By Soyoung Ho
SPACs are hot. Once regarded as somewhat shady as blank check companies, they have become the darling of the deal-making world today. The number of SPACs—Special Purpose Acquisition Companies—this year has skyrocketed, and there are even “serial SPACers” and “SPAC-offs.”
However, closing a successful SPAC deal is more difficult than many assume, experts cautioned. One advantage of SPACs is the relatively quick process of going public compared to a traditional initial public offering (IPO). But speed can be a disadvantage and may even scuttle potential deals.
“A lot of the newcomers in the space don’t understand the complexity of the SPAC space,” explained Will Braeutigam, a partner in the SPAC Execution Group at Deloitte & Touche LLP.
A simple SPAC is a shell company that raises capital publicly for the sole purpose of identifying and merging with a target private operating company. The merger transaction infuses the target company with capital that it might otherwise raise in an IPO.
Challenges of SPAC Transactions
After raising funds, a SPAC first goes through the initial registration process with the SEC just like a traditional IPO by filing Form S-1 then identifies a target company. The process of going from a private to public reporting company is complex, but there is not much room for error because SPAC deals happen more quickly. Following the IPO, the SPAC has 18 to 24 months to “de-SPAC” or complete a merger with the target company.
“This is where most private companies don’t … understand the financial reporting requirements that you have to put into the proxy, which is the very next document that has to be [filed with] the SEC to be voted on by the shareholders of the SPAC, whether they want to be in the deal or out of the deal,” Braeutigam said. “And that document is many times more onerous, more difficult to complete than an S-1.”
Braeutigam said pro forma financials are oftentimes much more difficult than an S-1, for example.
“To make matters more difficult, you may have to deal with forecasted financial information in a proxy but not in a S-1,” he said.
Unless the target company is very small or is a pre-revenue company, it will likely require three years of financial statements as opposed to two years for S-1.
Auditors also have to wade through more information for them to get comfortable with the financials.
“When I say harder, you are adding maybe 33 percent more work if you have to upgrade an entire another year from an AICPA standard audit to a PCAOB standard audit.”
The AICPA sets audit standards for private companies. The PCAOB writes audit standards for public companies.
Another challenge in SPAC transactions has to do with planning and preparation. In traditional IPOs, companies plan well in advance and may have done the necessary upgrade to their financial reporting process, said David Oberst, a partner in Deloitte’s M&A Transaction Services.
“Oftentimes, in a SPAC transaction, the business may just be looking for an exit,” he said. “They are going up for a sale, and the person that buys them just happens to be a SPAC. So, they have no intention prior to that divestiture maybe even doing a SPAC. Now all of a sudden, they are in a position where they need to pull together this information very quickly. And so, … just from a planning perspective, generally speaking, companies that are being bought by SPACs may not have done the advance planning … to get ready for such transactions.”
Moreover, Braeutigam said that often more money is needed for the deal to close. This is because the target company is larger than originally planned when the SPAC was set up. So, this could involve private investment in public equity (PIPE) to fill in for people who pulled out of SPAC and redeemed their shares.
In that instance, that PIPE information must go in the proxy.
“So, it’s just another compliance issue that companies have to deal with,” he said. “A reason that these move quickly is the PIPE commitment will only be for a stated period of time. So, they will basically be holding the feet of the SPAC making sure they get it done quickly.”
From deal announcement to close, it averages 140 to 150 days, he said, with some much faster. By contrast, the S-1 process is about nine months.
While SEC rules are not necessarily more complicated for SPACs, Oberst said back deals are more complicated than a traditional IPO.
“It can be a lot more work because the transaction itself is just more complicated given that you know you are dealing with two companies, and it’s also not only an IPO, it’s also a transaction,” Oberst said.
In the meantime, 2020 has been a record-breaking year for SPACs. There were over 160 as of late October this year, Braeutigam said. This compares to about 50 on average in the past three years. In terms of market capitalization, it was $10 billion in 2017. So far this year, it is $60 billion.
It is likely that the upward trend will continue.
A recent poll that Deloitte conducted during a September webinar shows increased interest in a SPAC transaction. About one third of almost 1,470 executives indicated they are likely to consider a SPAC transaction. This is largely because of the speed, and there is more pricing certainty in a SPAC compared to the IPO because it is priced upfront. This is especially attractive in a turbulent market.
However, a quarter of about 1,600 executives indicated that the most challenging aspect of SPAC is a condensed timeline. Almost one third indicated regulatory requirements, and about a quarter indicated either financial statement or internal control over financial reporting (ICFR) requirements as being the most concerning. The Sarbanes-Oxley Act requires company management to maintain and asset its ICFR, and its independent auditor must attest to it, though smaller reporting companies are exempt. Congress passed Sarbanes-Oxley in 2002 in response to scandals at Enron, WorldCom, and others that cost investors $85 billion.
SPAC Boom Equals Increased Demand for CFOs
This boom in SPACs and difficulties of navigating the public market have been driving up the demand for highly qualified CFOs.
“It’s been a record-breaking year for SPAC IPOs and also record-breaking year for requests on doing CFO searches for SPACs,” said Scott Atkinson, Managing Partner of the Global Venture Capital Practice at the executive search and recruitment firm Heidrick & Struggles International, Inc.
During the week of November 16, Atkinson said that he was approached to talk to a number of companies about CFO searches. And 60 to 70 percent of the conversations involved a company that was thinking about a SPAC. “It’s unheard of. Compared to that 10 percent last year, and then 0 percent the year before,” he said.
“And most are recruiting proven CFOs who have an existing track record of successes as a leader within respected public companies, which is notable because if you look around… in Silicon Valley, some of the unicorns that are going through more traditional IPO routes, many times, they are trading off on the proven public company CFO experience and bringing on board number twos. So, VP of finance who hasn’t been in the seat yet, but they’ve got great broad-based sets of experiences and the company’s going to elevate them,” he said.
For SPACs, he has not seen that as much. This suggests that SPACs that hire proven public company CFO tend to outperform companies without experienced CFOs.
Atkinson guessed that the demand for CFOs that have a proven track record at a public company may have to do with the unique structure of SPACs.
“SPAC IPOs approach investors before they have any commercial operations. Investors are prioritizing really on the credibility and experience of the management more than anything, so as you can imagine there is a real heightened focus on the CFO function,” he said.
Further, CFOs have a lot to do in a condensed amount of time.
“It’s really really challenging for even a seasoned CFO,” Atkinson said. “If the company’s making that CFO leadership change leading up to the SPAC…, the CFO needs to complete financial reporting requirements… in compliance with public company GAAP and SEC rules. They have market risk disclosures that they have to put together. They have to provide non-financial information for Form S-4 in a proxy statement. And then, oh by the way, they have to successfully respond to SEC comment” letters for any inadequate disclosures.
This article originally appeared in the November 20, 2020 edition of Accounting & Compliance Alert, available on Checkpoint.
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