So Your Private Equity Firm Wants to Do a SPAC. Here’s What You Need to Know…
When it comes to SPACs, the accountants are usually not the first phone call when it comes to choosing your deal team. It’s usually the underwriters first, then the lawyers and finally….the auditors. Accounting is not sexy. However, if you’re a Private Equity backed SPAC, the accountant is probably going to look like the hottest person in the room to you and you’re going to want to make them your first call. But here’s why…
We recently spoke with Jay Shepulski and Mark Deters at Withum, which has been the Accounting firm of choice on over fifty SPAC transactions that have included some of the more prominent private-equity sponsor groups. Of note, Withum has been the auditor for Silver Run Acquisition Corp. I and II (Riverstone Holdings), CF Corp. (Chinh Chu and Bill Foley), Spartan Energy Acquisition Corp. (Apollo Global Management) and Regalwood Global Energy Ltd. (The Carlyle Group), to name a few.
Clearly they have some expertise, so we asked Withum to put together the piece below on some very important considerations when it comes to PE backed SPACs. Read on….
Private Equity SPAC Considerations
As the SPAC IPO market continues to see large private equity backed sponsor groups enter the niche market place, here are some special considerations on the structure that these teams need to consider before they go to market with their deal. These considerations may not have an impact at the SPAC itself, but could have an impact at the PE management company and the funds that the group manages.
1. Founders Shares and At-Risk Capital
The first topic of importance that typically comes up in conversation with private-equity groups looking to back a SPAC team is, where should the ownership of the founder shares and the at-risk capital investment (typically warrants) reside? In the PE management company or at the fund level? The back-end ownership of these two equity instruments trigger other accounting and investment ramifications that sponsor groups should be considering.
Ownership of the founder shares in a management company at the private equity group triggers a consolidation analysis if that company is audited under US. GAAP. Since there is potential control at the management company level, the accounting teams at the sponsor group will need to carefully analyze whether the SPAC vehicle needs to be consolidated into the management company and non-controlling interest presented for the public shareholder interests. This creates a significant amount of additional work for the Company to perform the analysis, straining internal resources.
Additionally, if the conclusion of the management company is to consolidate the SPAC, the consolidated financial statements will be distorted and would not represent the activities of the management company since the SPAC activity would have to be included, creating a convoluted and confusing presentation with noncontrolling interest.
Additionally, if the management company owns the founder shares, but one of the funds that the group manages is responsible for the at-risk capital (e.g. warrants), this could raise a potential issue with investment management committees due to the allocation of carried interest at the fund.
In this scenario, the PE management company could have a higher upside for return since they will own 20% of the SPAC post-business combination and can potentially share in the success of the at-risk capital at the business combination through the carried interest allocation at the fund level.
Ownership of the founder shares and warrants at the fund level removes the need for a consolidation analysis since funds are typically scoped out of consolidation guidance under U.S. GAAP. However, this structure does trigger valuation considerations for the private equity group since the investment is required to be carried at fair value at the fund level.
While the SPAC is a public company with a readily determinable market price, the founder shares do not have the same rights as the public shares; they do not have the redemption right against the Trust Account and the shares have transfer restrictions, complicating the valuation of the investment.
2. Forward Purchase Agreements
The second topic, which consistently comes up, involves the decision to implement a forward purchase agreement, or other similarly proposed financial instrument, with one of the fund groups at the close of the IPO.
Forward purchase agreements have been added to many deals in recent memory to provide for an additional source of capital at the close of the combination. The intention of these arrangements can vary from the offsetting of redemptions, increasing the potential deal size (if needed), to providing additional liquidity to the potential target company. These arrangements need to be carefully worded in order to avoid liability treatment at the onset of the agreement.
The two main pitfalls of forward purchase agreements that immediately trigger liability treatment are variability in the shares being issued at a fixed price (e.g. $1,000,000 flat purchase price for a number of shares based on the fair value of the public shares at a future date) or shares to be issued under the forward purchase agreement containing a redemption feature.
While there are other features that can trigger liability accounting, these are the two definitive areas that require management to determine a fair value for the contract and marking it to market each reporting period. It is highly recommended that teams consider having their accountants review these agreements prior to signing them in order to understand the related accounting and disclosure requirements.
These considerations are what we have seen in the marketplace lately and they will continue to change as sophisticated investor groups continue to enter the marketplace. So stay tuned for further developments…
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And yes, that picture is from the movie, “The Accountant”
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