The financial statement requirements to get ready for a special-purpose acquisition company (SPAC) are largely like that of a traditional IPO. Broadly speaking, you’ll need pro forma financial information, usually from an independent auditor. This will contain your consolidated Balance Sheet, Statement of Operations, Stockholders’ Equity, Cash Flows and Notes. Then the SPAC and target need to work through accounting for the transaction to determine if the SPAC or target will be the acquirer for accounting purposes.
Let’s cover the items you’ll need to prepare for a SPAC:
3- to 5-year Audit of Your Financials (i.e., Balance Sheets, Statements of Income, Cash Flows and Changes in Shareholders’ Equity)
This audit will typically involve working with the accountants to make sure revenue recognition is accurate, making sure:
- Inventory is accounted for properly,
- Making sure EBITDA is accurate and
- Explaining the variances.
It’s helpful to put a financial statement package together that contains the balance sheet, income statement and cash flow statement, along with other analytics explaining the variances from all three statements. It is also helpful to include some bridges, such as EBITDA to Cash bridge, to help explain the net increase or decrease in cash. Once the total package of financial statements and analytics is complete, you should hand it off to external auditors for review.
Unaudited Interim Financial Statements for the Current Year
Depending on the SPAC transaction date, interim financial statements may be needed. If the deal is later in the year, at the least, the first-half reporting should be available for investors to review. This can be the same financial statement package created for the audit (mentioned above). This reporting is mostly helpful to see trends or show growth compared to the previous three years. There will typically be funding needed before the SPAC, so it’s good to include any covenant calculations that show the term loan, revolver and capital leases.
Set Up a Process to Close Financial Reporting and Quarterly Earnings on Time (i.e., Create Quarterly and Annual Accounting/Reporting Calendar)
Speeding up your close might involve getting new reporting software such as Workiva, which can be used for automation of reporting to remove delays during the reporting period. In that case, the software needs to be implemented before the first quarterly reporting cycle, so you have an accurate 10-K. You’ll also need an 8-K filing to notify shareholders (and the SEC) when a major event or corporate change takes place (i.e., the SPAC acquisition). The 8-K is usually prepared by an outside party/software.
Set Up Internal Processes Regarding SOX Compliance
These processes will help you make sure assets are safeguarded and you have reliable financial reporting to reduce fraud. Identify gaps, remediate and test effectiveness. (This is typically done with big four firms.) The process involves several meetings throughout the entire SPAC process to help identify if sufficient processes are in place across all departments. Private companies do not always have software locks, allowing anyone to go in and change things. (For example, an analyst might be able to go into SAGE and edit journal entries.) With public company readiness, a designated person/s must have access to the reporting software, accounting software and so on. Designation involves working with the IT department to name an owner (usually senior management) for every software platform the company uses.
Debt Summary and Covenant Calculations
These elements can also be included as a tab in the financial statement package. Debt summary and covenant calculations will usually contain any term loans or capital leases that the company has. For example, if you took out a PPP loan during COVID, it would be included here. Overall, it’s just a summary, by month, breaking down the company’s loans/debt and then bank adjusted EBITDA.
Executive and Stock Compensation Disclosures
SEC rules for an S-4 filing require extensive disclosures surrounding executives, their background and current and prior years’ compensation. Additionally, companies are required to disclose the details on how stock compensation is administered and calculated. These disclosures will need significant judgment and expertise that many private companies are not aware of or do not have. For example, compensation may seem easy to define, but are certain fringe benefits like car allowances included? Even determining which executives would be listed as an “executive” in SEC filings will require extensive discussion within the Company. Furthermore, Executive and Stock Compensation disclosure are areas of focus for the SEC for which many comment letters have been made.
Onboard SEC Reporting Roles (e.g., SEC Controller, Director, etc.)
Private companies usually do not have the necessary personnel in place that a public company requires. Public companies require a lot more detail and precision, which requires significantly more manpower. It’s helpful to bring in people that have an SEC public company background to help with the reporting (e.g., Assistant Controller, SEC reporting roles).
Financial Planning & Analysis Items
Diligence Regarding Financials and Operations
From an FP&A perspective, it’s necessary to essentially scrub the financials before the audit. This process will involve establishing several high-level KPIs for the board (highlighted below). These KPIs can help identify any dips in performance and can help with forecasting. For example, if there was a dip in margin or revenue for a particular month, you could diagnose if it was a volume or product mix issue. Maybe one office has lost money because it’s overstaffed, or perhaps lost margin on one of your most popular products reveals you need to find a generic alternative.
Business Performance Metrics
To prepare for a SPAC, you’ll need to put together a myriad of metrics to measure performance. While the exact metrics you need will be dependent on your business, here are some options:
- Top-10 Largest Customers
- Cash/Revenue per Business Day
- Headcount Metrics vs. Monthly Target
- COGS/Revenue per Full-Time Employee
- Geographical Metrics (if Company is National)
- Customer or Contract Profitability
- Quality Measures
- New Hire/Separation Trends
- New Customers per Business Day (Depending on Industry)
- Volume and Revenue Drivers (Commonly Requested from Boards)
When identifying metrics, focus on highlighting everything that affects company performance. These KPIs are necessary so investors know what to look for when reading your financials. If you are working with an outside firm to help with public company readiness, they will typically ask for these KPIs as well, so it’s a great habit to have them available during monthly financials. These KPIs are usually shown in the board deck as a few slides/graphs.
Five-Year Projection or Growth Model (Analyzing In-Process and Future Acquisitions)
While most companies will need a growth model of some sort, a five-year growth forecast is especially helpful for SPAC preparation. It will help to get investors on board by highlighting future growth. The process of building your model will involve taking at least the past two years’ budget/P&Ls, along with creating models for any future acquisitions.
For example, if you wanted to expand your retail locations into new states within the year, the five-year model will include projection models for those new states as well. A future office in Florida should include a buildup of revenue and COGs, along with the necessary drivers for its success and growth assumptions. Your assumptions might include answers to questions like:
- How much staff is needed, and how much should you pay them?
- Will you rent a space or build an office?
- How long will it take to turn a profit?
- How will you increase your customer base in that new location?
- Are you going to charge the same rates as in existing states?
- and any other growth assumptions).
Similarly, these projections should be created for each region the company believes it will expand to in the next five years, with each of them having their own assumptions and methodology. Once all the individual growth assumptions are complete, you then roll them up to a New Market summary that trends the revenue and margin by month.
Once you have your budget and acquisition models ready, you can create the 5-year growth model. Typically, this will be shown as a P&L by quarters and split by two sections—existing markets and growth markets. Further detail will include revenue by market, revenue/customer assumptions, expense assumptions and cash flow forecast.
Year-Over-Year Variance Analytics
These analytics should look at changes in the Balance Sheet (Current Assets Variances), Income Statement (Revenue and COGS Variances) and SG&A (e.g., Real Estate and Equipment, Employee Expenses, Professional Fees, Bad Debt). They can be included in the financial statement package, with notes next to any large variances to explain the change.
- If your Accounts Receivable increased, was there a timing difference in your collections?
- If current liabilities increased, did you have an increase in accounts payable or accrued expenses?
- Why did revenue increase/decrease YoY? (Maybe you saw more customers or COVID negatively impacted the business.)
Each line of the three financial statements will have notes explaining any material variances, which usually involves working closely with the accounting department as well.
Revenue Cycle Management
Accounts Receivable Analysis/Lookback for the Past 2-3 Years
This analysis should look at beginning to ending balance, adjustments and unapplied cash, customers with largest accounts receivable (AR) and how many days aging.
Having a good revenue cycle management team is important for public company readiness. Investors will want to see how your AR has trended over the past three years, so it’s essential to put together an AR Rollforward deck that showcases this. The deck should include the current AR, broken out by account and trended by month and summarized by an AR waterfall that shows the compounding effect of AR each month by days aged (1-30 Day AR, 31-60 Days AR, 61-90, 91-120, +120 Days).
This is also helpful to determine which AR bucket you have the most AR in. If you have AR greater than a year, it may be time to write it off or hand it to a collecting agency. Consider if you had a large sum of AR from two years ago. You wouldn’t collect that money due to how long overdue it is, but that’s a decision the board needs to make. It depends on the industry you’re in, but a good rule of thumb is that most of your AR should be within 60 days (80% of AR in 60 days, 20% in the +60 days bucket).
The AR Rollforward deck should also break down AR by individual customer, so you can see who your problem customers are. If you have a customer in the +120 Day bucket for significant dollars, then you need your collectors in the RCM department to tackle this. You may even have to cut ties with problematic customers.
Days Sales Outstanding Trend
Days sales outstanding (DSO) is a good metric for investors to see how long it takes for cash to come in the door. This should be included in the aforementioned AR deck, trended by month. To calculate DSO, divide AR by Revenue and multiply it by the number of days. Normally, a company will have one overall DSO that can also be broken down as DSO by account, depending on how granular a view is neccessary. It may also be helpful to look at DSO by customer to see if there’s a specific problem customer that takes a while to pay compared to your average. The AR deck is usually produced monthly and included as a few slides in the board deck.
Gross Collection Ratios/Cash Collections (Depending on Industry)
This helps determine how much revenue you can recognize each month if the company is on an accrual basis. To calculate GCR, divide charges by payments. That percentage is used for the accounts to book revenue each month.
In conclusion, preparing for a SPAC involves a comprehensive and meticulous checklist, encompassing financial statement requirements, accounting items, SEC reporting roles, and financial planning and analysis considerations. Implementing internal processes, conducting thorough diligence, and presenting transparent disclosures are crucial steps, ensuring a smooth transition to public company readiness and fostering investor confidence in the long-term growth prospects of the organization.