Business Owners – Are You Prepared if a SPAC Comes Knocking?
If you mentioned the acronym “SPAC” a few years ago you were likely met with a blank stare. While COVID-19 led the headlines in 2020, SPACs became the hottest investment vehicle on Wall Street dominating the initial public offering (IPO) landscape and private equity has played a significant role in the SPAC boom. Private equity’s contribution to the SPAC revolution is important because billions of dollars of capital are being added to an already overflowing investment war chest of “dry powder” estimated to be in excess of $1.5 trillion.
How SPACs Function
SPAC, according to the SEC, stands for special purpose acquisition company and it is a type of “blank check” company. The SPAC basically has no operations but offers securities for cash and places substantially all the offering proceeds into a trust or escrow account for future use in the acquisition of one or more private operating companies. Following its IPO, the SPAC will identify acquisition candidates and attempt to complete one or more business combination transactions after which the company will continue the operations of the acquired company as a public company.
Unlike the traditional IPO process, where a private operating company sells its securities in a manner in which the company and its offered securities are valued through market-based price discovery, the management team (and/or the directors, officers and affiliates) of the SPAC is solely responsible for deciding how to value the private operating company and how much the SPAC will pay for it. Similar to a private equity fund, SPACs generally commit to complete an acquisition within a specified timeframe.
The SPAC Boom
As illustrated below, SPAC IPOs exploded in 2020 with $83 billion raised by 248 SPACs (that’s $14 billion more than what was raised in the previous 16 years combined).
Source: SPACInsider.com & PKF Investment Banking
Through January 25, 2021, an additional 67 SPAC IPOs raised approximately $19.2 billion and there were 71 active filings for SPAC IPOs, indicating that capital raised in 2021 is on pace to far exceed that raised in 2020.
The Road to Being Acquired or Merged into a SPAC
While the availability of capital remains at record levels, the supply of high quality acquisition targets continues to be limited, which is why we foresee a “seller’s market” for companies that have shown resilience or that have flourished during the pandemic. However, merging into or being acquired by a SPAC is not the same as being acquired by another privately-held business or even by a private equity firm.
For private companies, this will mean providing financial statements and other content disclosures that comply with the SEC’s Regulation S-X Rule 3-05 and the US GAAP requirements of a public company, often on an accelerated timeline. Although the SEC issued new rules effective January 1, 2021 to simplify the requirements of Regulation S-X, many business owners and financial departments will still find the financial reporting and disclosure requirements quite onerous.
When it comes to the preparation and inclusion of financial information in a proxy or registration statement related to a merger with a SPAC, the following presents just a few items that may potentially be required:
- Audited financial statements of the acquisition Target for one or more years;
- Audits must be conducted in accordance with PCAOB standards, which may require additional work if previously audited in accordance with AICPA standards;
- Retrospective revision of financial statements if private company accounting alternatives were utilized (e.g., amortization of goodwill);
- Audited financial statements for any significant acquisitions by the Target entity during the prior one or two years;
- Adoption of new accounting standards at the same time as public companies;
- Complete “carve-out” financial statements of the acquired business if the Target is a division of another business;
- Pro forma financial information, including transaction accounting adjustments (i.e., purchase price allocation and fair value of identified intangible assets).
Back to the Future
Business succession can be a complex journey with many twists and turns which is why having a well thought out exit plan is essential. An effective plan should include an evaluation of potential exit strategies as there are different exit channels and each channel rewards different value drivers. In a competitive M&A environment, speed to close and depth of financial reporting are often important factors, and this will be particularly true with SPACs.
Based on the recent boom in fundraising, SPACs represent another possible exit channel in a crowded M&A market that could help sustain high valuation multiples for business owners seeking a liquidity event. Any sales process can feel overwhelming to a closely-held business. However, as briefly illustrated above, merging with a SPAC requires an even higher degree of coordination between buyers and sellers and a prudent business owner should give serious thought to how prepared their business is to be acquired by a SPAC, especially if the SPAC offers the highest purchase price.
So, before a SPAC comes knocking, do your homework and assess whether you can confidently answer the bell.
Contact Us
Robert Murphy
Senior Managing Director
rmurphy@pkfod.com
561.337.5324 | 201.788.6844
PPP Loan Guidance When There’s a Change of Control
Questions remain, but it’s time to move forward
When it comes to merger and acquisition activity, 2020 may very well become the year of “two halves.” After a significant decrease in M&A activity as a result of the pandemic in the first half of the year, we’re now seeing a notable increase in deals. According to Mergermarket, M&A activity in the U.S. declined 65% in deal value from Q1 to Q2 and roughly 45% in number of deals. More recently, between Q2 and Q3, M&A activity increased by 400% in deal value, with 1,036 deals totaling $402 billion.
With M&A activity on the rise, it’s important that buyers and sellers familiarize themselves with potential restrictions to a change in ownership and the related requirements of PPP Borrowers if a merger or combination of entities is contemplated or in the works.
PPP Loan Restrictions
With over 5 million companies receiving Paycheck Protection Program (PPP) loans (of these, more than 650,000 received loans exceeding $150,000 according to the U.S. Treasury), Buyers and Sellers contemplating a transaction were unsure how to address these loans, which resulted in different approaches. Adding to the confusion were different interpretations by Lenders and advisors of language in the PPP loan application regarding “change of ownership” restrictions.
On October 2, 2020, the Small Business Administration (SBA) issued a Procedural Notice providing guidance concerning the required procedures for changes of ownership of an entity that has received PPP funds. Included in the Notice is clarification that there are no restrictions on a change of ownership if:
- Prior to closing the sale or transfer, the Borrower has either repaid the PPP note in full or completed the loan forgiveness process.
- The SBA has remitted funds to the PPP Lender in full satisfaction of the PPP note or the PPP Borrower has repaid the portion of the loan that was not forgiven.
Definition of “Change of Ownership”
The SBA defines a change of ownership when the following occurs (in one or more transactions since the PPP loan was approved):
- At least 20% of the common stock or other ownership interest of the PPP Borrower is sold or otherwise transferred, including to an affiliate or an existing owner of the entity;
- The PPP Borrower sells or otherwise transfers at least 50% of the fair market value of its assets;
- A PPP Borrower is merged with or into another entity.
Required Notifications and Approvals
The PPP Borrower must notify the PPP Lender in writing of any contemplated change in ownership and provide the PPP Lender with a copy of the proposed agreements or other documents that would effectuate the transaction prior to the closing of any change in ownership.
When the PPP note is not fully satisfied, the PPP Lender may approve the change of ownership without prior approval of the SBA in these cases:
- The sale or other transfer is of 50% or less of the common stock or other ownership interest of the PPP Borrower; or
- For sales of 50% or more of the stock or 50% or more of the fair market value of the PPP Borrower’s assets, the PPP Borrower completes a forgiveness application reflecting its use of all of the PPP loan proceeds and submits it with any required supporting documentation to the PPP Lender, and an interest-bearing escrow account controlled by the PPP Lender is established with funds equal to the outstanding balance of the PPP loan. After the forgiveness process, the escrow funds must be disbursed first to repay any remaining PPP loan balance plus interest.
SBA prior approval is required for sales exceeding 50% or more of the stock or assets if a PPP Borrower is unable to establish the required escrow account. In addition, the PPP Lender must include the following information when submitting a request to the appropriate SBA Loan Services center:
- Reason why the PPP Borrower cannot fully satisfy the PPP note or fund the escrow;
- Details of the transaction;
- Copy of the PPP note;
- Any letter of intent and the purchase or sales agreement setting forth the responsibilities of the PPP Borrower, Seller, and Buyer;
- Disclosure about the Buyer’s existing PPP loan (if any); and
- List of all owners of 20% or more of the Buyer.
The SBA will review and provide a determination within 60 calendar days of receiving a completed request and may require additional measures as a condition of its approval. Noteworthy in an asset transaction is the SBA’s requirement that the Buyer assume all of the PPP Borrower’s obligations, including responsibility for compliance with the PPP loan terms. The assumption of these obligations will need to be included in the purchase and sale agreement or submitted to the SBA in a separate assumption agreement.
Continuing Obligations
Even if the transaction is structured as a stock sale or merger, the PPP Borrower will remain subject to all obligations under the PPP Loan. Furthermore, the SBA stated it will have recourse against the original owners for any unauthorized use of PPP funds by the new owners.
If a purchaser or new owner has a separate PPP loan, the SBA noted that the PPP Borrower and the new owner are responsible for segregating and delineating PPP funds and expenses for each Borrower and demonstrating compliance with PPP requirements with respect to both PPP loans.
Snapshot of SBA Notice
While not providing all of the answers, the SBA Notice does clarify these important matters:
- Sellers do not have to accelerate the forgiveness application process, especially if they are still expending funds on qualified expenditures in the 24-week covered period.
- More than one PPP Loan may be outstanding after the completion of a transaction.
- Buyer’s will be required to assume the PPP Borrower’s obligations with the SBA in a transaction structured as an asset sale (i.e., 50% or more of the fair market value of the assets). As a result, Sellers should expect additional indemnifications and, likely, an escrow of sales proceeds.
- PPP lenders may approve a change of ownership without prior SBA approval in certain situations.
Contact Us
Robert Murphy
Senior Managing Director
rmurphy@pkfod.com
561.337.5324 | 201.788.6844
M&A Outlook for 2021: An Active Seller’s Market
A Wealth of Opportunity for Owners Considering Selling Their Businesses
The year ahead holds the promise of a dynamic seller’s market likely to drive a healthy mergers and acquisitions (M&A) market. Companies with strong operating performance should be highly competitive. With a flexible approach and proper planning, even those that suffered setbacks can garner buyers with attractive offers in an arena flush with capital.
The promising M&A market in the year ahead reflects the interplay of several key factors: low interest rates, abundant capital in search of targets, larger companies seeking to grow and diversify through acquisitions, aging baby-boomer business owners ready to exit and optimism for an economic landscape improving with the rollout of COVID-19 vaccines.
Despite the pandemic-induced economic crisis that raged throughout the year, the Dow and S&P 500 finished 2020 at record levels, up 7.25% and 16% respectively. Public market activity was also strong in 2020, with 480 Initial Public Offerings (IPOs) in the U.S. market, including 248 Special Purpose Acquisition Company (SPAC) transactions, an increase over 2019’s 233 IPOs, with 60 SPACs. After taking a significant hit in the second quarter of 2020, M&A activity, along with the stock markets, rebounded sharply in the third and fourth quarters – a trend expected to persist well into 2021.
Source: Capital IQ and PKF Investment Banking Research
Private company transactions in 2021 are expected to continue the
strong comeback pace set in Q3 and Q4, 2020.
Favorable Interest Rates: Interest rates remain at historically low levels with the 10-year Treasury rate at 1.10% and the prime rate at 3.25%, as of January 22, 2021.
Demand Exceeding Supply: The setbacks many companies endured in 2020 have limited both the quantity and quality of attractive acquisition candidates, contributing to a heightened level of buyer demand that exceeds supply by a large margin. According to the Wall Street Journal, there is abundant pent-up demand for deals, coupled with an estimated $1.5 trillion in private equity “dry-powder” that must be deployed. This excludes the capital held by non-financial buyers that are looking for acquisitions and investment opportunities.
An Industry-Specific Approach: The 2021 market could be considered a “tale of two companies.” One company with operating results not impacted by COVID-19 sells at the same valuation multiple or higher as it would have pre-COVID-19 with the same or similar consideration structure. Yet, another company with financial performance negatively impacted by COVID-19 sells at a reduced valuation multiple with a 3-year earn-out component. The first example is more likely to represent companies in the e-learning, cybersecurity and home entertainment sectors while the second group includes the entertainment, hospitality and retail industries that suffered substantially. Therefore, in cases where COVID-19 has negatively impacted a company’s operating performance, buyer creativity and seller flexibility will be key to completing a transaction.
Trends to Watch: Sellers should be aware of, and keenly attuned to, essential developments affecting business valuations and transaction terms in the year ahead. Understanding how these can influence a sale are central to preparing for, and orchestrating, a successful deal. Examples include the following:
- Stable or increasing valuation multiples in sectors with minimal or no negative impacts from COVID-19.
- Lower valuation multiples in certain sectors due to decreased debt leverage, lower financial performance and lack of visibility with future earnings.
- Increase in use of seller notes due to decrease in debt leverage and desire for more liquidity at transaction closing.
- Increase in use of contingent earn-outs due to lack of visibility with future earnings or to bridge valuation gaps between seller and buyer.
- Increased use of subordinated debt in the capital structure due to decreases in bank leverage.
- Elongated due diligence period due to buyer/lender’s desire to see more current operating results, additional financial modelling scenarios and work from home/travel concerns.
- Heightened attention on continuation of profitability and growth.
- Adjustments for non-recurring COVID-19 impacts, both positive and negative.
In today’s M&A market, more than ever, valuation multiples, consideration structure, deal terms and closing time are specific to the company and the industry. We encourage business owners considering a sale in this promising market to contact us for a no-obligation, confidential conversation.
Contact Us
Robert Murphy
Senior Managing Director
rmurphy@pkfod.com
561.337.5324 | 201.788.6844