An article from the KPMG SPAC Intel Hub and IFRS Institute – March 5, 2021
In 2020, nearly half of all IPOs were executed through Special Purpose Acquisition Companies or SPACs – raising a record $76.2 billion1. SPACs offer an appealing alternative to the costly and time-consuming traditional IPO process. However, they are not exempt from the SEC’s filing and reporting requirements,2 which are especially challenging when the private operating company target is a foreign business historically reporting under IFRS® Standards. In this article, we explore these challenges and the structuring alternatives to solve them.
What are SPACs and why all the buzz?
SPACs are newly formed companies initially capitalized with nominal funds (to cover the initial expenses) by an experienced management team or sponsor, that then raise additional cash through an IPO. After completing its IPO, the SPAC looks to identify and complete a merger with a target operating company (target).
The SPAC may require additional financing to complete the merger and often identifies PIPE3 investors to provide additional capital. Generally, those PIPE investors are either affiliated with the SPAC sponsor or third-party institutional investors.
Once the SPAC’s public shareholders approve the merger, the transaction closes, and the target becomes a public entity (post-merger registrant). The process of consummating the reverse merger is colloquially referred to as the ‘de-SPAC’ process.
Private equity and hedge fund business models have adapted and systemically expanded to incorporate SPACs. Excess uncommitted capital, along with the current low interest rate environment, have made SPAC transactions even more attractive. Further, the market price volatility during COVID-19 has prompted some companies to forego the traditional IPO route for upfront pricing assurance.
“Speed is of the essence in SPAC deals,” says Aamir M. Husain, Partner, Advisory/Capital Markets Readiness. “A SPAC transaction may only take 3-6 months to complete, but it must adhere to strict SEC regulations. So management must make extra effort to ensure that all boxes are ticked on financial reporting, budgeting and forecasting, and internal controls in a timely manner.”
Financial reporting requirements of the target pre- and post-merger
A SPAC’s incorporation documents or equity agreements typically require the SPAC’s public shareholders to vote on the transaction. This triggers regulatory filings with the SEC pre-merger, with various financial reporting consequences for the target and comprehensive required disclosures.
Before consummating the merger, the SPAC files with the SEC either (1) a proxy statement on Schedule 14A or (2) a combined proxy and registration statement on Form S-4 or F-4 (a ‘proxy/registration statement’). The proxy/registration statement includes matters seeking shareholder approval as well as the target’s historical financial statements, management’s discussion and analysis (MD&A), and pro forma financial information showing the effect of the merger (SEC Regulation S-X Article 11 Pro Forma Financial Information).
The target’s historical financial statements must comply with SEC rules and regulations, including SEC Regulation S-X and SEC Staff Accounting Bulletins, which govern presentation and disclosures in the financial statements. They must also include two or three years of operations and be audited under PCAOB standards. The target may provide two years of audited financial statements, rather than three, if it would qualify as a smaller reporting company or if all of the following apply: (1) the SPAC is an emerging growth company (EGC), (2) the SPAC has not yet filed or been required to file its first Form 10-K, and (3) the target would qualify as an EGC if it were conducting its own IPO of common equity securities.
A Form 8-K (referred to as a Super 8-K) or Form 20-F (referred to as a Super 20-F) is due within four business days after the transaction closes. The Super 8-K includes all information that would have been required if the target were filing an initial registration statement on Form 10. This includes, among other information, the target’s historical financial statements prepared under US GAAP, unless the post-merger registrant meets the definition of a foreign private issuer (FPI).
The post-merger registrant status matters – US domestic registrant or FPI
The financial reporting requirements pre- and post-merger differ depending on whether the registrant qualifies as a US domestic registrant or as a FPI. After completing the SPAC merger, situations may arise where the post-merger registrant qualifies as an FPI. US domestic registrants present their financial statements under US GAAP. The FPI status comes with several benefits as detailed below.
Most SPACs are formed as Delaware corporations, but several have formed in foreign jurisdictions such as the Cayman Islands, British Virgin Islands or the Marshall Islands. Even though the SPAC and target may be domiciled in jurisdictions outside the US, the post-merger registrant may not necessarily qualify as an FPI, based on facts and circumstances.
Here we further explore some pre- and post-merger financial reporting issues that may arise when the target is a foreign operating company.
Merger of a US-domiciled SPAC and a foreign target
US-domiciled SPACs are by definition US domestic registrants and US GAAP financial statement preparers. The key question in a merger between a US-domiciled SPAC and a foreign target is whether the foreign target’s financial statements need to be converted to US GAAP, for which reporting periods and at what point in time. This question arises because post-merger the target, rather than the SPAC, will be considered the ‘predecessor’ to the post-merger registrant as defined and contemplated by SEC Regulation C Rule 405.
When the proxy/registration statement is filed, the merger has not yet occurred, and may not occur at all if the SPAC’s shareholders do not approve. Therefore, target’s financial statements can be presented under IFRS Standards as issued by the IASB Board, or a home country GAAP with a reconciliation to US GAAP5, in the proxy/registration statement. However, Article 11 proformas included in the proxy/registration statement still require presentation under US GAAP. Registrants (with the support of the target’s management) should be prepared to address the need to convert the foreign target’s financial statements to US GAAP, generally shown in the Article 11 proformas, as a transaction accounting adjustment.
Because the target will be considered the predecessor, its financial statements will become the primary financial statements of the US domestic registrant6. As a result, the financial statements of the target included in the Super 8-K need to be prepared using US GAAP.
This means that while a foreign target may avoid converting historical US GAAP financial statements for purposes of the proxy/registration statement in these circumstances, it still needs US GAAP financial statements within four business days of completing the SPAC merger. Additionally, US GAAP adjustments are needed for the Article 11 proformas. Considering the short start-to-finish timeline of SPAC transactions, this can be very challenging if not anticipated.
US GAAP conversions are transformational events that generally involve considerable time and effort, extending beyond just assessing, quantifying, and converting the target’s existing accounting and financial reporting into US GAAP. US GAAP conversions may significantly affect finance processes, internal controls, system configurations, and other business processes. Therefore, it is critical to identify potential US GAAP conversion requirements before or during negotiations to avoid delays during the SPAC merger process and adequately prepare the target for life as a public company and US GAAP preparer.
Additionally, the financial statements of the target included in the proxy/registration statement must be audited under PCAOB auditing standards7 and by considering PCAOB and SEC independence requirements. Often, those financial statements have been audited, but under other auditing standards such as International Standards on Auditing, which are not accepted for US filings. Companies contemplating a SPAC merger should consider these auditing and independence requirements and plan accordingly to prevent filing delays.
Merger of a foreign-domiciled SPAC and a foreign target
In certain situations, the SPAC is a foreign-domiciled company with predominantly US shareholders; therefore, it reports to the SEC as a US domestic registrant pre-merger. After a merger with a foreign target, the post-merger registrant may be able to qualify as an FPI as a result of the shareholder composition and/or its foreign nexus (see criteria). Registrants are encouraged to consult with the SEC staff to discuss their specific facts and circumstances if the company is unclear about their status, or if the registrant believes their situation presents a hardship.
FPI status would allow the foreign target to use IFRS Standards, as issued by the IASB Board, in its financial statements included in both the proxy/registration statement and ongoing reporting requirements. Also, the post-merger registrant would benefit from reduced financial reporting obligations, including the option to report under IFRS Standards on an ongoing basis. This outcome may be desirable if the foreign target itself is already an IFRS Standards preparer, which is why GAAP implications must be considered in the early stages of structuring the transaction.
Transaction structuring considerations
A few potential options may be available in mergers of a foreign target with a SPAC to comply with the Super 8-K or 20-F filing and ongoing financial reporting requirements.
- Convert the foreign target’s historical financial statements into US GAAP with the post-merger registrant continuing to report under US GAAP. This applies for SPACs domiciled in either the US or a foreign jurisdiction.
- Structure the post-merger registrant to qualify for FPI status. This applies to SPACs domiciled in a foreign jurisdiction. To qualify as an FPI, among the other FPI requirements noted, more than 50% of the outstanding voting securities of the post-merger registrant must be directly or indirectly owned by non-US residents.
This may be challenging to achieve in a SPAC merger, because it requires coordination between the target’s legacy owners, the SPAC’s shareholders and PIPE investors. Often, the target’s legacy owners (non-US residents) do not own greater than 50% of outstanding voting securities in the post-merger registrant. This would result in the post-merger registrant continuing as a US domestic registrant and US GAAP preparer.
Therefore, a key element in transaction structuring is to insert a NewCo that (1) will be the ultimate registrant following the ‘de-SPAC’ process and (2) qualify for FPI status at the transaction close. Alternatively, as discussed below, transaction structuring such as a corporate inversion in which the SPAC is incorporated in a jurisdiction outside the US could be a consideration. This could allow the post-merger registrant, as an FPI, to maintain home country GAAP or IFRS Standards reporting for ongoing reporting requirements.
- Structure the transaction as a corporate inversion. This applies to US-domiciled SPACs. As part of the transaction, the SPAC incorporates in a jurisdiction outside the US and, assuming the other criteria are met, would no longer be a US domestic registrant. This transaction structure may allow the post-merger registrant to qualify as an FPI and maintain home country GAAP or IFRS Standards reporting for the ongoing reporting requirements.
There can be many complexities involved when a foreign operating company is the target in a SPAC transaction. Careful planning is required to ensure the transaction execution timelines can be met, taking into consideration the pre- and post-merger financial reporting requirements. Advance planning for the potential need for a conversion to US GAAP or structuring the transaction in order for the ultimate registrant following the ‘de-SPAC’ process to qualify for FPI status at the transaction close will require evaluating options early during the SPAC merger negotiation phase. Identifying the issues and options early on and consulting with your accounting advisors and SEC counsel are critical to ensure the merger transaction is not unduly delayed.
- Data sourced from Capital IQ, and includes SPACs listed on the US exchanges.
- Including the Division of Corporation Finance (DCF) of the SEC’s recent CF Disclosure Guidance: Topic No. 11, which provides the DCF’s views on certain disclosure considerations for SPACs.
- Private investment in public equity (PIPE) transactions lead to additional reporting obligations, such as filing a Form S-1 or Form F-1 and complying with Regulation FD. The DCF issued a new Compliance and Disclosure Interpretation (C&DI) (Question 115.18) in September 2020, addressing, and limiting, the ability of shell companies, including SPACs, to use Form S-3 during the 12 months following a business combination.
- Exchange Act Rule 3b-4(c)
- Home country GAAP can also be reconciled to IFRS Standards as issued by the IASB Board under the SEC’s amendments to Regulation S-X for acquisitions and dispositions of businesses, which became effective January 1, 2021.
- CAQ International Practices Task Force (IPTF) meeting minutes from November 20, 2007.
- In October 2020, the SEC amended the Financial Reporting Manual for this requirement; see FRM 1140.5.