The pace of innovation in manufacturing processes and across other industries continues to accelerate during the lingering COVID-19 pandemic. Seeking growth opportunities, privately owned middle-market companies potentially can tap into a ready source of capital — investors anxious to deploy their cash — through the public markets. The proceeds from selling shares offer a source of liquidity for the private company owners, their founders, early-stage employees and other members of the C suite. Share proceeds may also be used to expand the business, fund research and development, pay off debt, or all of the above. As an added benefit, becoming public can also provide companies with publicity, standing and gravitas.
Historically, going public meant doing your own “IPO,” which required substantial experience in public market dynamics as well as size, time and money. Recently, there is a new way — going public via a merger with an already public special purpose acquisition company (SPAC).
A SPAC is an entity that has raised public capital from generally sophisticated investors. Often referred to as a “blank check company,” this entity has cash in the bank, a leadership team and an investment thesis but does not yet have an operating business. Generally, over a period of 18-24 months, a SPAC acquires an operating business that meets its investment mandate and transitions from a “blank check” status to operating status. This is generally structured as a reverse merger, and the operating entity becomes the publicly traded company. In effect, the operating company acquires the cash of the SPAC entity as well as its public company status.
In 2020, SPAC IPOs raised almost twice as much as they raised in the previous 10 years combined. As of September 2021, SPACs had raised approximately $122 billion in IPOs in the U.S. since the start of the year. That’s 23% more than the record-setting level recorded in 2020.
Increasingly, private companies have been identified by SPACs as legitimate targets. This process of becoming public will involve lower costs and complexity, at least initially. However, private companies that want to be legitimate candidates must be able to meet a much faster timeline of going public as SPACs are generally looking to move quickly. Therefore, private companies that are interested in the SPAC path to liquidity must engage in an IPO readiness process to show the investors that they have the process, procedures, people and technology to endure the scrutiny of the public markets. Once the transaction is complete, these private entities will be public entities and must be ready to comply with all related regulations that come as part of this event.
IPO Readiness and Risk Minimization
The process of getting ready to become a public company is complex and needs to be customized to your particular industry and situation. Forewarned is forearmed. Below we list a sample of areas we often see in need of remediation in order to get a company ready for the rigor and scrutiny of being publicly traded; these are the high priority items that are often most in need of attention for public company readiness.
Accounting, SEC Reporting & Financial Operations — Companies that choose to go through a SPAC IPO will have a host of reporting considerations and may need additional guidance on technical and transactional accounting, internal and external reporting, external audit preparation/valuation, and system implementation/integration/optimization in order to meet public company reporting requirements. Risks to be of aware of include:
- Inadequate/untimely monthly close process
- Lack of SEC-ready technical accounting skills to address matters such as ASC 606 (revenue)/ASC 340 (costs) and ASC 842 (leases)
- Historical financial statements may need to be restated and re-audited by a nationally recognized audit firm and in accordance with PCAOB audit standards (in lieu of less rigorous private company AICPA standards)
- Manual process for internal/external reporting
- Inadequate departmental organization and design
- Insufficient attribute planning (R&D studies, IRC Section 382 analysis)
Risk Advisory — Public companies also have unique internal controls requirements, including processes for managing financial and fraud risk, a robust internal audit function, IT general controls, financial and operational controls, and, in this environment, processes for cybersecurity. Specific indicators that improvement to your risk management function may be needed include:
- Lack of a formalized fraud risk assessment process
- Inadequate controls to detect or prevent accounting errors and fraudulent financial practices
- Limited or non-existent documentation or controls over information technology
- Lack of information security governance/plans and procedures
- Inadequate enterprise and board-level risk considerations
- Structure and legal entity issues
- Potential tax contingencies for matters such as state & local, sales & use, or international tax
- Inadequate disclosures and internal controls
- Struggle to attract/retain executive talent (unsure of competitiveness of total rewards package)
- Executives and shareholder interests are not aligned
Tax — Preparing to go public via a SPAC will involve some of the same tax processes reporting updates as would an IPO, including tax structure, value drivers and internal controls analysis. Signs your tax department may need additional guidance include:
Insurance & Benefits — The underwriting for your D&O liability insurance for a SPAC will address these factors:
- Advisory team – The stronger your advisory team (e.g., outside counsel, investment bank, auditors), the lower the inherent risk in being public.
- Background of management team and board of directors – Along with historical claims experience, this is a substantial underwriting consideration in evaluating the risk of offering D&O insurance. The more highly qualified and experienced your team is in the targeted class of business, the lower the risk.
- Potential conflicts of interest – Underwriters will be on the lookout for potential conflicts of interest between the sponsors, the SPAC and the operating company. For example, too much additional compensation to management for sponsoring the SPAC or sponsors acquiring a company where a board member has a previous relationship and will benefit from the transaction can be issues.
- Expected amount to be raised — The larger the fund raise, the higher the risk (and cost) of D&O insurance.
- Target class of business to be acquired and management experience in this class — Underwriters will take into account the targeted class of business. The lower perceived the risk of the targeted class and the better management’s experience aligns with the targeted class, the better the terms for the D&O program.
- Geography of target business — Underwriters want to place business in jurisdictions where they understand the laws and regulations. U.S.-based businesses are easier to underwrite than companies doing business internationally.
- Target criteria provided in the S-1 — The more specific the information in the S-1 about the target criteria, the more comfortable an underwriter will feel.
- Federal forum provisions — An S-1 that includes Federal Forum Provisions will be received more favorably. These are provisions in corporate charters requiring that claims under the Securities Act of 1933 (the "33 Act") be brought in federal court. The goal of the provisions is to reduce litigation over alleged false or misleading S-1 registration statements.
Compensation — Public companies have different compensation needs, so your company will need to re-evaluate market competitiveness of executive compensation, short- and long-term incentive plan design, employment agreements, and sales compensation plans. If you experience any of the following, consider enlisting additional support for your compensation approach:
- Key terms of employment agreements need updating (e.g., defining “for-cause” and “not-for-cause” severance, severance related to change-of-control, non-compete and non-disclosure definitions and requirements)
SPACs have been around for several decades but have gained in popularity over the past two years. These vehicles enable companies to become publicly traded without following the traditional IPO route. Merging with a SPAC generally allows companies to go public more quickly but requires the target entity to be ready for such a transaction. The SPAC process is subject to different regulations than a traditional IPO, and there may be less scrutiny than would occur in the traditional IPO process, which can make them financially riskier for investors. Although not required, taking a structured IPO readiness approach to identify areas of need prior to engaging in a SPAC transaction can address many of the primary issues as noted in this article and can shine a much more appealing light on your company for potential investors.
Should you have questions about SPACs or the IPO process, don’t hesitate to reach out to our IPO Advisory professionals at (415) 264-3731 or find us online here. For detailed information on the D&O insurance requirements, connect with Scott Kegler of CBIZ Insurance Services at (215) 840-2353.