SPACs and key considerations for audit and financial reporting

Although special purpose acquisition companies or SPACS have been around for decades, the last 3 years have become more popular as they have proven to be a good opportunity for private companies to enter the public market, mainly in the United States. 

But what is a SPAC and what kind of audit could help you prepare for SEC audits? A Special Purpose Acquisition Company  or SPAC, is an investment vehicle through which a developer agent makes an initial public offering (IPO) to raise capital and with those resources buy companies. This vehicle supports a unit which is made up of a share and an option (warrant), which can be exercised by the holder.

SPACs have a period of two years to make the acquisition, during this time the amount raised will be invested in a treasury bond and deposited in a custodian bank, only a portion will be retained for working capital needs. If the acquisition is not made in that period or the investors do not agree with the transaction, the remaining money will be returned to the holders, who have the right to vote.

What are some of the risks and challenges associated with merging a private company with a SPAC? According to Paul Munter, Acting Chief Accountant, here are some of the most relevant challenges:

Market and timing Risks

Some of the risks and challenges associated related to merging a private company with a SPAC arise due to the time line of such transactions, as SPACs have the potential to take private companies to public markets faster than in a traditional initial public offering.While a SPAC has 18-24 months to identify and complete a merger with a target company or liquidate and return proceeds to shareholders, the merger can occur within a few months, triggering a series of related regulatory reporting and listing requirements. Therefore, it is essential that target companies have an comprehensive plan to address the demands resulting from becoming public on an accelerated schedule, as they are potentially subject to review by SEC (Securities and Exchange Commission) staff.

It is essential that the combined public company have a capable and experienced management team that understands the information and internal control requirements and expectations of a public company and can effectively execute the comprehensive business plan in an expedited manner.

Financial reporting Risks

The combined public company must have finance and accounting professionals with sufficient knowledge to produce high-quality financial reports, which comply with all applicable accounting rules and regulations, including the SEC’s deadlines and periods.

Companies often face complex issues related to accounting and reporting their merger with the SPAC, such as the following:• Prepration of the financial statements in accordance with US Generally Accepted Accounting Principles (“US GAAP”) or, alternatively, preparation in accordance with International Financial Reporting Standards.

• Disclosure requirements, related to the identification of the predecessor entity, the form and content of the financial statements, and the preparation of pro forma financial information;
• Identification of the entity in the merger, as the acquirer, including variable interest entity considerations, and whether the transaction is a business combination or reverse recapitalization;
• Accounting for payment or compensation agreements and complex financial instruments;
• Application of other US GAAP such as earnings per share, segment reporting, and expanded disclosure requirements for certain topics, such as fair value measurements and postretirement benefit arrangements; and
• Determination of the effective dates of the modifications or new accounting standards.

Internal Control Risks

Public companies are required to maintain internal control over financial reporting (“CIIF”) and disclosure controls and procedures (“CPD”).

Pursuant to section 404(a) of the Sarbanes-Oxley Act (“SOX”), management is required to conduct an annual assessment of its ICFR. It is important that management understands when the first annual assessment is required, if an audit report thereon is required under Section 404(b). In addition, management is required to evaluate the effectiveness of the CPD on a quarterly basis.

Corporate Governance and Audit Committee Risks

Before, during and after the merger corporate board oversight will be essential. It is important that boards have a clear understanding of the roles, responsibilities, and fiduciary duties of each member, and that management understand their responsibilities for communicating and interacting with the board. The composition of the board is crucial, since, in general, a proportion of the members must be independent of the organization and must possess the appropriate level of experience and be prepared for key committee assignments, including the audit committee (accordingly).

The audit committee plays a vital role, in compliance with the rules of independence of auditors and the supervision of financial information, the CIIF and the external audit process. They significantly further the collective goal of providing high-quality, reliable financial information to investors and the securities markets.

Auditor Risks

The annual financial statements must be audited in accordance with the standards of the Public Company Accounting Oversight Board (“PCAOB”) by a registered public accounting firm that meets the independence requirements of the same and the SEC and under the standards of auditing and independence from the American Institute of Certified Public Accountants (“AICPA”). The firm should consider the need to change, increase, and include members with appropriate experience auditing SEC-registered entities under PCAOB standards.

An important aspect to consider in accepting or continuing an audit relationship is the independence of the auditor under SEC rules. Auditor independence is critical to the credibility of the financial statements and is a responsibility shared between audit committees, management and the auditor.

Independence, the auditor’s registration with the PCAOB, and other audit-related requirements should be assessed from the outset of the transaction, particularly as these considerations may result in the need to hire a new auditor or perform additional audit procedures on the financial statements. financials of the previous period.

At ECOVIS Mexico, we are aware that the quality of financial information and the quality of audits on financial statements provided to investors is crucial to protect investors regardless of the vehicle by which the company enters the public market.

Javier Villanueva Lara
Audit Manager
ECOVIS Mexico
Mexico
javier.villanueva@ecovis.mx