Special purpose acquisition companies (SPACs) have become a preferred way for many experienced management teams and sponsors to take companies public. A SPAC raises capital through an initial public offering (IPO) for the purpose of acquiring an existing operating company. Subsequently, an operating company can merge with (or be acquired by) the publicly traded SPAC and become a listed company in lieu of executing its ownIPO.
This approach offers several distinct advantages over a traditional IPO, such as providing companies access to capital, even when market volatility and other conditions limit liquidity. SPACs could also potentially lower transaction fees as well as expedite the timeline to become a public company.
However, the merger of a SPAC with a target company presents several challenges, including having to meet an accelerated public company readiness timeline as well as complex accounting and financial reporting/registration requirements that may differ based upon the lifecycle of the SPAC involved. The target company’s management team will need to focus on being ready to operate as a public company within three to five months of signing a letter of intent.
SPAC formation and funding
Generally, a SPAC is formed by an experienced management team or a sponsor with nominal invested capital, typically translating into a ~20% interest in the SPAC (commonly known as founder shares). The remaining ~80% interest is held by public shareholders through “units” offered in an IPO of the SPAC’s shares. Each unit consists of a share of common stock and a fraction of a warrant (e.g., ½ or ⅓ of a warrant).
Founder shares and public shares generally have similar voting rights, with the exception that founder shares usually have sole right to elect SPAC directors. Warrant holders generally do not have voting rights and only whole warrants are exercisable.
Typical SPAC timeline
A SPAC’s IPO is typically based on an investment thesis focused on a sector and geography, such as the intent to acquire a technology company in a certain geography, or a sponsor’s experience and background. Following the IPO, proceeds are placed into a trust account and the SPAC typically has 18-24 months to identify and complete a merger with a target company, sometimes referred to as de-SPACing. If the SPAC does not complete a merger within that time frame, the SPAC liquidates and the IPO proceeds are returned to the public shareholders.
Once a target company is identified and a merger is announced, the SPAC’s public shareholders may alternatively vote against the transaction and elect to redeem their shares. If the SPAC requires additional funds to complete a merger, the SPAC may issue debt or issue additional shares, such as a private investment in public equity (PIPE) deal.
The SPAC merger
Once formed, the SPAC will typically need to solicit shareholder approval for a merger and will prepare and file a proxy statement (or a joint registration and proxy statement on Form S-4 if it intends to register new securities as part of the merger). This document will contain various matters seeking shareholder approval, including a description of the proposed merger and governance matters. It will also include a host of financial information of the target company, such as historical financial statements, management’s discussion and analysis (MD&A), and pro forma financial statements showing the effect of the merger.
Once shareholders approve the SPAC merger and all regulatory matters have been cleared, the merger will close and the target company becomes a public entity. A Form 8-K, with information equivalent to what would be required in a Form 10 filing of the target company (commonly referred to as the Super 8-K), must be filed with the US Securities and Exchange Commission (SEC) within four business days of closing.
Overview of going public using a SPAC
Public company readiness
A target company in a SPAC merger will need to prepare itself for being a public company normally within a few months, which is a shorter timeline compared to a traditional IPO for substantially the same preparation, due diligence, prospectus-drafting and SEC engagement and oversight. Public company readiness for a target company should cover cross-functional topics such as: accounting and financial reporting, finance effectiveness, financial planning and analysis, tax matters, internal controls and internal audit, human resources (HR) and compensation, treasury, enterprise risk management, technology and cybersecurity.
Given the typical time frame under which the merger occurs, a robust, cross-functional project plan should be prepared and owned by a project management office and a project leader.
A SPAC merger normally requires multiple steps of legal / equity restructuring that impacts the tax status and considerations of the target company.
SEC reporting accommodations
The target company may qualify for reporting accommodations provided to a smaller reporting company (SRC) or an emerging growth company (EGC) in certain circumstances. Such relief can meaningfully impact the time and effort required to consummate the transaction. Target companies should discuss these accommodations with its advisors early in the readiness preparations.
The target company’s financial statements must be in compliance with SEC reporting requirements. Financial statement disclosure areas with substantial uplift, including earnings per share, segments, adoption of new standards, as well as quarterization, among others, can increase the time and effort required to prepare compliant financial statements.
The target company’s annual and interim financial statements included must be audited and reviewed based on PCAOB standards, which can add additional time and complexity to historical audits as compared to AICPA standards.
The accounting acquirer is the entity that has obtained control of the other entity (i.e., the acquiree) and may be different from the legal acquirer. If the target company is determined to be the accounting acquirer, the transaction will be treated similar to a capital raising event (i.e., a reverse recapitalization). If the SPAC is determined to be the accounting acquirer, purchase accounting will apply and the target company’s assets and liabilities will require a valuation to be stepped-up to fair value (i.e., a forward merger).
Pro forma financial statements are typically required and will provide a comprehensive view of the SPAC merger. The basis of presentation for the pro forma information is dependent on the expected accounting treatment of the transaction and typically include considerations for public shareholders’ redemptions, secondary transactions and impact from any tax status change from the SPAC merger. Early coordination amongst all parties will be critical.
The target company must prepare a MD&A disclosure for all periods presented in the financial statements so that investors understand the target company’s financial condition and results of operation. MD&A disclosures usually require extensive data analysis and generally contain sensitive financial and operating information.
A Form 8-K with equivalent information that would be required in a Form 10 filing of the target company (commonly referred to as the ‘Super’ 8-K) must be filed with the SEC within four business days of closing.
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