Special Purpose Acquisition Companies ("SPAC") are companies created solely for the purpose of raising capital via Initial Public Offerings (“IPO”) and in pursuit of transactions. These entities have grown in popularity, particularly over the past two years. Statistics show that 62 SPACs went public in 2019, collectively raising approximately $11.2 billion . In the first half of 2020 alone, SPACs raised more than $10 billion. The ongoing boom in SPACs may be extended by investors who are seeking better returns in the low-rate world that has followed the COVID-19 pandemic.
How does a SPAC work?
SPACs raise funds through an IPO, for the purpose of acquiring target companies identified for their investment value. (Subsequent to acquisition, the target company becomes a listed company without itself undertaking the IPO process.) Listing via a SPAC can reduce transaction costs, effectively streamline the listing process and shorten the listing preparation time frame. At the same time, there are some challenges associated with listing via acquisition by a SPAC. These challenges include:
Preparing for a listing within a significantly shorter time frame;
- Tackling more complex accounting work
- Navigating onerous financial reporting and registration requirements - although these requirements vary based on the lifecycle of a given SPAC; and
- Expediting changes in operations to begin functioning as a public company within six months of the signing of the letter of intent with a SPAC.
Formation and Timeline
The details of a SPAC IPO will typically be designed to suit the intentions of investors behind the SPAC. The structure of a SPAC may be determined by a particular industry and geographic location (for example, those intending to acquire a technology company in China will structure a SPAC with that end in mind), or the experience and background of the investors. Once a SPAC forms and completes its IPO, the funds raised through the IPO are deposited into a trust account. The SPAC needs to locate and complete the merger with a target company within 18 to 24 months or face liquidation, returning the funds raised through the IPO to public shareholders. Even when a target company is located, the public shareholders of a SPAC can vote against the transaction and choose to redeem their shares. In the event a SPAC needs more funds to complete a merger, the SPAC may issue debt or raise funds through a private placement of shares.
SPACs usually need to seek shareholder approval for mergers and acquisitions, and submit proxy statements. The registration statements will require shareholder approval, and include a description of any proposed mergers and governance changes. It will also contain a large amount of financial information concerning the target company, such as its historical financial statements, management’s discussion and analysis (MD&A), and pro forma financial statements assuming the completion of the SPAC merger transaction.
Five things to know about the SEC requirements
There are several Securities and Exchange Commission (SEC) requirements around the governance of SPAC mergers. The most important rules are as follows:
- A SPAC may be eligible to apply for relief as an emerging growth company and is not subject to section 404(b) of the Sarbanes-Oxley Act requiring auditors to audit the efficacy of the company’s internal control over financial reporting. The target company should discuss with its financial consultant whether it meets the relevant standards concerning the efficient preparation of financial statements.
- SPAC mergers often involve multiple legal and equity restructurings, which may affect the target company's tax status. The financial statements of the target company must meet the SEC's reporting requirements and the latest financial statements included in the registration statement must have a balance sheet date falling within the past 135 days. The target company must prepare MD&A disclosures for all periods in the financial statements so that investors can understand the target company’s financial status and operating results. MD&A disclosures usually require extensive data analysis and often contain sensitive financial and operational information.
- Pro forma financial statements are required in SPAC mergers and will provide a comprehensive view of the SPAC merger transaction. The basis for the presentation of pro forma information depends on the expected accounting treatment of the transaction, which usually includes consideration for the impact of public shareholder redemptions and any changes in taxation resulting from the merger.
- A Form 8-K and equivalent information from the target company's Form 10, often called "Super" 8-K, must be submitted to the SEC within four working days of the closing of a SPAC merger.
- After becoming a listed company, the target company’s annual and interim financial statements must be audited and reviewed in accordance with the Public Company Accounting Oversight Board’s (“PCAOB”) standards. PCAOB audits need to be performed by an independent accounting firm registered with, and regularly inspected by, the PCAOB.
SPACs continue to be a popular financial vehicle for companies pursuing an IPO. The SPAC merger process can be completed in just three to six months, which is much shorter than the timeline associated with traditional IPOs. Because of the speed at which SPAC transactions occur, effective project management is extremely important to their success. In particular, target companies must be able to expedite the preparatory processes associated with going public before a SPAC merger can be considered.
As always, contact your Friedman advisor if you have questions about SPACs, SPAC mergers or the process of going public.
Renaissance Capital IPO Intelligence, "US IPO Market, 2Q 2020 Quarterly Review"