Use of Special purpose acquisition (SPAC) vehicles have spiked over the past year because private equity and venture capital firms have excess cash they need to put to work, accounting practitioners said mid-June. And about 400 are eagerly trying to find a target company – with hundreds of billions of dollars chasing a finite amount of deals and therefore valuations are sky-high.
“The SPAC wants to find a target company and once they do their mindset is ‘now show us that you’re worthy for us to take you public,’” Nina Kelleher, director, leading financial services within EisnerAmper Digital, said. “To do this the private company really needs to be operating almost as a public company, ready to go, to be acquired and hit the ground running, enabling the SPAC to execute within their timeline,” she said.
A SPAC is a shell corporation without performance history or revenue that is formed for the sole purpose of raising capital through an initial public offering (IPO) to then acquire a target business.
Attorneys caution the rush to go public via a SPAC vehicle, termed “De-SPACing,” comes with substantial risk.
“It is not uncommon for these companies in the first few months of life as a public company to have to make significant balance sheet adjustments, and to have to report publicly that their outside auditors have identified material weaknesses in their internal controls over financial reporting,” Kevin LaCroix, attorney and executive vice president, RT ProExec, a division of R-T Specialty, LLC, said.
The biggest thing in a De-SPACing transaction, depending on which SPAC the company merged with, is “having to get auditor attestation of your financials in your first year,” Bonnie Roe, Attorney, Cohen & Gresser LLP, said. “Which basically means that before you do the transaction you have to have started the process that would enable you to do an audit of your internal controls for the year that you were in.”
To avoid financial reporting woes, accounting teams said the SPAC-IPO marketplace should be mindful of the following:
“The number one accounting issue right now before the De-SPAC is how to account for warrants,” David Steimel, partner in Plante Moran’s Audit and Professional Standards practice, said. A warrant is a written call option under which the counterparty has the right, but not the obligation, to purchase a specified quantity or amount of common stock from the issuing entity at a specified price. The SEC in April “pretty much upended 20 years of accounting interpretation that would have allowed warrants to be equity classified,” Steimel said. “Interpretations from the SEC or guidance from the SEC required about 450 restatements – it really created a lot of havoc in the marketplace,” he said. “You can’t have a successful De-SPAC transaction until you have addressed that accounting,” said Steimel. “Deals have fallen through because of that –we’re talking hundreds of millions of dollars in deals that have fallen through because they weren’t able to get their S-4 effective on a timely basis,” he said.
The accounting for warrants is covered under ASC 480, Distinguishing Liabilities from Equity, and ASC 815, Derivatives and Hedging, subjective rules that are tough to master. These standards require companies to assess whether the warrants should be equity or liability classified. If the warrants are liability classified then they need to be accounted for at fair value, which includes numerous subjective assumptions. The changes in fair value between reporting periods runs through the income statement. This introduces volatility into earnings. “SPACs are not staffed to handle complex accounting issues like that, and so that has required them to reach out to third party experts to handle both the accounting and the valuation of those forms,” Steimel said.
Goodwill is an accounting term for the figure that is recorded on the balance sheet after subtracting the book value of a business from the higher price that was paid for it. Some De-SPAC transactions reveal exorbitantly high figures allotted to goodwill, as much as 85 percent. “Relative to other M&A transactions, it’s off the charts,” Steimel said. “What we’re seeing in the marketplace are situations where a much higher proportion of the purchase price is allocated to goodwill, so these synergies need to be realized quickly to reduce the risk of future impairments,” he said.
Goodwill accounting rules (ASC 350) differ for public companies. Under private company GAAP, companies have the option to amortize goodwill and can treat a subsequent goodwill impairment test as a triggering event. “The SEC does not recognize that [private company version of the] standard, you cannot amortize goodwill in a public company, so there is a required annual assessment,” Steimel said. “You can look at that goodwill qualitatively, what my concern is ‘can a newly public company qualitatively say that my goodwill is impaired based upon the economic results,’” he said. “When you have 60, 70, 80 percent of a transaction price going to goodwill, financial results have to be there, and the question is within a year or two years are the economic results going to be there that are going to justify that level of goodwill.”
#3. Segment Reporting
Topic 280, Segment Reporting, is a topic target private companies have to mindful of because the rules are unique to public companies. “The standard requires you to evaluate how the company looks at its business, what type of financial information the chief operating decision maker is reviewing, how he or she is looking at the business units and once that’s established then that creates reporting sets which goes under the public filings’ reporting segment and then ultimate reporting units which are evaluated by goodwill,” Demetrios Frangiskatos, co-leader of BDO’s SPAC Assurance Practice, said. “There is a systematic process to evaluate how those segments are developed and I think that’s a bit of a newer process for some of these private companies to come up with their valuations,” he said.
#4. Lease Accounting
ASC 842, Leases, a substantially new accounting standard that public companies have already adopted but goes into effect in 2022 for private companies. The standard requires the full magnitude of a company’s long-term lease obligations to be reported on balance sheets, a significant change. The primary challenges for companies are twofold: a quicker, earlier adoption of the new standard than originally planned; and the loss of policy options only available to private companies, Sarah O’Sullivan, Accounting Director at LeaseQuery, said.
“Because 842 is already mandated for public companies, private companies planning a transition to public must account for this, often having to adopt the standard both earlier than originally planned and, often, on a condensed timeline,” O’Sullivan said. “Additionally, private companies have options in a few areas—most notably use of IBR or risk-free rate–that public companies do not,” she said. “What this means is that private companies that haven’t already adopted 842—which is the majority of them—may need to spend time rethinking their implementation to account for policy elections they were planning to use but may no longer be an option for them once they become a public company.
#5. Accounting Staff
Companies need to be able to produce accurate financial statements on a timely basis, reports that can withstand heavy SEC scrutiny and under the glare of the public, Jack Kristan, partner in Plante Moran’s Risk and Accounting Advisory practice, said.
“A lot of the organizations that are the target entities, might not necessarily have the sophistication to keep with the pace of a public company – quarterly filings with the SEC and quarterly reviews that are going to be done by an external auditor,” Kristan said. “There’s a lot that’s going to be required of people, process, and technology. Processes are going to change. You’re probably going to have to staff up. Sometimes we see organizations have been run with very unsophisticated accounting platforms—those might not be adequate to support the needs of a public company,” he said.
Attorneys also noted that all good accounting efforts can become moot if the SPAC and the target company do not share a similar vision or culture. Velodyne Lidar Inc., for example, is suing Graf Industrial Corp.—its SPAC!
“I’ve been in mergers, and the time one failed spectacularly was due to personalities,” LaCroix said. “The unit, in 18 months of the acquisition, literally no longer existed because everyone just walked out the door—just left, because of just basic incompatibility in terms of culture and approach to business and how things get done.”
Additional analysis of the lease standard can be found in the Accounting and Auditing Update Service [AAUS] No. 2016-15 and SEC Accounting and Reporting Update Service [SARU] No. 2016-13 (March 2016): Special Report: Accounting for Leases—an Explanation and Analysis of Accounting Standards Update No. 2016-02.