More from the SEC on SPAC IPOs
The question of using a SPAC/Special Purpose Entity/Blank Check Company to become a public entity has come into vogue as the number of IPOs skyrocketed in recent months – as least up to the end of the first quarter of 2021 when the trend suddenly halted. To a large extent much of the conversation focuses on the question of whether a private entity merging with a public SPAC is prepared for the obligations and burdens of being the steward of a public company.
A number of commentators have suggested that the Commission had some impact on the demise of the SPAC-IPO trend. Perhaps. The Commission has published two statements recently on the question. One by the Division of Trading and Markets, discussed in an earlier article (here); a second, was penned by Acting Chief Accountant Paul Munter (here). While there is some overlap in the statements, each serves as a cautionary note and checklist for those about to assume the responsibilities of senior positions with a public company, viewed from a different prospective.
Mr. Munter begins his statement by focusing on financial reporting. Regardless of the form or structure used to become public, the key is “[h]igh quality financial reporting – a result of stakeholder(s) throughout the financial reporting system working together . . . for the shareholders. The merger of a SPAC and private enterprise thus presents a series of difficult and complex financial reporting and governance questions. Those include questions regarding the market and timing, financial reporting considerations, internal control issues, corporate governance points and considerations regarding auditors.
First, a key point centers on the markets and the question of timing, according to Mr. Munter. The transition from private company to public entity represents a significant undertaking. Yet SPAC transactions typically take place over a period of months. In contrast, in the more traditional model the transaction may take place over a period of years. This difference – the compression of preparation time – can significantly impact the new management team. Yet as a public company that group will be called on to deal with a range of questions from understanding the dictates and requirements of public reporting to maintaining an effective system of internal controls. All of these issues are critical to the proper functioning of a public company. The compression, coupled with the difficulty of the responsibilities assumed by the new management team, puts a large premium on the selection of members for the team as well as their preparation requiring a carefully prepared and well-thought-out plan.
Second, issues regarding financial reporting require a knowledge of the obligations imposed by the Commission and others along with the participations of skilled accounting professionals. This is because the management team will be confronted with a series of financial reporting issues in addition to the management and government questions that will arise. The questions will include:
· Determining if the financial statements should conform to GAAP or IFRS
· Questions regarding the form and content of the financial statements
· The identification of the surviving entity for accounting purposes
· Accounting for earn-out or compensation arrangements and complex financial instruments, and
· The application of GAAP for public business entities
Third, internal controls are a key consideration. Generally, the controls govern financial reporting and disclosures. Under SOX Section 404 “management generally needs to conduct an annual evaluation of its ICFR. . .” It is critical that management understand the timing of the first annual assessment required. Management must also be prepared to evaluate the effectiveness of a “public company’s DCP [disclosure controls] as of the end of each fiscal quarter . . .”
Fourth, to ensure proper corporate governance it is important that the different groups involved managing the entity understand their roles, responsibilities, and obligations. The board, for example, should have a clear understanding of its role along with the obligations of the fiduciary duties assumed. It is equally important that management has fully assessed its role, obligations and methods for communicating with management. In addition, the role of the audit committee and its important obligations must be understood by the board, management and those who will join the committee. And, each group involved should be prepared to establish the proper tone at the top of the organization. All of this hinges on effective communication.
Finally, the new organization must be prepared to deal with the auditors and their key role. This requires familiarity with the requirements of the PCAOB and the SEC in this regard, including the key independence rule. It is also important that the audit firm be prepared for the issues that will arise during the transition from private to public company on a compressed time line. All of these considerations, and others should be carefully assessed early in the process of transiting from a private firm to one that is public.
The apparent rush to an IPO by SPACs reflected in the statistics at the end of the first quarter has ended. Whether that resulted from the publication of the statements by the Acting Chief Accountant and the Division of Trading and Markets or for other reasons is a matter of conjecture.
What is important is that those involved with the IPO of a SPAC are properly prepared. Read together, the two statements from the Commission staff provide an important check list for those involved with these transactions. Investors considering purchasing shares of the new firms would also do well to carefully consider the points presented before purchasing shares.