Top Considerations for Private Firms Considering a SPAC

Special purpose acquisition companies (SPACs) are one of the hottest ways to go public right now...

Special purpose acquisition companies are one of the hottest ways to go public right now. To date, 300 SPACs have conducted IPOs raising nearly $100 billion in 2021, already surpassing last year’s totals.  Scarinci & Hollenbeck was ranked in the top 20 law firms in each of the last two years in the number of SPAC IPOs in which it served as counsel, and is presently advising a number of entities related to the SPAC IPO and de-SPAC processes.

Not surprisingly, the skyrocketing growth of the SPAC market is resulting in closer scrutiny by the Securities and Exchange Commission (SEC). On March 31, 2021, the SEC’s Division of Corporation Finance issued a statement discussing several accounting, financial reporting, and governance issues that a private operating company should consider before undertaking a business combination with a SPAC in the de-SPAC process.

SEC Statement on Special Purpose Acquisition Companies

The “Staff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies” (Statement) outlines several areas that the Division of Corporation Finance believes private companies should closely evaluate before commencing a de-SPAC or SPAC IPO process. They are divided into the following categories:

Shell Company Restrictions

The Statement emphasized that SPACs are subject to certain limitations that should be considered by the SPAC and by the private company engaging in the de-SPAC business combination with a SPAC before undertaking in such a transaction. These include:

• Financial statements for the acquired business must be filed within four business days of the completion of the business combination pursuant to Item 9.01(c) of Form 8-K.  The registrant is not entitled to the 71-day extension of that Item;
• The combined company will not be eligible to incorporate Exchange Act reports, or proxy or information statements filed pursuant to Section 14 of the Exchange Act, by reference on Form S-1 until three years after the completion of the business combination;
• The combined company will not be eligible to use Form S-8 for the registration of compensatory securities offerings until at least 60 calendar days after the combined company has filed current Form 10 information; and
• The combined company will be an “ineligible issuer” under Securities Act Rule 405 for three years following the completion of the business combination, which has consequences during that period that include that the combined company: can’t qualify as a well-known seasoned issuer; may not use a free writing prospectus; may not use a term sheet free writing prospectus available to other ineligible issuers; may not conduct a roadshow that constitutes a free writing prospectus, including an electronic roadshow; and may not rely on the safe harbor of Rule 163A from Securities Act Section 5(c) for pre-filing communications.

Books and Records and Internal Controls Requirements

The Statement notes that an issuer’s obligations under the Exchange Act’s “books and records” provision, requires issuers to maintain books, records, and accounts in reasonable detail that accurately and fairly reflect the issuer’s transactions and dispositions of its assets, and its “internal controls” provision.  This requires that issuers devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances about management’s control, authority, and responsibility over the issuer’s asset.  These documents are among the “most important for effective and reliable financial information for investors and markets.”

As highlighted by the SEC,these books, records and internal control requirements apply to SPACs before the business combination, as well as to the combined company after the de-SPAC transaction. Accordingly, the Statement recommends that SPACs and the private operating companies consider these requirements when planning for a business combination because the private company may not have prior experience, among other things, with the following:

• Annual or interim reporting;
• Application of SEC rules and disclosure requirements, including reporting deadlines, filer status and its impact on disclosure, predecessor determination, the form and content of financial statements, and when other entity financial statements and pro forma financial information are required by Regulation S-X; and
• Adoption of new accounting standards in the financial statements required in the business combination filing or the subsequent Form 8-K that are not yet effective for private companies.

“Upon consummation of the business combination, the combined company will need the necessary expertise, books and records, and internal controls to provide reasonable assurance of its timely and reliable financial reporting,” the Statement advises.  “A private operating company may have viewed the necessity for those capacities differently prior to the business combination, and may not be able to develop those capacities without advance planning and investment in resources.”

Initial Listing Standards of National Securities Exchanges

If the SPAC is listed on a national securities exchange, such as the New York Stock Exchange LLC or The NASDAQ Stock Market LLC, the combined company must satisfy quantitative and qualitative initial listing standards in order to remain listed after the merger, which include certain corporate governance requirements. Accordingly, the SEC advises that private companies consider how they will maintain a listing throughout and after the merger. It also notes that material risks associated with delisting, such as the likelihood of the commencement of delisting proceedings by an exchange or the failure to maintain a listing, could trigger disclosure requirements for the combined company.  

The Statement specifically notes that a company seeking to list must meet minimum standards, such as the number of round lot holders, publicly held shares, market value of publicly held shares, and share price. “For example, if the SPAC lost round lot holders through redemptions prior to the business combination, the combined company should consider whether it would meet the round lot holder requirement upon consummation of the business combination,” it states.

Additionally, the combined company also must meet qualitative standards regarding corporate governance, such as requirements regarding a majority independent board of directors, an independent audit committee consisting of directors with specialized experience, independent director oversight of executive compensation and the director nomination process, and a code of conduct applicable to all directors, officers, and employees. “There is a risk that a private operating company that has not prepared for an initial public offering and is quickly acquired by a SPAC may not have these elements in place in order to meet the listing standards at the time required,” the Statement warns. “Advance planning may be necessary to identify, elect, and on-board a newly-constituted independent board and audit committee, and for them to adequately oversee the preparation and audit of the company’s financial statements, books and records, and internal controls.”

Key Takeaway

The statement of the Division of Corporation Finance, like all staff statements, carries no legal force or effect. Accordingly, it doesn’t alter or amend any applicable securities law, and doesn’t create any new obligations. However, such statements do reflect areas of concern that the SEC is monitoring.

Notably, the SEC’s Acting Chief Accountant, Paul Munter, also recently issued a statement on SPACs. The “Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies” highlighted a number of important financial reporting considerations for SPACs, including the accounting for warrants issued in connection with a SPAC’s formation and IPO.

At this point, while it appears there will be new interpretations by the SEC under existing rules, it is unclear if the SEC’s concerns will result in new regulations or if the increased scrutiny will seriously dampen the SPAC market. Nonetheless, private companies contemplating SPACs should stay apprised of legal updates and be mindful that the transactions may become more complex in the near future.

If you have questions, please contact us

Any person or entity considering participation in a SPAC or in the de-SPAC process needs the advice and assistance of experienced professionals.  The Securities and Investment Banking Group at Scarinci & Hollenbeck, headed by Dan Brecher, is a well-known team of attorneys with decades of experience in hundreds of securities offerings, numerous widely published writings and lectures to the Bar on securities offering practice. If you have questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.