Two announcements in mid-April capture the highs and lows of the stock-market trend known as SPACs.
First came word that the Securities and Exchange Commission in the U.S. was reassessing its financial reporting guidance. The change would classify SPAC warrants with certain terms as liabilities instead of equity instruments—and potentially cool the SPAC market. That was Monday, April 12.
Then came Tuesday, and with it news of the biggest valuation ever for a SPAC deal. Grab, a Singapore-based multinational, would merge with a SPAC backed by Altimeter Capital. Grab is Southeast Asia's answer to Uber but larger and more diversified. The company will reportedly be valued at around US$39.6 billion.
These two events sum up one of the most compelling exit or financing strategies to come along in years. But as the SEC guidance shows, SPACs raise their own financial reporting issues. Let's review SPACs' special place in capital markets and the accounting changes companies should expect when pursuing a merger with one.
What is a SPAC?
SPACs, or special purpose acquisition companies, are an alternate way for companies to go public.
While they have existed for decades, SPACs soared in the past few years—and skyrocketed in 2020. SPACs raised more than US$83 billion last year and have already eclipsed that number in 2021, though volume has plunged in April.
SPACs have mostly exploded in the U.S., adding a cross-border accounting layer for Canadian companies.
“You're not just going public,” says Armand Capisciolto, National Leader of BDO's Accounting Advisory practice. “You're going public in an entirely different reporting environment. Canadian private companies approached by U.S. SPACs need to upgrade their financial reporting—and they need to do it quickly.”
How does a SPAC work?
SPACs comprise two steps:
- Creating a SPAC
A publicly traded company is formed as an initial public offering (IPO). This shell company has one purpose: raise capital to acquire another company. Investors in the SPAC rely on the management, also called sponsors, to find quality companies. Because no one knows the identity of the target company when the SPAC is created, SPACs are often called blank-cheque companies.
- Merging with a SPAC
The SPAC sponsors find a company to buy. If the target company owners and the SPAC's shareholders agree to the transaction, the target company merges with the SPAC. Since the SPAC is already a publicly traded company, the target company becomes public in a reverse takeover. This step is also called a de-SPAC. If the SPAC sponsors don't complete a deal in two years, they liquidate the SPAC and return the funds to their investors.
Target companies: benefits of a SPAC
For target companies and their founders, merging with a SPAC can provide easier access to capital markets. This is especially true for small and midsize companies, which may not fit the standard IPO profile. Valuations are also often higher with a SPAC merger than with a traditional IPO transaction or private equity deal.
SPAC mergers also happen more quickly—in a matter of months versus years for an IPO. There's no need to stage a roadshow for investors, since the SPAC is already public. The disclosure process may be simpler than for a traditional IPO. For example, the target company files an S-4 document with the SEC, instead of the more onerous S-1.
Express IPO, but no shortcuts for financial reporting
SPACs' reputation as an easier road to IPO have fueled what many have called a SPAC bubble. Yet the SEC had warned the markets even last year that companies shouldn't expect a regulatory shortcut. Merging with a U.S. SPAC means staying on the right side of the SEC both before and after the merger.
To pursue a SPAC merger, Canadian target companies must adjust their accounting in three ways:
- Switch their accounting framework—from International Financial Reporting Standards (IFRS) or Accounting Standards for Private Enterprises (ASPE) to U.S. GAAP. Many companies merging with a SPAC have previously raised private equity financing. This adds complexity when switching the accounting framework.
- Upgrade their financial reporting to reflect their new status as a public company. They must provide necessary information for the SPAC's SEC filing, including audited historical financial statements. Audits need to be redone under U.S. GAAP and Public Company Accounting Oversight Board (PCAOB) auditing standards. Companies should also be prepared for increased scrutiny as a public company after the merger.
- Update their internal processes and controls to meet U.S. requirements for public companies. Implementation efforts may require a risk assessment, additional hiring and training of staff, and new processes or systems to support financial reporting and operational management.
For many small and midsize companies, going public means a shift in mindset. Many organizations operate with lean accounting teams and basic accounting systems. To expedite the merger and simplify the audit, they must prepare U.S. GAAP financial statements and filing documents. This sprint diverts attention from the business in the short term. Companies typically need outside help to perform the work quickly and professionally.
“Your company's financial reporting matters to any investor,” says BDO's Armand Capisciolto, “and SPACs are no different. It can be a real difference-maker for Canadian target companies.”
Has the SPAC bubble burst?
The SEC's guidance on SPACs may prove to be a correction of an overheated market. Observers had already questioned whether enough quality companies existed to match the interest of SPACs. And they had commented on the many celebrities attached to SPACs, who added star quality but little strategic value.
Yet BDO's Armand Capisciolto says the SPAC party may not be over.
“There are still hundreds of SPACs seeking target companies,” he says. “In the short to medium term, SPACs will remain one of several exciting options for Canadian founders seeking an exit or financing. Target companies can get a leg up by putting their financial reporting in order.”