SPACs, or special purpose acquisition companies, have been around since the early 1990s. Yet the meteoric rise to prominence has taken place mostly over the last year or so. Between January 1 and May 19, 2021 (the date that SEC Chair Gary Gensler delivered remarks to a Senate finance committee), the SEC had received more than 700 S-1 filings for SPACs. That number was 75 percent higher than traditional initial public offering (IPO) filings from the same period. During the same timeframe, completed SPAC IPOs were more than 150 times higher than traditional IPOs. Despite its popularity and perceived advantages of this non-traditional path of going public, SPACs still present similar financial and other challenges for CFOs. For this reason, it is essential to understand the key issues at play when a company is pursuing a public filing through a SPAC merger. To help clients, prospects and others, Windham Brannon has provided an overview of the key details below.
What is a SPAC?
A SPAC is an option for a company to go public without the encumbrances associated with traditional IPOs. Essentially, it functions like a reverse merger:
- Investors (an experienced management team or sponsors) pool money together with the intent to acquire an existing private company.
- The SPAC goes public as a shell company, which means it does not have assets besides a limited cash reserve and investments, nor does it have an actual operating business – yet.
- SPAC investors then seek out an acquisition target to take public.
- When the target company goes public, it does so under its own name, and the SPAC investors retain a portion of preferred stock known as founder shares.
SPACs originated from “blank check” companies, or public companies without any specific business plan or purpose. Blank check companies would go public with the intent of an unspecified imminent M&A transaction. Though early blank shell companies had somewhat of a poor reputation, modern SPACs have evolved and are much more secure – though that does not mean they are without risk. FINRA notes that it is possible for SPACs to operate as blank check companies, in which case they would be subject to additional requirements. Most are structured so that investors’ funds are not explicitly required to be held in escrow until after the transaction has occurred.
Today’s SPACs have a timeframe by which to complete a merger or acquisition, usually 18 to 24 months. Although, as one attorney noted, SPACs can take a company public in as little as a month if the market conditions and funding line up. In addition, they are known to be a quicker alternative to an IPO and this speed is one of their primary advantages. Using private investment in public equity (PIPE), SPACs can secure capital for the transaction even quicker than before.
For many companies, the advantages of a SPAC merger are the speed, relative simplicity and control over share prices compared to a traditional IPO. Some fees can be less, although it is becoming more common to require liability insurance to protect the directors and officers (D&O). This D&O insurance can be costly. The other costs of an IPO tend to be more condensed since the entire process is quicker.
Additionally, while the SPAC itself does not need to prepare the same level of documentation that a traditional IPO undergoes, the target company must be ready to go public. Most of the work preparing audited financial statements, required public disclosures and other SEC filings fall on the target company’s leadership.
This is where CFOs need to be prepared for SOX compliance.
SPAC Financial Readiness Best Practices
It can be challenging to prepare for a SPAC transaction and post-transaction financial readiness. Yet, target companies will need to be ready with SEC-compliant audited financial statements, strong corporate governance, systems optimization and processes to enable timely reporting and monitoring, internal control over financial reporting (including general computer controls), and regulatory and investor filing requirements all within an expedited timeframe.
CFOs may need to upskill their team, invest in new or upgraded financial infrastructure and implement new processes to ensure financial reporting can be completed on time. SOX compliance can often get lost in the shuffle of getting processes and systems in place and it is common that many CFOs of pre-SPAC companies are unprepared for these various compliance demands.
SOX 404 Compliance
Section 404 of the Sarbanes-Oxley Act (SOX 404) mandates that all publicly-traded companies must establish internal controls and procedures for financial reporting and must document, test and maintain those controls and procedures to ensure their effectiveness. Internal controls over financial reporting (ICFR) is management’s responsibility and many companies, upon a SPAC merger, find that they are unprepared to launch on their own. Particularly, ICFR refers to policies and procedures that:
- Accurately and fairly reflect transactions involving the company’s assets,
- Provide reasonable assurance that transactions are recorded properly and in accordance with financial reporting frameworks, and
- Properly detect, mitigate and correct potential fraud that would have a material effect on financial statements.
After becoming registered with the SEC, SPAC companies will need to include four items in their annual filing: a statement of management’s responsibility to establish ICFR, a statement identifying the framework to assess the effectiveness of ICFR, management’s assessment and a statement from the external auditor.
Management should treat SOX 404 compliance as a major project; employ project management principles to organize, identify, assess, test and document controls and processes. It can take several quarters if there are limited controls and documentation in place already.
The first place to start is a risk assessment and high-level benchmarking. Document all controls and processes and identify controls already in place. From there, companies should identify weaknesses, test the operating effectiveness of controls already in place, review issues and fill controls gaps, and determine a timeline to bring all controls in compliance.
Auditors and advisors can help SPAC companies bring ICFR to full SOX 404 compliance in a number of ways, including overall project management, approach and scope, as well as top-down, risk-based control implementation. One of the biggest, if unintentional, mistakes SPAC companies can make is trying to achieve SOX 404 compliance on their own.
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SPAC activity has soared in recent months, and it is likely the market will continue to support this quicker path to going public for the near future. For all its benefits, there are risks to both investors and target companies who are not prepared for the accelerated timeline or other associated risks. If you have questions about the information outlined above or need assistance with another, tax, accounting or assurance issue, Windham Brannon can help. For additional information contact Dean Flores.
