This article was updated October 18, 2021.
Special purpose acquisition company (SPAC) transactions saw a significant uptick within technology, life sciences, health care, financial services, and manufacturing industries in 2020 with historic records in early 2021.
While no longer at those record levels, SPACs offer an increasingly common way for private companies to enter the public market; however, there are unique challenges pre- and post-acquisition, so S-1 initial public offerings (IPOs) are still a reliable option.
A SPAC is a public entity that’s established with the intent of acquiring a private operating company. The acquired company then becomes a public operating company without going through a traditional IPO process of its own.
We sat down with Amanda Rose, an attorney and partner with Fenwick, who shared her insight on public and private financing transactions with a focus on SPACs. Rose advises life sciences and technology companies on corporate finance, Securities and Exchange Committee (SEC) reporting, and governance matters.
Following is a segment of that conversation, highlighting questions and answers spanning the following topics:
To learn more, watch our on-demand webcast or read our articles addressing SPAC frequently asked questions (FAQs) and SPAC accounting considerations, including benefits and pitfalls.
How to Get Started with a SPAC
Findley Gillespie: If a CEO or CFO wants to access the public markets through an IPO or SPAC, where should they start? Hire counsel and auditors and talk to investment bankers? What else?
Amanda Rose: Yes, it’s a good idea to hire counsel and auditors and talk to investment bankers.
If you’re interested in a SPAC, hiring an auditor to start working on audited financial statements is really important because it can take several months, if not longer. Auditors, and anyone working with SPACs, are busy—so getting the process started sooner rather than later is key.
Working with legal counsel early in the process is also vital. They can draft some of the disclosures and, maybe more importantly, be there as a resource to help you better understand the structure, options, and pros and cons between an IPO, SPAC transaction, or direct listing.
Your banker can help survey the SPAC landscape, run important models, and help you understand potential valuation. That’s an important step to understand what the economics might look like.
Often, banks can be biased toward one structure or another, so it’s helpful to have a legal resource present that has experience with each structure to help advise from an unbiased perspective.
Findley: With SPACs being the new option for going public, are you spending a lot of your practice helping clients to understand if a traditional S-1 IPO or SPAC is better for their company?
Amanda: It really varies. I’ve worked with companies that initially start with a SPAC transaction and then move to an S-1 IPO later in the process. They sign the term sheets with a SPAC, and then we find a disconnect between the valuation on the term sheet and the valuation the private investment in public equity (PIPE) investors are willing to invest at.
That incongruency can potentially blow up a deal because it alters the economics so that a SPAC transaction doesn’t make sense for the target company. The target company could be holding less than 50% after the de-SPAC transaction, so that can change its view and transaction approach.
I also work with companies that are considering both a SPAC transaction and S-1 IPO. If they’re working with a higher quality bank that thinks they have a profitable path through a traditional IPO, that approach tends to be less expensive, less dilutive, and, in certain cases, actually quicker than a SPAC transaction.
A SPAC transaction often includes identifying the SPAC, negotiating the SPAC, and navigating the uncertainty around redemptions. We work with a lot of life science companies for which the trust-account cash that comes with the SPAC is an important element of the transaction.
If we’re not sure what cash redemptions look like, that can change the economics of the transaction. Having a banker evaluate these elements can help you model your approach and think about assumptions critically.
These complications have led some companies to lean toward traditional IPOs. Obviously, that isn’t always the case; there are times when a SPAC transaction makes sense. We’ve worked on some really successful SPAC transactions where there was a low redemption rate, and we negotiated for earnout and redemption of warrants from sponsors that impacted dilution in a positive way.
Overall, it’s important to really dig into the economics and potential levers of each transaction approach for your company’s specific facts and circumstances.
Findley: When a SPAC goes public, does it identify a target or a sector?
Amanda: SPACs can target an industry, and most SPACs have some sort of industry focus. However, by law, they can’t specifically have a target company in mind when going public—that’s a Securities and Exchange Commission (SEC) rule.
Once the SPAC entity goes public and the IPO closes, it can start negotiating with target companies. So, the SPAC management and board will identify a set of target companies and reach out to them to conduct due diligence and eventually sign a letter of intent or term sheet, which usually contains an exclusivity provision to lock in the relationship for a certain period of time.
Given how hot the IPO market is right now, especially in life sciences, companies are going public in earlier stages of development than I’ve ever seen. So just because you’re at an earlier stage, I wouldn’t say the IPO market is necessarily closed to you right now.
But, in a SPAC transaction, it’s important to know that the interested PIPE investors are often the same investors you’d be going out to in a traditional IPO—so whatever valuation they’re putting on their PIPE would likely be similar to the valuation in an IPO. If you’re thinking it might not be the right time to pursue a traditional IPO, keep in mind that raising the PIPE in a SPAC transaction might be challenging now and in the near future as well.
We’re also seeing SPAC sponsors or other insiders that backstop or anchor the PIPE, and the PIPE then backstops the redemptions. If you choose to go this route, it opens up another way to raise capital in the PIPE that makes the SPAC available to you, but it also changes what the merged company looks like as a public company. It will be very thinly traded with very few institutional investors, potentially making it difficult to raise capital as a public company.
Findley: Jeremy, what are some takeaways from your clients that were initially pursuing a SPAC transaction and changed to a traditional IPO?
Jeremy Kuhlmann: A lot has been written about how quickly a company can go public via SPAC transaction, with some deals closing quite quickly. And that can be true if a company is prepared.
From a timing perspective, traditional IPOs can also come together quite quickly, especially if a company is willing to dedicate the right amount of resources to the project.
The all-virtual environment has made the process more efficient in some ways. There’s no longer an expectation that the company and its legal, diligence, banking, and audit teams have to be physically in the same room for organization meetings, drafting sessions, and road shows. This can greatly reduce the duration of the transaction. We’ve also seen changes to the timing and amount of SEC comments, which helps keep the process moving as well.
Finally, the returns on newly public companies via some of the IPO exchange traded funds (ETFs) were strong in 2020. As an example, the Renaissance IPO EFT, which invests in newly public companies such as Peloton, Uber, and Zoom, saw annual returns of 107% in 2020.
While we don’t have much history for companies that have gone public via SPAC transaction, it seems returns from companies that have gone public via a SPAC aren’t as high as those that go through a traditional IPO.
Findley: If a client wants to move forward with a SPAC transaction, how do they actually find a SPAC?
Jeremy: Unlike the past, when only certain banks were participating in these transactions, all the major banks are now focused on SPAC transactions. If a company is a good target in one of the emerging areas, like electric vehicles, it wouldn’t be surprising to me if it’s approached by a SPAC sponsor without needing to seek one out.
If that hasn’t happened yet, reach out to your network of accountants, attorneys and other advisors, who may be able to refer you to bankers that can connect you with SPAC sponsors.
As a potential target looking to be acquired, companies can also seek out SPACs that are specifically targeting investments in your company’s industry. A few examples include renewable energy, fintech, health care, and biotech. I’d go about it by identifying SPACs with prominent leadership, directors, and advisors in your sector.
Findley: I think some of the lift in SPAC transactions during 2019–2020 was due to economic and political instability related to COVID-19 and the US presidential election. With SPAC transaction terms being fixed as a negotiated deal, which removes some of that market volatility, how does PIPE play into that pricing and valuation?
Jeremy: Certainly, target companies are currently getting lured in by the surprisingly high valuations for SPAC merger deals. What’s often required to complete the transaction is a private investment in public equity, or PIPE, which is a financing transaction that is completed alongside the merger portion of the deal to help capitalize the target company after the transaction.
In certain cases, we’re seeing valuations differ significantly between the PIPE and merger deals as targets try to obtain similar valuations from a pool of new investors in the company. Part of that difference comes from the target company needing to entice new investors to participate, so they often get to buy in at slight discounts. This is similar to what we see in many successful traditional IPOs—no one wants to see their investment trade down after the transaction.
Findley: Amanda, both of our firms have seen SPAC mergers that didn’t go through. What could stop a merger from being completed?
Amanda: SPAC transactions are subject to SPAC shareholder approval, and sponsors can have a tough time getting their new shareholders to approve deals—especially with some of the high valuations we’re seeing. The shareholder base also often changes after the SPAC IPO, which can be challenging.
Even if a SPAC shareholder votes in favor of a deal, they can opt to redeem their shares prior to the merger transaction and have the initial cash they paid for the SPAC unit returned. If enough redemptions like this occur, it could leave the SPAC with insufficient capital to complete the deal, which then has to be covered by the PIPE investments we’ve discussed.
Findley: I’ve heard of SPACs that promised they’d do all of the heavy lifting on the registration statement, including the PIPE. What are things that they can and can’t do, and what does the target company’s management need to do?
Jeremy: The target company is ultimately responsible for its own books and records. If its internal financial records, such as quarterly trial balances, historical capitalization tables, and executive compensation information, aren’t in good shape, then additional help from the SPAC won’t remedy those issues. The SPAC may be able to help organize the information that goes into the registration statement, but it can’t create it and verify it’s complete and accurate.
Findley: Many companies are being told a SPAC transaction is faster and easier than an S-1 IPO, often taking about four months to complete. Is a SPAC faster and easier?
Jeremy: It ultimately depends on how prepared the target company is for the transaction. In addition to the legal and regulatory items that need to come together for a SPAC transaction to occur, a target company will need to provide a minimum of two years of PCAOB-audited financial statements in addition to interim periods that may be disclosed. In many cases, if a target company isn’t prepared for this part of the process, the audit and reviews could extend that typical timeline.
An S-1 IPO, on the other hand, typically takes upwards of six months. As noted above, the all-virtual environment and changes to the timing and amount of SEC comments have contributed to a more expedient process for traditional IPOs.
Findley: Jeremy, with roughly 400 SPACs looking to acquire a company in 2021 and a deadline on their completion, what are your thoughts on supply and demand between the number of SPACs and the number of quality target companies?
Jeremy: As you point out, it’s a bit of a numbers game. There’s a window of time when a SPAC has to find a target, which is generally 18–24 months from formation. The data clearly shows the amount of money tied up in SPACs has increased dramatically in the last few years, and we believe the number of qualified targets that exists likely isn’t growing as fast as the capital that’s chasing those targets.
This means it will be increasingly competitive for SPACs to find qualified targets, especially for those SPACs that are aging closer and closer to their 24-month window. That certainly could be one of the factors driving these valuations higher. But what’s unclear is whether those valuations are sustainable and if investors in the SPACs can expect to see continued healthy returns after the merger transaction. Time will tell.
Findley: With companies having three options to go public right now—a traditional S-1 IPO, direct listing, and SPAC merger—what are the types and profiles of companies that would be best suited for each type?
Jeremy: The SEC approved a new listing rule from the New York Stock Exchange (NYSE) allowing companies to sell new shares through direct listings. Before, they could only sell existing shares belonging to employees or early-stage investors.
Theoretically, direct listings may better reflect market demand for a particular company’s stock because, unlike a traditional IPO process, every interested investor will input the number of shares they would buy at what price, not just large institutional funds. This, of course, assumes there’s sufficient market demand for the shares offered for resale.
Direct listings are generally better suited for companies with well recognized brand names. Setting the initial reference price to be included in the preliminary prospectus may also prove challenging with a direct listing, especially in cases where a company doesn’t have comparative prices for recent private transactions similar to the subject company.
One benefit of the traditional S-1 IPO process is that the approach allows an underwriting syndicate of research analysts to help educate investors on the company’s business model. Investor relations for direct list companies will have to play a larger role in that process. There are also financial and distribution standards a company must meet to qualify for a direct listing.
With a SPAC transaction, there’s the advantage of quickly entering the market, but this can only occur if all audits are complete and the company is ready to be public, which often isn’t the case. A SPAC transaction allows a target company to obtain a long-term investor-base via PIPE at an agreed-upon price versus having to gather the investor-base right before the transaction during the traditional roadshow process.
The SPAC transaction’s success also depends on how well the market understands the business. For example, gaming companies have at times been hard sells to public investors, usually due to the hit-or-miss nature of creating games. If there isn’t a comparable direct public company, a SPAC may make the most sense.
Findley: Amanda, a lot of companies believe they don’t need to raise money right now. Given how hot the market is, they feel they should do either a small IPO or a SPAC merger to allow them access to the public capital markets in the future. Can you share your thoughts on that?
Amanda: I always advise my clients—and I work with a lot of life sciences companies—that if you have an opportunity to raise capital, you take it. You don’t always know when markets might shift, change, or close.
That being said, companies have to keep in mind they’re going to be public when they come out of a merger, and there’s a high cost to being public, even just from an expense and resource perspective. You need to have a fully built out management team, finance team, and independent board that’s meeting regularly. You also need to comply with various SEC and exchange rules and regulations. Each of those elements introduces a significant time and resource expense, so that’s something to weigh.
Transaction readiness depends on the company-specific considerations and the next-value inflection point. It’s important to think about when that next-value inflection point is and what the right time is for your company’s transition.
If your company doesn’t feel like it has the processes in place to become a public company, it might be a better option to take a look at other private financing alternatives. If your company does have the time and resources to become a public company, this is a great time to go public. The capital is there, and we’re seeing companies go public at much earlier stages of development than in prior years.
Readiness, Infrastructure, and Corporate Governance
Findley: Jeremy, we’re seeing many companies go public at much earlier stages. How does that change their preparation processes?
Jeremy: There’s a lot of pre-transaction work companies can do now to get ready for a transition. From a financial statement perspective, companies should:
- Close their books so at least two years of PCAOB audits can be performed on those balances
- Record accrual and other adjusting entries for any interim—quarterly—periods that may be required for the filings
- Pinpoint and address technical accounting issues that could arise in areas like debt or equity arrangements and stock-based compensation
- Verify valuation work is complete, such as timely 409A valuations
- Unwind private-company alternative accounting policies, such as the amortization of goodwill
- Prepare policies in areas that require disclosure as a public company, like segments and earnings per share
Finally, companies should think about what will be required of them to operate as a public company post-transaction. Do they have the right people, processes, and systems in place to execute their close process quickly and meet reporting deadlines required of a public company?
Depending on size, they would also want to consider internal-control requirements of the Sarbanes-Oxley (SOX) Act, such as Section 302 certifications, and when they’ll need to have an auditor provide an internal control over financial reporting opinion.
Findley: What are the core infrastructure components a target company needs to prepare?
Jeremy: After determining your books and records are in shape for the rigor of a PCAOB audit, I would shift focus to the transaction document itself and make sure the parties contributing to the drafting of the document understand their roles.
If your company is pursuing a traditional IPO, the business section will be very important for telling the company’s story. The company usually works with their legal counsel when drafting this section.
In the case of a SPAC transaction, the Form S-4 contains many legal disclosures related to shareholder votes that must be finished to complete the transaction, so that may be the focus of the company and legal counsel. Form S-4 documents must also disclose pro forma information, assuming minimum and maximum redemption ranges. That process can take some time.
The finance and accounting team, assuming there is one, focuses on drafting sections of the document, such as management’s discussion and analysis and the F-pages, which contain the audited financial statements and notes. If your company doesn’t have resources that perform this kind of work, external consulting service providers can act as an extension of your management team to draft elements of the project.
Once your private company becomes a public company, it comes down to whether or not you have the right people, processes, and systems in place to meet all the rules and regulations of being a public company.
Findley: Amanda, some private companies need help cleaning up their corporate and legal infrastructures before going public. For example, making their contracts readily available and organizing their agreements and cap table. Is that something you can help them do before they begin conversations with bankers and set up a virtual data room?
Amanda: That’s a really important point. If your company has material collaboration agreements, they should be compiled in an easy place to save time in the due diligence process. That’s something we can definitely help with through completing a cap audit, reviewing legal compliance, and supporting data room preparation. The process usually includes:
- Getting the legal house in order
- Making sure they have a clean cap table
- Verifying they’ve collected all the books, records, and minutes
- Completing issuance agreements for all of the equity that’s been issued as a private company
- Finalizing all of the material agreements
When a SPAC term sheet is signed, it’s all hands on deck; everyone is trying to complete diligence as quickly as possible from a legal perspective.
Your company will have three lawyers from three different law firms—the SPAC’s counsel, target’s counsel, and the placement agent for the PIPE—pouring through each of those steps. Even earlier than that, SPACs will need to do some due diligence as well. If you’re a life sciences company, for example, all of the regulatory communications, minutes, books, and records should be in individual folders and ready to go.
Findley: If a company has a general counsel, when should SEC counsel be engaged?
Amanda: SEC counsel should be engaged as soon as you consider going public, whether that be through a SPAC, traditional IPO, or direct listing. Capital Markets counsel can help you evaluate the options and begin preparatory activities, some of which can take several months. Counsel can help you identify key work streams and hurdles, and assist in making sure you’re ready when the transaction kicks off. This prep work can significantly shorten the transaction timeline.
Findley: Jeremy, with so many companies suddenly deciding to go public, many audit firms have found themselves no longer independent under SEC and PCAOB standards. If an audit firm has a private-company client that decides to go public, what’s the process of independence and client continuance?
Jeremy: Auditors are required to be independent to provide a PCAOB audit opinion on a company’s financial statements. There are rules governing auditor independence that essentially disallow services that put an auditor in the position of auditing their own work. This means auditors can’t provide services, such as tax provision or financial statement drafting, that would be considered impermissible under PCAOB and SEC independence rules.
So, prior to performing PCAOB-compliant audit work, an auditor must verify it hasn’t performed any impermissible services to the company, its substantial shareholders or officers, directors, and those in financial reporting oversight roles.
Findley: What’s the difference between an American Institute of Certified Public Accountants (AICPA) audit and PCAOB audit? Is it just different disclosures?
Jeremy: It’s likely a private company’s auditor will have to revisit its overall risk assessment process when moving from an AICPA to PCAOB audit, given the increased risk associated with a broader distribution of the financial statements to potential investors and the public markets. Often times, overall materiality is lowered to account for the increased risk, which can result in incremental testing.
I’ve also seen additional income statement testing be required. Testing according to the audit risk tables is required for PCAOB audits, which can lead to additional samples and attributes needing to be tested. For AICPA audits, a fixed amount of income statement testing is often done just for classification purposes.
Finally, there will be additional focus areas to more specifically address the related party and significant unusual transaction rules for public companies in addition to areas such as cybersecurity.
Findley: Should a company elevate their AICPA audit to a PCAOB audit if an expected SPAC transaction is 12–24 months away? What’s the right preparation sequence a company should apply on the core accounting side?
Jeremy: In my opinion, it's never too early to get your books and records in shape to withstand a PCAOB audit, especially if it becomes clear your financial statements will be included in a registration statement of some kind. A company’s decision to pay its auditor to perform the added procedures is often based on their specific facts and circumstances and how much certainty there is around a transaction.
One thing we’re seeing is companies requesting we perform an AICPA audit while having the PCAOB standards in mind, including performing our risk assessment and setting materiality to meet public company standards. If your company is unsure about its transaction path, that might be a good place to start.
In terms of order of operation, I would say focus on full-year books and records first, followed by quarterization-type work. Then, draft the additional sections of the financial statements once you’re closer to knowing for sure a transaction is happening. In the most extreme cases of compressed timelines, these steps may need to be done in parallel.
We’re Here to Help
The SPAC transaction process can vary greatly depending on a private company’s circumstances. To learn more about SPAC transactions and how to get started, contact your Moss Adams professional. You can also learn more in SPAC Transactions: Tax and Operational Considerations for Target Companies or Accounting Considerations for SPAC Transactions, or watch our on-demand webcast.