When asking if a SPAC is a hack, I’m really asking: “Are SPACs good at what they do?” This is a difficult question to answer. I will say that SPACs are good at one thing, providing an alternative path for a company to go public. This alternative path has been incredibly popular lately with an explosion of SPAC transactions in 2020, showing no signs of slowing in 2021. SPACs, like all other securities offerings, have risks. However, SPACS, and each of the parties involved, have unique risks. They also have unique accounting and financial reporting considerations, and since I work for a company that specializes in accounting training, that was the part that intrigued me the most. But before we can get to those unique considerations, we must first understand the SPAC itself, the key players involved, and how a typical transaction works. This post will do just that, and in next week’s post, I’ll share those accounting and financial reporting considerations.
Explosion in growth
The Special Purpose Acquisition Company, or SPAC for short, has been around for decades. But only in recent years have they seen a tremendous increase in popularity. So much so that according to SPAC Research (www.spacresearch.com), the number of SPAC transactions went from 59 in 2019 to 248 in 2020! Even more staggering is the dollar value of those transactions, $13.6 billion in 2019 to $83.3 billion in 2020. There are no signs of a slowdown. In January 2021 alone, there were $26 billion in transactions!
Why such a sudden increase in popularity? SPACs allow an alternative method for a private company to go public. Rather than the typical initial public offering and filing of Form S-1 with the SEC, the SPAC transaction is an alternative. However, it’s not the form filings that companies are looking to avoid, rather it is market risk. The use of a SPAC allows a company to mitigate the increased market volatility risks of traditional IPOs. We’ll see how this risk is mitigated when exploring how a typical transaction works.
There are several key players in the SPAC transaction. First, the sponsor. These are the initial investors that form the SPAC and lead it through the SPAC process. SPAC sponsors vary from business executives, to companies, to private equity investment funds, among others. Second is the target company. This is the private operating company that the SPAC ultimately acquires. The target company is the one that is seeking to go public but wants to avoid the traditional IPO process. Finally, the investor. SPAC investors are commonly retail investors. They invest in the SPAC and then ultimately become shareholders in the newly public target company. We’ll see how this works next.
How a typical SPAC transaction works
- SPAC formation – The sponsor forms the company and assembles the management team, chooses legal counsel, and selects underwriters. The sponsor and its management team often pay a nominal amount for an equity stake in the newly formed entity.
- Initial public offering – Shortly after formation, the SPAC begins the initial public offering process. Remember, at this point it is basically a shell company mostly consisting of cash. The SPAC files an initial registration statement with the SEC, usually Form S-1, and responds to any SEC comments. At this point, the SPAC begins selling to investors. Most often a SPAC sells “units” which consist of one common share and a warrant. Once the IPO is complete, those units are separated into common stock and tradable warrants. All proceeds raised from selling units, shares, and warrants are held in trust until a target is acquired.
- Target search – Flush with cash, it is now time to find a target company to acquire. Sometimes the sponsor has a target company in mind when the SPAC is formed, but many times the search begins after the SPAC’s IPO. This process is similar to a typical M&A transaction and involves the same level of vetting and due diligence. SPACs typically have no more than two years to complete this process. If a target company is not acquired in the two-year time frame, the SPAC’s governing documents require it to liquidate and return cash to investors with interest.
- Shareholder vote – The merger with the target company will typically require a proxy filing with the SEC and possibly a Form S-4 filing. SEC proxy rules and company bylaws usually require SPAC shareholder approval before the completion of the acquisition. This is often referred to as the “de-SPAC” process in practice because once the acquisition is complete, the company will become an operating company and will no longer be a SPAC. Some SPACs are structured so that investors can redeem their shares. So, if an investor is not satisfied with the acquisition, it can redeem its shares for cash.
- Acquisition close – If the shareholders approve the transaction, the acquisition closes and the target company merges into the SPAC. Essentially, the target company becomes a publicly traded entity. SEC rules require the filing of a “Super 8-K”, which contains similar information to that which would have been required in a registration statement for a traditional IPO.
So, now that we understand the basic SPAC transaction, let’s get back to what makes the transaction attractive. SPACs provide benefits to all the key players but for the target company, it allows them to forgo the typical IPO process and mitigate market volatility risks. How? First, a shortened timeframe. The typical IPO process can take 6 months, maybe even more. In a SPAC transaction, the acquisition of the target company can occur in less time. Second, fixed pricing. Pricing a traditional IPO is challenging and market volatility can change the final price significantly. Companies sometimes abandon IPOs due to market changes. With the SPAC transaction, the pricing is fixed for the target company since it and the SPAC agree on pricing up front, just like in a typical acquisition.
While there are benefits for the key players in a SPAC transaction, there are unique risks as well. In addition to the risks are significant accounting and financial reporting considerations. And those considerations will be the subject of next week’s post!
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