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SPACs may bring accounting risks

3 min read

The frenzy over SPACs — special purpose acquisition companies — shows no signs of slowing down as the latest hot trend on Wall Street.

This past January saw a record month for listings with around $26 billion of share sales, according to data compiled by Bloomberg News.

Also referred to as a blank check company, a SPAC raises capital from investors for a future merger or acquisition target. Like most financial instruments, SPACs present risks and rewards, and require due diligence from accounting firms to help avoid landmines.

Identifying the accounting acquirer

This one is pretty murky — especially when the transaction is a mix of cash and equity — but oh-so-critical for any related accounting and appropriate presentation and disclosure in the financial statements. Although ASC 805 is the business combinations gospel, and you should absolutely use it as a guide, there could still be a significant amount of judgment required to determine the accounting acquirer.

To add a layer of complexity, in the case of a reverse merger or acquisition, while the SPAC is the legal acquirer and the target business is the legal acquiree, for accounting purposes, these roles are reversed. This occurs when a public entity — the SPAC — acquires the equity interests in a target, private company in exchange for equity in the public company. Companies use reverse mergers or acquisitions to allow the combined entity to retain its public company status. As for the actual accounting, ASC 805 will tell you if the transaction creates a business combination or the acquisition of an asset or group of assets accompanied by a recapitalization.

Determining the predecessor entity

Likewise, the entities involved must decide who will be considered the predecessor entity. This is the one that presents historical financial statements for the combined entity before the transaction. In general, however, the target business is the predecessor entity. In the case of multiple target businesses, the predecessor entity is usually the one that makes up the most significant portion of the combined entity's operations.

Remember, determining the predecessor entity is an entirely separate process from identifying the accounting acquirer. You should perform each analysis independently from the other.

Form and content of financial statements of target business

Since the target businesses are almost always private companies, their historical financial statements generally comply with U.S. GAAP requirements for nonpublic entities. But post-SPAC IPO, those historical financials must now comply with Regulation S-X and the U.S. GAAP requirements for a public company. What exactly does that mean? Don't be surprised if you have to revise those historical financials — while also including additional disclosures — before filing them with the SEC.

Target business historical audits

If a target business is the predecessor entity in the combined entity's financial statements, they must be audited by an independent auditor under PCAOB auditing standards. However, if a target business isn't the predecessor entity (but must include its historical financials, per other SEC rules), then those historical financial statements can be audited under AICPA standards...

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