Beware of These Five SPAC Risks
Partnering with SPACs is becoming a popular alternative to IPOs for growing companies—but they should be aware of these risks.
Partnering with special purpose acquisition companies (SPACs) is becoming an increasingly popular alternative to the traditional, and potentially complex nature, of an initial public offering for growing companies. If you are considering SPAC investment, be cognizant and aware of the following risks:
Misaligned Goals: Many SPAC management team members have a professional investment background and do not necessarily have expertise in the specific market segment in which the target company is focused. It is important that both SPAC management and the operating company management agree on significant issues, such as target markets and key operating metrics, at a granular level.
Deal Collapse: Although a SPAC and an operating company may enter into exclusive negotiations, it is less than certain that the acquisition will actually be completed. There are deals that never made it to the finish line after months of due diligence (financial, tax, legal, HR, IT, etc.), as well as more meetings and calls than teams care to remember. These deal collapses were driven by a variety of factors, including changes of heart by either the buyer or the seller, or external environmental factors, including turbulent financing markets and the global COVID-19 pandemic.
Delayed Timelines: Typically, a SPAC has a limited time horizon in order to invest. During this time, the SPAC must not only identify a target and negotiate a deal, but also complete the deal and comply with all reporting requirements. While a SPAC acquisition may require less time than a traditional IPO, the merged company must still comply with all Securities and Exchange Commission filing requirements, including complex financial statements and other financial reporting requirements, which can take significant time to prepare.
The Responsibilities of Being Public: It is sometimes said that going public—despite its challenges—is easy, while being public is the hard part. Many private companies are not prepared to be a public registrant and do not possess the sustainable processes and controls required for the rigors of public company financial reporting. Of course, the company has been “closing our books on a monthly basis for management reporting.”
However, the current team should also be able to produce timely and accurate quarterly financial information (including international consolidation, tax provisions, share-based compensation, etc.), with appropriate reviews, and a Form 10-Q due to the SEC within 45 days after the end of the quarter.
Talent Attrition: All companies face the risk of key employees leaving for “another opportunity.” In the case of a SPAC-acquired entity, the cultural and regulatory environment can change overnight as the company becomes a public registrant. While many employees may view this as an opportunity, there is the risk that some employees, including key members of management, may leave pre- or post-transaction.
SPACs are exciting investment opportunities for taking a business to the next level, but participants must be aware of the known risks. Considering how you plan to accommodate potential outcomes can help create a successful investment.
For more information about SPACs and the IPO market, reach out to DHG at email@example.com.
John Stewart is a partner in the Raleigh office of DHG. He serves as co-managing partner of DHG Technology and is involved with the private equity services group for the firm.