The past couple of years have seen a spike in the use of special purpose acquisition (SPAC) vehicles because venture capital and private equity firms have excess cash that has to be put to work. There are plenty of them trying to find a target company, due to which valuations have reached sky-high. According to Arthur Hall, the SPACs are looking for a target company and once they find it, they want to determine if the company is good enough for them to take it public. This means the private company should be ready to go public and hit the ground running, allowing the SPAC to execute the acquisition within their given timeline.
A SPAC is essentially a shell corporation that doesn’t have any revenue or performance history and it is established for the sole purpose of raising capital via an initial public offering (IPO), which is then used for acquiring a business. As per Arthur Hall, it is a given that these companies have to make some adjustments in the first few months to their balance sheet after they go public. They also have to report publicly that their material weaknesses have been identified by outside auditors in their internal controls related to financial reporting.
The biggest step involved in merging with a SPAC is to have an auditor attest your financials in the first year. This means that before the transaction is complete, the company should begin the process that would enable them to do an audit of their internal controls. There are some accounting issues that need to be mastered in SPAC IPOs for the process to go smoothly. Some of them are highlighted below by Arthur Hall:
Accounting for warrants is the first and most prominent accounting issue that needs to be dealt with. Arthur Hall states that a warrant is basically a written call option that gives the counterparty the right to buy a specified amount or quantity of common stock at a specified price from the issuing entity. This is not an obligation and it should be noted that this is after the adjustments made by the SEC, as they upended accounting interpretations that would have allowed these warrants to be considered as equity.
The SEC has taken notice of SPACs recently and new regulations are being introduced and Arthur Hall says that this has created a great deal of havoc in the marketplace. Addressing the accounting aspect is important for completing the SPAC merger. A number of deals have fallen through because they weren’t able to resolve these issues in a timely manner, which translates to hundreds of millions of dollars. As per the rules pertaining to the accounting of warrants, companies need to assess whether they are to be treated as liability classified or equity.
If it is the former, then the warrants have to be accounted for at their fair value, but this can bring volatility into the earnings. SPACs are not founded for handling complex accounting issues like this, so they have to reach out to third party experts for dealing with them.
This is an accounting term that refers to the figure recorded on the balance sheet after a business’s book value is subtracted from the higher price paid for it. As per Arthur Hall, a number of SPAC transactions reveal that high figures are allotted to goodwill and these have to be realized quickly for reducing the possibility of future impairments. However, public companies have different goodwill accounting rules. Private companies can amortize goodwill, but this is not recognized by the SEC. As this cannot happen in public companies, there has to be an annual assessment.
Private companies have to be mindful of segment reporting because the rules are different for public companies. Arthur Hall states that it involves considering how the company looks at its business, the type of information that’s being reviewed for decision making by the chief operating decision maker, how they look at business units and then create reporting sets that go under public filings. All of this is a new process for private companies because they have just gone public, which means they need to evaluate how these segments are developed.
It is also essential for companies to be able to produce financial statements on a regular basis and as Arthur Hall says, these reports have to be accurate. This is because they are scrutinized by the SEC and also need to be able to withstand public scrutiny as well. A lot of businesses that end up as target entities don’t necessarily have the sophistication that’s needed for keeping up with the pace of a public company. After all, they were private until the SPAC reverse merger and now they have to worry about quarterly filings with the SEC as well as quarterly reviews that will be performed by an external auditor.
To put it simply, all of this requires a lot of process, people and technology. Arthur Hall highlights that it obviously means processes are going to change and the company would also need to add more staff. There have been cases where organizations were using unsophisticated accounting platforms, which cannot be considered suitable for supporting the needs and requirements of a public company. It should also be noted that all good accounting efforts can go to waste if the target company and the SPAC don’t have a similar culture or vision.
For instance, Velodyne Lidar Inc. is suing its SPAC, which is called Graf Industrial Corp. Experts will tell you that mergers have failed because of personalities and incompatibility in terms of approach to business and culture and how things are done.
Understanding these accounting issues is of the utmost importance as per Arthur Hall because it can allow the private company to merge with the SPAC smoothly and learn how to function as a public company quickly and without committing any mistakes that can create problems in the long run.
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