GPs to look for diamonds in the rough with SPAC deals

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Jeremy Swan, CohnReznick

Last year witnessed the meteoric rise of special purpose acquisition company (SPAC) deals. But, as regulators take a closer look at this development and fewer deal-ready companies are available for acquisition, the industry could see a slow-down in momentum. 

“This latest iteration of the SPACs market is a lot more mature, and the industry is starting to see bigger names putting their weight behind it. There is growing market acceptance of SPACs for a whole range of reasons,” outlines Jeremy Swan, Managing Principal – Financial Sponsors & Financial Services Industry, CohnReznick.

He says that from a financial perspective, a SPAC arrangement can be very attractive for general partners (GPs) because a smaller amount of money needs to be put to work up front: “As the sponsor of the deal, PE firms can walk away with a 20 percent stake in the business for a smaller upfront investment than a comparable PE transaction. In addition, the exit period also has the potential to be much faster than the typical 10-year private equity fund. This means managers have the opportunity to get a significant return in a shorter period of time.”

However, Swan suggests that the rise of SPACs could be causing some conflict between GPs and limited partners (LPs), who have been raising a few issues in this regard: “Some have expressed concern about SPACs taking time and energy away from the private equity fund to which they committed capital. They are paying the management fee and want to understand how much time the management team is spending on the SPAC that they are not invested in.

“This has been resolved in multiple ways. Some GPs have siloed their SPAC operations or set up specific teams to manage this part of their business. Others have also figured out ways for LPs to participate and co-invest in the SPAC. Whatever option the PE firm chooses to take, the crucial element is to make sure their communication is transparent and LPs know where they stand.”

Preparation is critical

From the perspective of the company the SPAC is targeting, Cindy McLoughlin, Managing Partner and SPAC services leader, CohnReznick, gives her view on how these companies can best prepare themselves for the SPAC process.

“I often see companies that are not ready to be a public company. Whether they’re going into a SPAC or taking the IPO route, the end game is going public, and when it happens, it does so very quickly. Companies are sometimes not prepared for that. 

“Companies choosing to go into these SPAC deals need to understand the risks associated with them. They need to be prepared for the disclosure and reporting requirements they are going to have to comply with.”

In McLoughlin’s view, the logistical compliance nature of the historical financials is the most challenging element of the process. This is often a stumbling block for most target companies wanting to go into a SPAC. To get ahead of it, she advises: “Not only do companies need to be ready to provide PCAOB-audited financial statements, but they must be ready to file quarterly financial statements. I recommend clients start doing hard quarterly closes, not just their year-end close ahead of any deal. Once they go public, companies will need to have those numbers comparatively, and going back in time to recreate what is needed and present financials in a compliant manner is a big undertaking.”

She also stresses the importance of having the right resources and experts available: “In addition to working with firms like ours, companies often need to hire other people internally, and we recommend they do that at an early stage. Having the right internal people with the technical acumen who have been through this process can make a real difference.”

Although the end result of a SPAC process is the company going public, McLoughlin points out that the process is not only quicker and less costly than a traditional IPO, but also more discreet: “Companies choosing the SPAC route will not need to tell the world their financial information until they’re sure the deal will go through. This is an advantage in case the deal doesn’t happen and allows them to pivot without perceived tarnish of the valuation.”

This might change depending on regulation, but as things currently stand, operating companies have the opportunity to tell their story their way. They can also talk about projections, which is something they wouldn’t be able to address in a traditional IPO process.

Retail opportunity; slower outlook

SPACs also provide private equity firms with one thing they’ve always been clamouring for: a way to tap into the retail market.

Private equity managers have always wanted to access retail investor dollars, and the appetite has also been there from the investor perspective. Swan comments: “SPACs are a liquid version of a private equity deal for retail investors. The level of risk they are exposed to depends on the level of disclosure and diligence provided. However, not every SPAC deal is done with the same rigour of due diligence as a private equity deal, so this may lead to greater risk for the retail investor.”

This growing retail access to private equity has led to increasing focus on SPACs on behalf of the Securities and Exchange Commission (SEC). New guidance that sets out how accounting rules apply to key elements of these companies could disrupt the industry’s trajectory.

In fact, a chilling effect on new SPAC issues followed when the SEC recently set forth its views on the accounting for warrants containing certain specific features that, for most SPACs, were previously classified and accounted for as equity instruments. In many cases, this new interpretation will mean that the SPACs must now classify these warrants as liabilities and report them at their estimated fair values at each reporting period, and reflect the corresponding adjustments in their Statements of Operations. Restatements of previously filed financial statements may be necessary.

In addition, certain types of Working Capital Loans typically provided for by the sponsors might contain conversion features that need to be analysed for embedded derivative considerations. SPACs may want to revisit Forward Purchase Agreements with sponsors to subscribe for additional shares concurrent with a business combination, depending on how the agreement is structured; it could potentially trigger additional accounting considerations. Last but not least, while most warrants have similar terms, “all warrants are not created equal,” so management and their accounting advisors should be sure to execute a thorough analysis of existing terms to determine appropriate accounting. 

Discussing the outlook for the SPACs market, McLoughlin notes that the SEC holds the reins: “If they start tightening the rules, then the market dynamics will change. It will most likely slow the market down somewhat, which is not necessarily a bad thing and will highlight the importance of quality over quantity.”

According to Swan, it is getting harder for GPs to find quality deals, which means companies that are ready for a SPAC deal. “They’re having to look at some of the second-tier opportunities. This means those deals are going to take longer. GPs need to find those diamonds in the rough that can get ready for the process quickly. 

“Many of the companies picked up in earlier SPAC deals were ready to go public – they could have gone down the IPO route if they wanted to. The companies available now need more work, which will automatically slow the timeline. Therefore, we can expect to see around 30 or 50 percent of deals actually being done.” 


Jeremy Swan, Managing Principal – Financial Sponsors & Financial Services Industry, CohnReznick
Jeremy Swan is the National Director of CohnReznick’s Financial Sponsors & Financial Services Industry practice and also leads the efforts of the Firm’s M&A Consulting Services practice. Jeremy is responsible for management of CohnReznick’s Financial Sponsors and Financial Services Industry practice which includes all work conducted at the firm level, fund level, and across portfolio companies. Jeremy serves as the lead and/or relationship partner for many of CohnReznick’s largest private equity firm and portfolio company engagements, managing teams across service lines and maintaining a single point of contact at the private equity firm level. With more than 20 years of experience advising financial sponsors and emerging private and large, multinational portfolio companies, Jeremy has extensive experience working with financial sponsors as both an investment banker and a consultant. He has expertise in mergers and acquisitions, IPO readiness, financing transactions, post-acquisition integration, and operational and financial due diligence.

Cindy McLoughlin, CPA, Managing Partner, SPAC Practice Leader, CohnReznick
Cindy McLoughlin, CPA, leads CohnReznick’s SPAC practice. With more than 25 years of experience, she has expertise providing audit services to mid through large-sized companies typically backed by private equity. Before joining CohnReznick, Cindy was the partner in charge of the audit practice of a large, national accounting firm in Long Island, New York where she led numerous engagements and served as the concurring partner on the audits of several large public companies. She also held responsibilities there as an internal audit quality reviewer. Cindy has received countless accolades including the Achievers’ Award from the Long Island Center for Business and Professional Women, the Corporate Leader award from Long Island Women’s Agenda, Top 40 under 40 from Long Island Business News’, and was also named one of Long Island’s Top 50 Most Influential Women in Business.

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