. Expediting the timeline to become a public company can mean the difference between success and failure for smaller operations.
Cons of a SPAC
The merger of a SPAC with a target company can also present a variety of challenges. This means having to meet an accelerated public company readiness timeline. Small slip-ups can really cost you and there’s not a lot of time to mull things over.
Complex accounting and financial reporting and/or registration requirements may not align with the lifecycle of the SPAC involved. This is why it’s important for the management team to focus on being ready to operate publicly within 3-5 months of signing the letter of intent.
Conclusion
SPACs are gaining popularity as a potential liquidity option for many types of companies. The timeline really makes or breaks the decision, as some companies thrive on a 3-5 month IPO process while others are hoping for the extra space to sort things out.
It all comes down to how well prepared the target company is in advance of the SPAC merger. This is where project management becomes an essential facet of success. The right oversight can reduce execution costs, increase efficiencies, and provide working participants with enhanced transparency and accountability.
