SPAC Process and Lifecycle
SPAC or a special purpose acquisition company is a shell company listed on a stock exchange with the purpose of acquiring a private company and, therefore, making it public without going through the traditional IPO process. SPAC process differs from tradition IPO in a way that the target that eventually becomes the public company is not involved in SPAC’s formation and IPO.
SPAC is registered with the SEC and is a publicly traded company. Therefore, general public can buy SPAC’s shares before the merger or acquisition takes place.
Investments in SPAC’s shares have their own risk profile, different from the investment made as part of traditional IPO. In a traditional IPO, issuer’s prospectus focuses on historical facts and its past performance. Underwriters market offering of shares following the announcement of the initial price range. In theory, the price at which shares are offered to the public should reflect demand for the shares and estimates of future performance of the issuer. Underwriters conduct significant due diligence on the issuer and assume liability under section 11 of the Securities Act 1933 for the information disclosed in the prospectus. Specifically, section 11 of the Securities Act imposes civil liability for misstatements or omissions of material facts in a registration statement offering securities. Subject to this liability are the issuer, directors, underwriters and accountants.
In contrast, SPAC securities are offered at what can be referred to as a notional unit price, typically $6, $8 or $10 per unit or share. SPACs do not pre-identify possible acquisition targets while underwriters do not undertake any due diligence on actual or potential acquisition targets. While some SPACs are specific about the industries or regions in which they will seek to acquire an operating company, others are more open-ended.
Typical steps of SPAC lifecycle include the following:
- SPAC Formation;
- SPAC’s IPO;
- Target Search;
- Shareholders Vote;
- de-SPAC or Acquisition Completion;
- SPAC Wind-Up; Return of Capital;
In 2020 SPACs raised a record $82 billion outpacing capital raised in traditional IPOs. In 2021 to date SPACs raised more than $90 billion through 2/28 and accounted for about 72% of all initial public offerings.
SPAC formation is executed by so called SPAC’s sponsors often times acting as SPAC’s management team. Sponsors contribute nominal capital to fund formation and offering costs in exchange for so called founder shares. The shares typically make up 20% of SPAC’s shares following the IPO exclusive of warrants held by founders.
SPAC’s IPO involves filing an initial registration statement with the SEC (Form S-1) and responding to SEC comments. Taking SPAC public takes less time than in traditional IPO as SPACs do not have any substantial operating activities.
Generally, SPAC’s financial statements included in S-1 filing reflect cash contribution by founders, issued shares, certain insignificant expense items. Many SPAC’s financial statements include deferred offering costs, i.e. legal, underwriting and other similar payments made in relation to future IPO. Such payments are reported as part of SPAC’s assets before the IPO takes place.
As part of the IPO, SPAC issues equity units. Typically, the units have two components- shares of common stock and a warrant. Warrants will trade separately shortly after the initial IPO. The common shares often trade at a discount to the cash held in escrow. Warrants are exercisable only upon successful completion of a merger transaction. Warrants issued to public shares are commonly referred to as public warrants, while warrants issued to sponsors simultaneously with the IPO are referred to as private warrants. IPO equity units (and public warrants) are primarily sold to hedge funds and other institutions.
SPAC’s sponsors are allowed to acquire additional equity units. However, generally, sponsors are prohibited from selling their shares prior to completion of the merger.
Typically, IPO proceeds less proceeds used for certain fees and expenses, are held in a trust account. Similar to an escrow arrangement, proceeds are held by a third party until the merger transaction is consummated or the SPAC is liquidated for not having completed the merger. Generally, SPAC invest the proceeds in relatively safe, interest-bearing instruments.
Naturally, investment in SPAC’s units before the close of the merger is a bet on whether a merger will be complete and, if so, whether the merger is an attractive investment.
Although preparation of SPAC’s financial statements included in S-1 filing may not involve substantial time and effort, SPAC’s S-1 filings is also required to include other financial information including capitalization table, use of proceeds and MD&A.
Capitalization table presents capital structure of the SPAC before and after the offering. The table is a pro forma financial statements disclosed in the registration statement. Reported in the column “as adjusted” or “post-IPO” in the table is the amount of common stock subject to possible redemption (temporary equity), estimated fair value of warrants typically reported as a liability as well as the amount of permanent equity and other capital items assuming that the IPO takes place. Since private and public warrants and securities subject to redemption are issued as part of the IPO, warrant liability and temporary equity equal zero in historical, per-IPO financial statements included in S-1 filing.
Most of SPAC’s proceeds are placed in a trust for a future acquisition of a private operating company. Use of proceeds section discloses amount of expected IPO proceeds and their use such as offering expenses (legal fees, accounting expenses, etc.), proceeds held in a trust account and proceeds not held in a trust account. The information is prepared consistent with requirements of § 229.504 of Regulation S-K.
MD&A disclosures must be provided pursuant to § 229.303 of Regulation S-K.
SPACs are considered an “emerging growth company” (ESG) and, therefore, they take advantage of certain exemptions from various reporting requirements otherwise applicable to other public companies. Specifically, SPACs are not required to comply with the auditor attestation requirements of Section 404(a) of the Sarbanes-Oxley Act of 2002. The above exemption will no longer apply if the SPAC cease to be an EGS as a result of a merger.
As an ESG, a SPAC can also omit management’s assessment of internal controls in the first Form 10-K after an IPO. For example, if SPAC has filed S-1 registration statement in June 2021, management will evaluate and report on SPAC’s system of internal controls beginning with SPAC’s Annual Report on Form 10-K for the year ending December 31, 2022
Additionally, being an ESG, SPAC may elect to defer the adoption of new (or revised) accounting standards until they become effective for private companies.
It may take SPAC’s sponsors more than a year after SPAC’s initial IPO to identifying an appropriate merger opportunity. Company’s time to identify a suitable target is limited to 24 months with no extension through SEC approval or otherwise beyond that period.
The process of identifying the appropriate target is similar to any other M&A transaction where sponsors review potential targets as part of financial, legal, and tax due diligence process. Overall, SPAC sponsors are compensated for identifying merger opportunities. Generally, no salaries, finder’s fees, or other cash compensation are paid to sponsors or management team prior to the initial business combination.
Generally, SPAC sponsors and managers have a strong incentive to buy a company since they will get 20% of the target at a nominal price.
Following the IPO, the SPAC is obligated to file quarterly Forms 10-Q and annual Form 10-K. SPACs management will need to address a number of accounting issues including presentation and measurement of stock subject to possible redemption, classification and measurement of warrants and the two-class method applicable to EPS. Refer to FinAcco’s publications “SPAC Accounting Issues” and “Accounting for Warrants” discussing the above issues in more detail.
Following the IPO, a SPAC must demonstrate that it has at least $5 million in net tangible assets (NTA) defined as total assets less liabilities and intangible assets. Classification of public and private warrants as liabilities and classification of shares subject to possible redemption as temporary rather than permanent equity will make it more difficult for a SPAC to comply with NTA test. As a compliance measure, SPAC’s terms of incorporation limit maximum threshold for redemption of public shares as such that SPAC’s net tangible assets, after such redemption (and payment of deferred underwriting commissions) will be at least $5,000,001.
If SPAC’s management identify an appropriate target, it must then seek a shareholder approval. Typically, a SPAC acquisition requires the approval of at least 60% of the shareholders while some deals require 80%.
Completion of the merger transaction requires entity to file a proxy with the SEC, obtain and respond to SEC’s comments, mail the proxy to the SPAC’s shareholders and hold a shareholder meeting to approve the merger. Shareholder approval will also be required in relation to certain specifics of the merger including issuance of shares necessary to execute the transaction, the structure of combined company’s board of directors, etc.
Generally, a SPAC is required to mail the merger proxy statement to investors 20 days before the shareholder vote. It is common for sponsors to commit their shares, generally constituting 20% of all shares to vote in favor of the transaction at SPAC formation. Public shareholders who do not wish to invest to the proposed initial business combination have the right to redeem their shares.
A proxy statement is a statement required of a firm when soliciting shareholder votes. A proxy statement, otherwise known as a Form DEF 14A (Definitive Proxy Statement) is prepared in accordance with section 240.14a-3(a) of Securities Exchange Act of 1934 referred to as the Exchange Act.
Generally, SPAC underwriters should not engage in proxy solicitation if part of the underwriting or advisory fee is contingent upon the successful completion of the transaction. In such cases, underwriter’s recommendation to vote “yes” on the proposed transaction would have a conflict of interest.
Acquisition Completion- General
To close the acquisition, SPAC must meet substantial reporting requirements relating to the target. One of the most substantial requirements is provision of financial statements prepared under US GAAP and SEC reporting requirements and audited under PCAOB standards. The financial statements should be for at least two most recent fiscal years or since inception. Provided financial statements must be as of a date not earlier than 134 days before the filing date, except for third-quarter financial information, in which case the financial statements are timely through the 45th day after the most recent fiscal year-end. Unaudited financial statements should be provided for any interim periods that are required to meet the above age requirements. Financial statements for three years may be required depending on the size of the target, specifically, whether the target meets the definition of a smaller reporting entity.
SPAC will also be required to provided pro forma financial information to be prepared according to age, form and content requirements of SEC’s Regulation S-X, article 11. SPAC pro-forma typically includes considerations for redemption rights of public shareholders’, and potential impact from any tax status change resulting from the SPAC merger.
SPAC should also provide management’s discussion and analysis (MD&A), market risk disclosures, respond to SEC comment letters, meet other reporting requirements. MD&A should comply with the requirements of Item 303 of Regulation S-K for all periods presented in the financial statements.
Overall, target companies in SPAC mergers face the same challenges as a company that performs a traditional IPO.
For underwriters, one-half of the underwriter’s or adviser fee can be contingent upon completion of the acquisition, which incentivizes the underwriters to close the transaction.
Within four days after completion of the transaction, combined company is required to file form 8-K that must contain substantially the same information that would be required for companies that go through a traditional IPO. Companies undertaking traditional IPO are required to file SEC’s Form 10 used to register a class of securities for trading on U.S. exchanges. The form to be filed by the combined company is commonly referred to as “Super 8-K”.
The process of the merger or, more specifically, the stage after the execution of a definitive acquisition agreement and before the actual combination with the target company is commonly referred to as a “de-SPAC” or de-SPACing. Many investors who purchased SPAC securities before the merger either sell them on the secondary market or have their shares redeemed before or shortly after the de-SPAC.
Acquisition Completion- PIPE deals
PIPE or private investment in public equity involves selling shares of a publicly traded SPAC at a discount to a publicly traded price to a select group of accredited investors through a private arrangement. The goal of a PIPE deal is to raise additional capital required to close a business combination transaction with the target when the cost of acquiring the company exceeds existing funds in the trust account. PIPE transactions allow to raise capital more quickly without performing a secondary offering and filing Form S-3. Executing a PIPE transaction also avoids underwriting expenses related to a secondary offering.
Acquisition Completion- Accounting Considerations
Initial business combination transactions often structured as a reverse acquisition. A reverse acquisition occurs if the legal acquirer (the entity that issues securities) is identified as the acquiree for accounting purposes and the entity whose equity interests are acquired or the legal acquiree is the acquirer for accounting purposes. Generally, shareholders of the accounting acquirer become controlling shareholders of the combined business. ASC 805-40, Reverse Acquisitions has unique accounting requirements pertaining to reverse merger transaction including reporting of equity accounts of the combined entity.
Management will need to address a number of accounting issues associated with the proposed merger transaction. These issues may include identification of the acquirer, from the accounting perspective, accounting for the reverse merger, re-assessment of classification of private and public warrants as liability or equity instruments.
Wind-Up SPAC; Return of Capital
Depending on SPAC’s terms of incorporation, a SPAC has 18 to 24 months from the date of its IPO to acquire a target. If an acquisition is not consummated during that period, the SPAC must dissolve. In this case, the IPO proceeds held in trust are returned to investors. If the SPAC is dissolved, investors will be entitled to a pro rata portion of IPO proceeds held in the trust account plus interest income less relevant expenses. SPAC sponsors do not receive a pro rata distribution from the escrow account unless they purchased their shares or units following SPAC’s initial IPO.
If SPAC is liquidated, previously issued equity warrants will expire worthless.
About 10% of all SPACs that filed for IPO or 26 individual entities have liquidated between 2010 and May 2021- see spackinsider.com.
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