Growth Through Acquisition: Using SPACs and PE to Raise Funds
by Laura M. Crowley, CPA, MBA and Eric M. Diefenderfer, CPA, Citrin Cooperman –
March 14, 2022
Private companies have various options to raise capital when compared to public companies. These options are quite different from one another, so it is important to determine which option suits a particular business best and will allow it to grow successfully.
There are various avenues a private company can take to acquire the capital it needs to grow its business. Some popular options include taking on a private equity (PE) investor or being acquired by a special purpose acquisition company (SPAC). These options have different requirements the acquiree must meet in order to have a successful transaction, and they carry different risks to the private entity seeking an investment.
SPAC Acquisition Considerations
In anticipation of a merger with a SPAC, a private operating company needs a plan for the additional regulations that it will be required to adhere to after becoming a public company through the business combination, which includes complying with public company disclosure requirements on an accelerated basis when compared to the typical timeframe for private companies. This would include disclosures regarding the company’s merger with the SPAC, which is made known prior to the deal close.
One of the regulatory requirements that the operating company will need to have in place prior to the transaction closing is to have an audit under Public Company Accounting Oversight Board (PCAOB) standards to comply with Securities and Exchange Commission (SEC) requirements for financial reporting. The SEC has indicated they will not review a registration statement for a private company and SPAC merger if the registration statement does not have an opinion signed by an auditor registered with the PCAOB. In addition, the operating company may need to engage a new auditor, as the existing auditor may not satisfy auditor independence under SEC rules or may not be registered with the PCAOB.
After the acquisition transaction, the operating company will be subject to the exchange listing requirements that apply to the SPAC it transacted with. These requirements will include corporate governance oversight, which may include requirements such as an independent board of directors and audit committee with specialized experience regarding financial reporting matters.
Another consideration the operating company must address is that, as a public company, management has to set up and maintain sufficient internal controls over financial reporting and adhere to the public company financial reporting requirements. Additionally, certain members of management will be required to provide a quarterly certification to its financial reporting and the related internal controls.
If the operating company does not have proper planning to address these items, it may experience ongoing delays or possibly not be in compliance with public financial reporting requirements.
Private Equity Acquisition Considerations
With the PE alternative, the private operating company does not have to face the complexities associated with becoming a public company, however, there are other considerations to be mindful of. A PE investment generally involves taking on an owner in the form of a fund that has an ownership stake in the private company. The fund, in turn, has investors comprised of institutional investors and high-net-worth individuals who are seeking an above-market return on their investment (ROI). A typical PE investment is expected to last around five years before the PE firm will seek to exit the investment and monetize their ROI.
A private company hoping to attract an investment from the PE sector should first do a thorough self-assessment. This would include assessing the capacity and capabilities of its operations, analyzing its financial results and assessing the skills and longevity of its management team.
In assessing its current operating environment, a private company seeking a PE investment should understand its competitive place in its industry and identify any operational challenges. These might include excess capacity, gross margin pressure or other factors. The company should also identify strategic objectives so it can begin discussions with the PE investor around where the experienced management team sees opportunity for the business. The goal of the PE investor is ROI, which is typically achieved by reducing expenses and increasing profits of the acquired company or by implementing a growth strategy to increase top-line revenues. Some PE shops might look to develop an industry niche to take advantage of economies of scale by bringing together smaller independent businesses under one common umbrella. Before getting into talks with a PE firm, management should have a good understanding of their business and where it fits so they can focus on the partner that can best help them execute the desired strategy.
PE investments are typically priced at a multiple of earnings before interest, taxes, depreciation and amortization (EBITDA). As the target operating company, management’s goal is to support a higher EBITDA because that will lead to a larger cash infusion. Commonly, EBITDA is adjusted for expenses that are not expected to recur once the investment transaction is completed. These can include items such as above-market compensation or expenses incurred with parties related to the current owners. Management should evaluate their financial records to consider these potential add-backs and begin to develop the support for these items before getting into negotiations to take on a PE investment.
Finally, the private operating company should evaluate its current management team to understand the skills each individual brings, as well as whether or not a person would be likely to stay with the company long-term. A PE investor who invests in a diversified portfolio of private companies may want some or all of the current management team to remain with the company, while another PE firm may bring in their own management team to oversee the investment. In either case, the PE investor will want accountability from management so they can monitor the progress of their investment, and there will be more demands on the management team as they seek to execute the strategic vision and achieve the desired ROI over the time horizon of the investment.
Whether a private company opts for the SPAC route or a PE investment to fund its growth opportunities, careful consideration should be given to the choice of strategy and which is the best fit for the company and its future plans.
Eric M. Diefenderfer
Eric M. Diefenderfer, CPA, is a director at Citrin Cooperman. He is a member of the NJCPA.
This article appeared in the Spring 2022 issue of New Jersey CPA magazine. Read the full issue.