The Securities and Exchange Commission’s scrutiny of special purpose acquisition companies and advice on how to account for warrants is slowing down business activity.
Last week, the SEC released a staff statement on accounting and financial considerations for SPACs, also known as “blank check companies”. The SEC basically said that warrants, which are typically issued to early investors in such companies, might not qualify as equity instruments and instead would be recorded as liabilities measured at fair value on the books of the company. ‘a society (see the story).
PSPCs have become an increasingly popular way for companies to go public in recent years. With a SPAC, investors essentially create a shell company to raise funds through an IPO, but with the primary purpose of acquiring another company. Companies that have used SPACs to go public include DraftKings, Virgin Galactic, Opendoor and Nikola Motor, according to CNBC. With the orientation that follows shortly in the wake of a Warning March 31 of the SEC on Financial Reporting and Auditing Considerations for Companies Merging with PSPCs, and another SEC statement on the same day, when it comes to accounting, financial reporting and governance issues related to SPACs, the SPAC market suddenly shifts to a more cautious stance. Accounting and consulting firms that have supported their clients in the preparation of an after-sales service must now take a step back and reassess their approach.
“The statement they issued referred to two terms within these instruments, which would make a large number of these collateral instruments to be liabilities,” said Demetrios Frangiskatos, co-head of the practice of BDO’s SPAC insurance. “They would have a passive classification versus equity. It has actually been a big task over the last few days, evaluating the statement, what it means for instruments that are already outstanding, that have had their IPO and deposits. Companies review them and assess whether the change in accounting will result in restatement. What the guidance basically tells you is that these instruments can no longer fit into the equity structure of the balance sheet. They must be marked to market over a period and the change in their fair value goes to the income statement. This will essentially affect all SAVS that have occurred and SAVS transactions where the equity instruments still belong to the operating company and they have not been exercised or redeemed. It’s a big deal.
The SEC statement could change the accounts of many companies. “It appears that a significant amount of them will need to be reassessed and potentially reformulated,” Frangiskatos said.
So far, advice has come from the SEC’s Division of Corporation Finance, but if the SEC uncovers any abuse, it could involve its enforcement unit. “Given the explosion of PSPCs over the past 15 months and the risks they present to investors, the Division of Enforcement is likely focused on investigating potential wrongdoing associated with the identified risks and challenges. by Corp Fin and the Acting Chief Accountant, and will act quickly. recommend enforcement action if necessary, ”said Caitlyn Campbell, former SEC enforcement lawyer and now a partner at international law firm McDermott Will & Emery.
The SEC’s string of warnings and statements appear to be slowing PSPC deal activity, but that’s probably not the only factor. “The market slowed down a bit for various reasons, and maybe that was a necessary slowdown,” Frangiskatos said. “There has been such a high volume for a period of time, and obviously this focus has also slowed it down because those who want to deposit have to value the instruments, maybe change the terms, make sure their accounting firm is comfortable with accounting classification.
Companies must assess the accounting treatment between liabilities and the equity method and their audit firm must know the fair value. “It’s going to take a certain amount of work,” Frangiskatos said. “It’s slowing down the industry, at least right now. “
Until the SEC’s last directive last week, the PSPC boom seemed to be reaching its peak. “The pace at which it was going for a while is a pace that is probably difficult to maintain in the long run,” said Frangiskatos. The market was already starting to show signs of slowing at the start of the month. “There’s been such a volume of passing through the SEC, we’ve heard that some of the reviews might take a little longer, which isn’t surprising, so maybe that’s part of it,” a- he added.
He noted that it takes time for operating companies to prepare and have their audits performed in accordance with Public Company Accounting Oversight Board standards so that they can be acquired by a PSPC and then “de-PSPC”. and become operating companies again. “Obviously, not all of these private companies had necessarily planned to enter the capital markets as part of their short-term plans,” Frangiskatos said. “Some of them have pivoted because of this change in the market.”
Reassessing PSPC accounting will require expertise in the dark rules. “The recent SEC scrutiny of PSPC’s accounting and valuation findings is tied to highly technical and complex accounting rules,” said David Larsen, general manager of the alternative asset advisory practice at Kroll. “The SEC had previously not raised questions regarding the specific accounting treatment that is now under the microscope. SEC Questions essentially halted any new IPO filing or acquisition of PSPC until PSPC resolves the related accounting and valuation issues. Some have questioned whether the SEC is using very complex, judgment-based accounting matters as a means of slowing down an overheated PSPC market. Although it is too early to fully conclude, the potential restatement of the SAVS financial statements to apply the updated accounting interpretation reporting certain warrants as a liability rather than equity, is unlikely to have occurred. significant direct impact on the value of the SAVS shares listed on the stock exchange. Even though the financial statements need to be restated, there is no impact on cash flow other than the cost of hiring lawyers, accountants and valuation specialists to help resolve the issues. financial reporting, audit and evaluation techniques. “
The SEC previously warned investors in March against Celebrity Promoted PSPC after athletes like Shaquille O’Neal and Serena Williams teamed up with various companies. “However, celebrity involvement in a PSPC does not mean that investing in a particular PSPC (s) is generally appropriate for all investors,” the SEC said. “Celebrities, like everyone else, may be brought into a risky investment or may be better able to bear the risk of loss.”
The SEC also issued guidelines in December on disclosures involving SPACs. “They publish guidelines on disclosures, which ensures solid disclosure about how transactions are structured, making sure people understand what the sponsor and the banker is and what the strategy is, etc.” , said Frangiskatos. “They’ve really just tried to make sure that the integrity of the process is maintained and that these operating companies know what they’re in store for when de-PSPC happens.”
Businesses need to be aware of the implications of auditing for after-sales service, and businesses have helped them prepare for it. “We started seeing this wave several months ago where companies had AICPA notices and asked us to do enough work so that they could have a PCAOB notice so they could be ready for a PSPC to be. audited, ”said Frangiskatos. “We have continued to see this wave and momentum come over the last couple of months, where they want to have several years of audit opinions on the PCAOB standards. If PSPC was an exit strategy, they want to prepare for it. “
To prepare a client for a PSPC deal, companies like BDO must handle both auditing and accounting, especially in light of all SEC guidelines.
“There are many sides to the house,” Frangiskatos said. “There’s a side of the house where there’s a business that was audited before, maybe not to PCAOB standards, or maybe it was audited by a business that wasn’t registered. , and she brings in our team to have them work, review and review and audit their financial statements, assess GAAP, make sure they’re up to PCAOB standards, assess disclosures and things like that. But we have another side of the house preparing for the IPO and preparing a company with financial reporting expertise and support so that they can develop processes and infrastructure so that they can be ready to go. do 10-K and 10-Q in case a PSPC occurs. At the same time, these teams will perform a gap analysis and assess possible gaps in their operational structure from a governance, financial reporting and technology perspective and assist management and investment teams through this so they know these are the things you need to think about, this is what your timeline will look like, this is the type of reports you will need, these are the types of things public companies have, here is where you have challenges. Our team will do an assessment and, if necessary, will come and help you. It’s becoming more and more common because some companies haven’t made investments to become public companies, so they need to scale up quickly. Calling on our expertise to help them has been extremely valuable in bridging this gap. “
Until recently, the IPO market seemed to have shifted more towards PSPCs, but that could change now with all of the SEC guidance released in recent months. “There’s a whole universe of important things they need to think about, and when we work with companies, we try to remind them that you really need to be prepared for all of this so that when you go into prime time and you reach out to the public markets, you’ve really developed the right skills, ”said Frangiskatos. “In some cases, they bring in our accounting and advisory team to help them get there and close some of that gap while still making those investments. It’s a very interesting time and there are quite a few challenges our teams are working on and helping these teams prepare to enter the market.