What companies should be aware of before embarking on the SPAC journey

According to the EY quarterly report, Global IPO Trends: Q1 2021, the number of SPAC IPOs in the first quarter of 2021 have completed more deals and raised more in proceeds than in the whole of 2020. With the rising interest in SPACs, we speak to Chan Yew Kiang (CYK), Technology, Media & Entertainment, and Telecommunications Assurance Leader and Partner, Ernst & Young LLP and Sandie Wun (SW), Partner, International Tax and Transaction Services, Ernst & Young Solutions LLP, to share tax and audit considerations for companies that are looking to go public via the SPAC route.

What are some of the advantages of the SPAC route over the traditional IPO route for companies seeking to go public?

CYK: The SPAC format in the US offers speed to market and an accelerated IPO process for companies going public through it. Without an actual business function, the “shell” company would complete the IPO process first. The expected period for audit and comment by the Securities and Exchange Commission (SEC) is also likely to be shorter for the shell entity.

The credentials of the sponsors, financial intermediaries and founding investors of the SPAC will help to strengthen the investing public’s confidence. A robust executive team can also help the SPAC to raise capital faster and at higher amounts, which works to the advantage of the target company if additional funding is needed for the acquisition.

Private investment in public equity transactions, which often accompanies a SPAC, also provides a long-term investor base for the target company, while reducing the risks of selling to public investors at a road show and being subject to market volatility. By going public through a SPAC, the target company gets early assurance from investors of an agreed price, not just before an IPO.

And what are some of the potential issues that companies should be aware of when considering the SPAC route? 

SW: Whilst opportunities may knock on the doors of companies in the form of SPACs proposing merger possibilities, it is important that the company is ready to be listed. The company is instantly listed after the merger and along with that, comes the expectation of it being run as a listed company. For starters, in mergers into and with US-listed SPACs, the company may (automatically) fall into the US tax net. There will also be transaction taxes and related tax filing obligations to be taken care of, whether in relation to any pre-merger restructuring required or at the point of the merger.

CYK: Additionally, from the perspective of the companies that are considering mergers with a SPAC, they should consider the costs of such transactions. Typically, it is not uncommon that the sponsors would take 20% of the merged entity in the form of equity. And while the SPAC may offer a faster route for companies to go public, we are also seeing such transactions taking longer to complete outside of the US. Target companies may face challenges in their readiness to operate and report as a public company in the US. The need to fulfil the responsibilities of being a US public company with limited resources and knowledge of the SEC’s requirements can be a challenge for many. If the companies are not ready, the audit process may take longer than usual. In addition, there may also be legal and financial consequences arising from incomplete or inappropriate disclosures.

What are some examples of legal and financial ambiguities that companies will need to be aware of?

CYK: Warrants are common features in SPAC transactions, with SPACs typically selling warrants to their sponsors to help fund their initial costs, and also selling units comprised of shares and warrants at the IPO. These latter warrants are presented as an added benefit for the initial SPAC investors, who may be required to wait as long as 18 to 24 months for the SPAC to enter into a business combination with an operating company. Historically, many SPACs, with the support of several accounting firms, have classified the warrants as part of equity of the entity. The SEC has challenged the accounting for the warrants and this may lead to additional considerations and delays.

The SEC is also considering rules relating to restricting the safe harbour protections for forward-looking statements granted to SPACs in their merger filings. If that safe harbour is removed, companies could be held liable if they are unable to meet their financial guidance issues during the M&A process.

Since there are many different stakeholders involved in the merger with a SPAC, what needs to be considered when an operating company is looking to list via the SPAC route?

SW: Companies should start planning as early as 24 months prior to the SPAC merger. Strategic options should be evaluated, and a SPAC readiness assessment and diagnostic ensue.

There may also be a need to restructure to simplify or integrate the legal and business structure of the group to bring about synergies, which will, in turn, strengthen the equity story. Conversely, there may be parts of a company’s structure that may be purposefully carved out for the SPAC merger. Such structural and business model considerations will inevitably need to be undertaken in discussion with relevant stakeholders.

From a tax perspective, it is key that such decisions are not deliberated in silos without due consideration of the corresponding tax impact for stakeholders. For example, in many parts of the world, a restructuring exercise involving the sale of assets or shares would trigger capital gains tax, stamp duties and occasionally other local levies. Change of control rules may trigger the forfeiture of valuable tax attributes, creating higher cash taxes in the future.

As the equity story is being fine-tuned and the timetable is mapped out, the overall offering concept, including the merger structure, will need to be evaluated. The successful consummation with a SPAC weighs heavily on managing the tax consequences to the SPAC sponsor, who would expect the merger to be executed in a manner that does not impact them adversely from a tax perspective. Structuring the merger, whilst balancing the interests of shareholders and the company, may therefore not be straightforward. It often involves negotiation between the various stakeholders and requires special planning with careful timing of steps.

For companies with operations in Asia, each country has its unique business environment and challenges, as well as different levels of maturity of the tax regime, systems and laws. An assumption that all countries deal with tax issues in relation to a corporate restructuring, and for that matter a SPAC merger, in a singular manner is risky and incorrect. Hence, having in-depth local knowledge is key when it comes to understanding how local tax regulations are implemented in practice and, more importantly, applied to new or novel scenarios.

Finally, the jurisdictions in which a company operates will also impact where it may want to finally locate its head office (whether or not in the jurisdiction where the company is listed). Alternatives will need to be assessed for their tax efficiency on profit repatriation in light of the operating locations where profits are generated. With the growing scrutiny from the international tax community on base erosion and profit shifting (BEPS), it is also critical to ensure that the company has sufficient economic substance in the selected location to remain viable.

This In conversation with article features Chan Yew Kiang, Technology, Media & Entertainment, and Telecommunications Assurance Leader and Partner, Ernst & Young LLP and Sandie Wun, Partner, International Tax and Transaction Services, Ernst & Young Solutions LLP.