SPACs managers must educate targets to avoid accounting risks

EisnerAmper managing director Angela Veal highlights the biggest potential accounting mistakes in executing de-SPAC transactions.

SPAC target companies aren’t always aware of how to account for different compensation arrangements, notably stock-based compensation, and mischaracterizing them could require a restatement of financials from the target company.

EisnerAmper managing director Angela Veal says while she hasn’t seen this happen yet during a de-SPAC, it is a risk that requires a great deal of discussion between the SPAC manager and the target company.

Veal warns that there are a number of technical accounting complexities associated with a de-SPAC transaction. Notably, under Accounting Standards Codification 805, the de-SPAC requires the accounting acquirer to be identified, which will determine which company’s financial statements are required to be reported.

Veal says both parties need to determine if the de-SPAC will be a reverse recapitalization or a business combination, which require different accounting from day one.

“If it’s a reverse recapitalization, the target company is considered the accounting acquirer, and the books and records would simply continue on a continuation basis,” Veal explains. “The injection of capital from the PE firm or from the SPAC is considered a capital injection. The accounting is totally different from a standard business combination.”

In terms of financial reporting, once the target company has been identified by the SPAC entity itself, it needs to ensure that the company’s auditor is able to audit financials under the PCAOB independence standards, and can convert all of their private company financials into public company financials.

And, Veal says that if the target company adopted any private company accounting standards, then they need to unwind those and adopt public company standards.

Additionally, both the SPAC and the target company must make sure the target company’s management team is capable of going through the de-SPAC process and getting the company ready to be a public company. Subsequent to that, the management team needs to make sure the company is complying with the SEC rules and regulations. The SEC views de-SPACs no differently than traditional IPOs and expects the combined public company to produce financial reports that meet SEC rules and regulations.

The SEC requires that the target company provide three years audited financial statements. The target company may provide two years audited financial statements if it is a smaller reporting company with less than $100 million in annual revenues or it is an emerging growth company with less than $1.07 billion in annual revenues.

Because most SPACs will have some holding in the target company post-transaction, it is important to make sure the company’s management team understands its regulatory and accounting requirements, Veal notes.

“One of the biggest mistakes I’ve seen is where the target company doesn’t know their reporting and auditing requirements they have following the de-SPAC. This has caught a lot of company management off guard so it would be best practice for the SPAC manager to educate the target company on the post-transaction obligations.”

Finally, Veal says that the de-SPAC has to consider employee compensation that was in place before the deal, and what it will look like after the deal. Many companies offer stock-based or equity compensation to employees. Post-transaction, the target company is required to establish a shareholder-approved equity incentive plan and an appropriate share reserve.

“When dealing with shares of the existing target company and the entity de-SPAC, it can get pretty complex, so I would advise both parties to speak with an accounting advisor to determine the best way to categorize and value these compensation arrangements to get proper accounting and make correct financial reports,” Veal concludes.