Accounting Considerations for Targets of Special Purpose Acquisition Company Mergers

This blog was first published on November 5, 2020 and recently updated on July 19, 2021.

In past thought leadership, we reviewed the most important accounting considerations for special purpose acquisition company (SPAC) sponsors. However, there are also several key considerations for target companies that are preparing for the de-SPAC process. 

The de-SPAC process is the period when the SPAC entity acquires the target company and completes the contemplated merger. Through the de-SPAC process, the target company becomes the operational public company.

In this blog, we’ll take a closer look at key accounting considerations for special purpose acquisition company merger targets undergoing the de-SPAC process. Let’s start by reviewing what SPACs are, how they’re formed, and their advantages for companies that want to go public.

What Are SPACs?

SPACs are publicly traded companies formed for the sole purpose of raising capital through an IPO to acquire an unspecified business. The management team that forms the SPAC (the “sponsor”) creates the entity and funds the offering expenses in exchange for founder’s shares.

Also known as “blank check companies,” SPACs don’t sell products or provide services. Instead, their only assets are the funds raised during their IPO. SPAC sponsors may have an acquisition target (or two) in mind, but these are not identified during the IPO process. Before offering shares to the public, SPACs seek out institutional investors and underwriters.

How Do Sponsors Form SPACs?

As the SPAC IPO raises capital, the money is placed in an interest-bearing trust account until the sponsors find a private company looking to go public through an acquisition. SPAC sponsors typically have two years to complete an acquisition before facing liquidation.

If an acquisition is made, investors can swap shares for those of the merged company or redeem them to recoup their original investment plus interest. Special purpose acquisition company IPO funds can only be disbursed to complete an acquisition or return money to investors during liquidation. Once an acquisition occurs, the company is usually listed on one of the major stock exchanges.

What Are the Advantages of SPACs?

Smaller companies (which are typically private equity funds) favor special purpose acquisition company transactions because selling to a SPAC can boost their sale price. Acquisition by a SPAC also offers a faster IPO process because the acquired company can go public more quickly and gain an immediate influx of capital. Plus, the target company can negotiate its fixed valuation with SPAC sponsors.

Accounting Considerations for Target Companies Preparing for the De-SPAC Process

If you’re a target company preparing for the de-SPAC process, there are several important accounting considerations to keep in mind. We’ll provide detailed guidance on each of these items below.

1. Upgrade to Public Company Reporting

Fulfilling the requirements associated with completing your merger transaction involves supplying all of the necessary information for associated SEC filings. This includes audited historical financial statements, along with compliance with SEC Regulation S-X and associated disclosures.

SEC Reporting Requirements

Public companies are required to file periodic financial statements and disclosures, which allow investors to make informed decisions. The most common SEC filings include:

  • Form 10-K, which is a comprehensive summary of a company’s financial landscape.
  • Form 10-Q, which is a condensed version of Form 10-K that’s filed on a quarterly basis.
  • Form 8-K, which is used to disclose major developments that occur between 10-K and/or 10-Q filings.
  • Form S-1, which provides information about securities being offered by a company.
  • Proxy statements, which provide company management salaries and perks for investor review.
  • Form 3, which is the initial public filing that discloses ownership amounts.
  • Form 4, which identifies any changes in company ownership.
  • Form 5, which is an annual summary of Form 4.
  • Schedule 13 (Beneficial Ownership Report), which is required when an owner acquires 5% or more of a company’s voting shares.
  • Form 114, which is required when investors choose to dispose of company stock.
  • Foreign investment disclosures, which allow investors to diversify their portfolios.

SEC Regulation S-X

This regulation governs audited annual reports that are sent to public companies or mutual fund shareholders at the end of each fiscal year. These public company reporting documents include items like your balance sheet, cash flow statement, income, and more.

AICPA Standards

Any prior audits performed under American Institute of Certified Public Accountants (AICPA) standards must be upgraded to Public Company Accounting Oversight Board (PCAOB) standards. Additionally, you must complete any required interim reviews. AICPA standards include:

  • Audit and attest
  • Consulting service
  • Continuing professional education (CPE)
  • Forensic services
  • Peer review
  • Personal financial planning
  • Preparation, compilation, and review
  • Tax
  • Valuation

PCAOB Standards

The Sarbanes-Oxley (SOX) Act requires the PCAOB to establish professional practice standards for public accounting firms. These standards apply to the preparation of audit reports for public companies, broker-dealers, and other issuers. PCAOB public company reporting requirement standards include:

  • Attestation
  • Auditing
  • Ethics and independence
  • Quality control

2. Implement New Internal Processes & Controls

Under SEC staff guidance, special purpose acquisition company management may skip reporting on the internal controls of acquired businesses when they take over financial reporting. This is stated under Section 404(a) of the SOX Act in the first Form 10-K following a material business combination.

However, SPAC management must implement a plan that addresses the requirements of Section 404(a) as soon as practicable due to the amount of time and effort it takes to complete that process. Implementation efforts may require a robust risk assessment, additional hiring and training of personnel, and new processes or systems to support financial reporting and operational management.

The SPAC must also review its entity structure and organizational management, financial reporting close process, information technology systems, investor relations, treasury functions, and internal or external SEC legal functions.

3. Understand Technical Accounting Complexities & New Standard Implementations

Finally, it’s essential that target companies undergoing the de-SPAC process fully comprehend new ASC standard implementations. Keep in mind that these accounting standards and others have differing implementation dates for publicly-traded and non-publicly-traded entities.

Additionally, there are a number of private company accounting elections and practical expedients that may require the unwinding of historical accounting, as well as increased disclosure requirements for newly public companies.

There are several important accounting standard differences between public and private companies that you must prepare for, which we’ll review in detail below.

ASC 805: Business Combinations

Here are the most important components of Accounting Standards Codification (ASC) 805: Business Combinations:

  • Describing the proper accounting treatment that should be used by the acquirer when combining businesses.
  • Providing a broader definition of a business.
  • Requiring the use of an acquisition method.
  • Recognizing assets acquired and liabilities assumed as defined in ASC 820: Fair Value Measurement.

As noted above, applying ASC 805 to a merger transaction requires identification of the accounting acquirer. This may be a challenging process that requires substantial judgment. Determining the accounting acquirer has a significant impact on the basis of financial statement presentation. It also affects which company’s financial statements must be reported at fair value on the date of the merger transaction.

The SPAC and the continuing operating entity may enter into a number of financial transactions that involve highly complex financial instruments. These may include:

  • Multiple classes of redeemable and non-redeemable stock
  • Warrants
  • Promissory notes for sponsors for funds used to pay fees until completion of the SPAC IPO
  • A forward purchase agreement

Additional complexities may arise if a private investment in a public company (PIPE) commitment is obtained to finance a portion of the purchase price. PIPEs involve the purchase of shares at a price below their current market value to help the stock issuer raise capital for the public company.

ASC 606: Revenue from Contracts with Customers

This standard applies to public, private, and nonprofit entities that enter into contracts with customers to transfer goods and services. It’s intended to eliminate variations and inconsistencies in how businesses handle accounting for similar transactions across industries.

ASC 842: Leases

This standard requires almost every lease to be recorded on your balance sheet and classified as a sales, direct financing, or operating lease.

ASC 326: Current Expected Credit Losses (CECL)

This standard requires entities to record estimates of expected credit losses over the span of their financial assets. It primarily affects businesses holding assets that aren’t already accounted for at fair value through their net income.

Are you the target of a special purpose acquisition company merger? Centri offers a variety of services to businesses during the de-SPAC process, including M&A support, technical accounting and position papers, valuation services, risk advisory, CFO advisory, and audit support. Contact our team of experts today to learn more.

About Centri Business Consulting, LLC

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