Updated March 2023

We get it. Acronyms can be scary. FBI, YOLO, SEC (both the commission and conference), NASDAQ – it's not just a matter of understanding what the letters stand for but, more importantly, the underlying meaning as well. And while a special purpose acquisition company (SPAC) might seem like another confusing bowl of alphabet soup at first, SPAC is an acronym that's all bark and no bite. Or maybe just a little gnawing but nothing major.

So give us a few minutes as we explain what a SPAC is, when and why they're used, and dispense a few hands-on insights for good measure. Sure, the Great SPAC Crash of 2022 put a massive damper on things. However, volatility will ease and the regulatory picture will focus at some point down the road. And when they do, you’ll be glad you read these musings.

What is a SPAC?

Distilling the concept to its roots, think of a SPAC as a type of blank check company that raises capital from investors through a specialized IPO. Sponsors form SPACs for to-be-determined (TBD – acronym madness) purposes, usually a future merger or acquisition target.

Of course, not just anyone can or should establish a SPAC since, like any other type of investment, trust is an absolute requisite. Therefore, only experienced sponsors – both firms and individuals – with sterling reputations and demonstrated success in the space use SPACs to raise capital.

A Brief History of SPACs

SPACs have a bit of a rocky history, through no fault of their own. They've been bouncing around the financial markets in some shape or form since the economic Wild West days of the 1980s. In those earliest iterations, they were a relatively unregulated group of open-ended, ill-defined offerings – at least compared to today's SPACs – often with extremely vague business plans and no particular investment targets in mind. Naturally, without today's regulatory environment to keep them in check, fraud was rampant.

Thankfully, the SEC stepped in to provide some much needed boundaries for these shell companies, laying the groundwork for the modern SPAC. Since the 90s, their popularity has – once again – ebbed and flowed according to market conditions, the health of the IPO market, and the overall economic environment. They surged just before the Great Recession but virtually disappeared for a short time afterward, only to reemerge like a financial Phoenix in 2015 and calm down again as of late.

Between regulations and the warm embrace of private investment, investment banks, and stock exchanges alike – including the Big Board itself, the New York Stock Exchange (NYSE) – SPACs have become an increasingly vital component of the capital markets in recent years. Throughout the pandemic, there seemed to be a high-profile SPAC around every public equity corner, despite their inauspicious beginnings.

Long story short, the modern version of the SPAC is nothing like its earliest ancestors, with a record-setting 613 SPAC IPOs hitting the stock market in 2021. Granted, the fervor has nearly flatlined since then due to market volatility, general uncertainty, and the SEC’s recent proposed rules. Still, for the right entities and under the right circumstances, SPACs will continue to be an appealing pathway to public company status.

Advantages of SPACs

For the most part, companies and investors use SPACs as an alternative route to a traditional IPO. In fact, SPAC sponsors, investors, and target business owners all enjoy specific benefits from SPACs.

• Sponsors – For raising capital, SPACs provide access to a much broader base of potential investors, especially in comparison to private placements. And their lucrative potential upside doesn't hurt much, either. Hedge funds, private equity, and other institutional investors all prioritized SPACs during their recent run-ups.
  
  
• SPAC Investors – SPACs provide the opportunity to co-invest with successful sponsor firms and individuals. Also, they provide certain liquidity provisions and protection measures against potential downsides, at least until closing on target business combinations.
  
  
• Target businesses – SPACs give privately held companies easier access to public markets, particularly during market instability. That access to capital can fund their post-merger operations and growth strategies, while still allowing existing owners to share in that growth through stock rollovers.

Disadvantages of SPACs

Is it even necessary to say that no financial instrument, entity, or vehicle is perfect? Probably not. So, as you might imagine, there are some disadvantages to SPACs as well.

• Sponsors – Like any initial public offering, SPACs are susceptible to execution risk if the market isn't as receptive as expected, much as we saw beginning in 2022. Likewise, investors can reject any proposed business combination, adding another source of risk that a standard IPO doesn't have to worry about. Also, depending on the particulars of the deal, governance and management issues could arise if the agreement integrates the target company's management with the SPAC's management team.
  
  
• SPAC Investors – Time is money, and when the invested capital is inaccessible while sitting in the SPAC trust waiting for a suitable target, it could be making a higher return elsewhere. If the sponsor never finds such a target and the SPAC liquidates, well, at least investors more or less get their money back, but that’s certainly not what they were looking for in an investment. Of course, investors are also subject to standard investment risks after shareholders approve a target business and an acquisition closes, but that’s obviously not unique to SPACs.
  
  
• Target businesses – Once the sponsor identifies a potential business combination and strikes a deal, it's up to the investors to decide if they support or reject that deal through a proxy vote. Yes, that's a significant benefit for investors, but also represents a definite risk for the target companies. Don’t uncork that champagne until those votes are counted.

SPAC Transaction Timelines

Now that we've discussed what SPACs are, some of their pros and cons, and why they're unique in the IPO market, let's roll up our sleeves a bit and get into some of the nitty-gritty. And we're going to start with a typical SPAC transaction timeline split into three main phases, each with specific key objectives.

1. Initial IPO – The same general process as a standard IPO, just more streamlined and less complex

• Incorporate the SPAC and sell the founder shares
• Prepare and file the S-1 with the US Securities and Exchange Commission
• Obtain underwriting agreements
• IPO roadshow, pricing, and closing

2. Search for a target business – The reason the SPAC exists in the first place

• The SPAC files any regularly required SEC filings during this search phase
• Identification of the target business or businesses
• Perform due diligence on those businesses
• Prepare the proxy filing
• Sign the SPAC acquisition and other financing/commitment agreements

3. Approval and closing of the transaction – dotting i's, crossing t's, and getting the investors' stamp of approval
   

• Finalize and announce the acquisition agreements
• File the preliminary proxy with the SEC
• Obtain SPAC shareholder approval of the transaction through a majority shareholder vote
• Redeem common shares for investors opting out and close the transaction
• File Super 8-K with the SEC

To tie a bow around that brief timeline, the IPO process itself is essentially the same for a SPAC as a traditional IPO and operating company. It still features underwriters, valuations, public shareholders, a registration statement and prospectus, and most of the other terminology you're already familiar with. However, the SPAC process and lifecycle are generally simpler and more straightforward, at least until the sponsor chooses a target company.

A Slightly Deeper Dive into the SPAC Pool

For the sake of both brevity and bandwidth, we're not going to take an extraordinarily deep dive into SPACs, but we certainly want to flesh things out a bit more for you. So let's take a look at some of the finer details to give you a better idea of how a SPAC works.

SPAC Structure and Capital Raising

• Equity sold in a SPAC IPO consists of units, usually one share of common stock and a warrant to buy a fractional share in the future.
  
  
• The warrant – don’t forget our insights on accounting for such warrants – is to compensate investors for investing in the SPAC before the business combination.
  
  
• The sponsor places all IPO proceeds into an escrow or trust account, typically held in short-term US government securities or cash equivalents.
  
  
• Sponsors can access that trust account to fund an investor-approved business combination, satisfy redemption requests, or use the interest to cover operating expenses or working capital needs.

Identifying a Target Business & Completing a Transaction

• SPACs must complete a business combination or liquidate within a set time after their IPO, usually 24 months.
  
  
• A SPAC cannot identify a target business before closing its IPO, nor can it have any communication with a potential target prior to that point.
  
  
• Once a sponsor identifies a target business, the sponsor management team then prepares and files a proxy statement to solicit shareholder approval, as discussed in phase #3 of our timeline above. Once again, the identification process could take up to two years, sometimes longer in isolated cases.
  
  
• After approval, the combined entity is the publicly traded company, usually governed by a board of directors that includes both the SPAC's sponsors as well as directors chosen by the target business. The sponsors can choose to keep the target company's management or actively manage the combined business themselves.

Accounting & Reporting Considerations

Once again, we're not going too terribly deep on this topic, but still want to provide the broader brushstrokes that you should keep in mind, whether you're a sponsor or target business.

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 as well as appropriate presentation and disclosure in the financial statements. Although ASC 805 is the business combination 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 SPAC merger or acquisition, while the SPAC is the legal acquirer and the target business 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 US GAAP requirements for non-public entities. But post-SPAC IPO, those historical financials must now comply with Regulation S-X and the US GAAP requirements for a public company. What exactly does that mean? Well, 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, then 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.

Pro Forma Financials for the SEC

Pro formas are one area where a SPAC transaction usually has a bit more complexity, simply from the numerous accounting issues to evaluate. And you're typically evaluating all of those issues well before you finalize the transaction. Therefore, take a look at some of our previous insights on pro formas and start them early because time has a way of slipping through even clenched fingers.

And that's a SPAC IPO in a nutshell. Granted, there's plenty of other important details to consider but, for the purposes of an introduction and high-level explanation, this is a very good place to start as the market is still gathering its bearings. And needless to say, whether you’re looking at a traditional or SPAC IPO route, Embark’s Capital Markets team is always available to dig in and help you wherever and whenever you need us.