Are SPACs Still Going Concerns?

By Drew Bernstein, Co-Chair, MarcumAsia on February 8, 2022
Are SPACs Still Going Concerns?
Drew Bernstein, Co-Chair, MarcumAsia
Drew Bernstein, Co-Chair, MarcumAsia

An unprecedented number of funded SPACs will lead auditors to take a hard look at their viability

Heading into the audit season for 2021 financial reports, expect independent public accountants to take a hard look at how many of the bumper crop of special purpose acquisition companies (SPACs) are likely to be still viable twelve months from now.

Determining if a public company qualifies as a "going concern" is a required element of any annual audit. With operating companies, management needs to assess if it is probable that the issuer will be able to continue to meet its financial obligations for a period of one year after the date of when its year-end financial statements are issued. Management and auditors must scrutinize the company's operating trends and available sources of liquidity. If it is evident that cash flows and available financing are insufficient to meet the requirements of staying in business, then it is appropriate to opine that there are “substantial doubts” as to the ability to continue as a going concern or even apply liquidation accounting treatment.

Following the enormous boom in the SPAC IPO market in 2020 and 2021, there are 590 SPACs that have completed their IPO but have yet to announce a business combination target, according to SPAC Insider. The index of de-SPACs, or private companies that have completed a SPAC merger, has declined by 58% since June of 2021 as investors turned against many of the speculative, early-stage names that embraced SPACs as a path to public status.

Auditors will need to look at the available cash resources of each SPAC to see if the company can cover an additional 12 months of costs associated with being public, along with completing due diligence and closing on a merger with a private company.

SPACs require an additional level of analysis due to the time limit on their ability to execute a business combination. In most cases, SPACs have anywhere from 12 to 24 months from the date of the IPO to complete a transaction. If they fail to close on a deal within that time frame, the SPAC self-liquidates and returns the funds held in the trust with accumulated interest to investors.

SPAC sponsors have powerful economic incentives to complete a merger, given a liquidation causes them to forgo any opportunity to profit on their “promote shares” and to lose their entire upfront investment funding the listing and ongoing costs associated with being public. In recent years, liquidations have been exceedingly rare, with only two in 2020 and none in 2021. But current market conditions — including the sheer number of SPACs competing for deals, the poor performance of most de-SPACs, and a more deliberate review process by the SEC — could make it tougher to get deals across the finish line in 2022.

If a SPAC’s deadline to complete a business combination will be reached within twelve months of the filing, then the default assumption will be that there is "substantial doubt" whether the business can continue as a going concern. To overcome this presumption, the SPAC sponsors will need to demonstrate both the intention and capability to complete a business combination or obtain an extension on the deal clock. In many cases, SPAC management can buy additional time by paying more funds into trust, or overfunding the trust, to increase the guaranteed return to investors from redemption or liquidation of the trust.

To determine if the SPAC’s financial statements should include a “going concern opinion,” auditors will first look at the amount and timing of the required financing commitment using the SPAC's cash flow projections. Then the auditors will want to understand:

  • Is there a definitive agreement in place with a prospective merger candidate, and are the terms sufficiently binding (beyond a preliminary LOI)?
  • If there is minimum cash commitment for the deal to close, is it backed up by committed capital in the form of a PIPE or forward purchase commitment?
  • If the SPAC is likely to run out of time before bringing a merger to a vote, do they have the financial resources to pay for more time?
  • If the SPAC has borrowing arrangements with the sponsors or other affiliates, are these firm commitments, and are they backed by the capacity to pay?

Under the relevant accounting rules (ASC 205-40), the standard is whether management's plans will "alleviate substantial doubt about the entity's ability to continue as a going concern." This requires that management must be able to implement a plan that will effectively mitigate the conditions or events that raise substantial doubts about continuing as a going concern. In the case of SPACs, management needs to demonstrate that they will be able to bring a merger to a successful conclusion or obtain an extension.

If substantial doubt exists, the company must provide a narrative in the footnotes of the financial statements as to the conditions or events that raise the doubt, management’s evaluation of these factors, and management’s plans to mitigate them. If those plans do not alleviate the substantial doubt, the company must note that.

These disclosures may provide a revealing window as to how industry insiders view the prospects of dealmakers to sustain SPACs’ remarkable track record of finding willing merger partners and avoiding liquidation. Investors are advised to pay close attention to what they say about how the dynamics of the SPAC market are evolving following the enormous boom of the past two years.

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