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SPACs and Reverse Mergers – New Trends for Taking a Company Public

Traditionally, when a company wishes to go public, they typically go through a traditional IPO process. This initial public offering requires following a lengthy process that can be both costly and time-consuming. As a result, some startups and businesses have chosen alternative routes. Some companies have decided that a direct listing allows a better strategy. Over the years, other options have also emerged. These include various types of mergers and acquisitions that enable a company to bypass traditional requirements. (Read more about the growth potential of mergers and acquisitions in this Bold story.)

In recent months, reverse mergers and special purpose acquisition companies (SPACs) have increased in popularity. These represent ways by which companies can go public by merging or acquiring other entities. Interestingly, these are not new approaches or concepts, as they had been popular in previous decades. However, understanding their advantages and disadvantages is essential before choosing which public offering strategy to pursue. Only then can companies best position themselves to achieve the company goals they desire.

“Regardless of what path they choose, the endpoint is the same. And you wake up after the ringing of the bell at the exchange, and you have an obligation to the stakeholders.” – David Ethridge, Deals Managing Director and U.S. IPO Services Leader, PricewaterhouseCooper

Understanding Reverse Mergers and SPACs

Before a company can decide how best to go public, various options for going public should be well understood. In terms of a traditional IPO, companies must first hire banks to underwrite their company. They then publicize their business’s potential to investors. They are also required to sell a block of shares at a set price before finally going public. In terms of benefits, a traditional IPO is well structured, highly predictable, and offers a great way to publicly promote a business. It also allows a great way to raise capital. However, it can be costly and often requires several months to complete.

One option that businesses may choose instead of a traditional IPO is a direct listing. Unlike a traditional IPO, a direct listing does not require bank underwriting, and it does not require selling a block of shares. As a result, it is often less expensive and much more efficient. However, it does not provide an opportunity to raise capital in the process. It also has limited opportunities to publicly promote company services and products. Understanding this, companies that pursue a direct listing usually have strong brand recognition already with little need for capital.

In addition to traditional IPO’s and a direct listing, two other options also exist for going public. The first involves SPACs, which are essentially public companies created by investors. Once formed, SPACs have two years to acquire an existing private company. Upon its acquisition, the private company becomes public by default. Reverse mergers are quite similar to SPACs. However, with reverse mergers, a private company merges with an existing public company in order for itself to become public. In both cases, SPACs and the public company purchased in reverse mergers usually have little or no value. This makes both SPACs and reverse mergers typically easier, faster, and less expensive ways for going public.

“[SPACs and reverse mergers] actually create competition around the way we distribute shares to the public market, and competition to the IPO process is probably a good thing. [But] for good competition and good decision making, you need good information.” – Chairman Jay Clayton, Former SEC Chairman

Looking at SPACs and Reverse Mergers Historically

In recent months, both reverse mergers and SPACs have gained attention. Specifically, in the first quarter of 2021 alone, more than 300 SPACs formed. In the process, they raised more than $100 billion in capital from investors. This has been complemented by the increasing use of AI in mergers and acquisitions. While SPACs have two years to find private companies to acquire, they do not have to specify these companies in advance. Because of this, some believe there is currently a bubble of SPACs that is unsustainable. The same applies for reverse mergers. There is likely a limited amount of existing public companies with which private companies might choose to merge. Based on the increasing number of SPACs and reverse mergers as of late, skepticism is therefore on the rise.

This is not the first time such bubbles have existed. Reverse mergers have been around since the 1970s. They reached their peak around 2010, at which time investors, regulators and even the media became skeptical. In terms of SPACs, they have been present since the 1990s. They too have undergone their ups and downs over the years. The recent attraction of SPACs and reverse mergers reflect industry changes. Because there are more speculative companies in pre-revenue stages that need capital, these vehicles for going public look attractive. Specifically, these options permit discussions of future revenue projections where traditional IPO’s do not. Companies in biotech, cleantech, and electric vehicles find SPACs and reverse mergers a valued option for this reason.

The Bottom Line for SPACs and Reverse Mergers

When it comes to SPACs and reverse mergers, these could offer ideal opportunities for going public in select cases. But for SPACs, their share price has historically fallen in value after an acquisition. And in terms of reverse mergers, the subsequent merger must be immediately compliant with all SEC rules. Plus, recent comments by the SEC suggest upcoming changes are likely in regulating these public options. Greater transparency and access to information are probably going to be required. Certainly, SPACs and reverse mergers may be a great choice for some strong companies looking to avoid the IPO process. But they aren’t likely to replace traditional IPOs as a preferred route for going public any time soon.

 

Explore your mergers and acquisitions options with the experts experienced in helping corporate buyers and middle-market private equity source and close acquisition opportunities.

A Modern Take on Due Diligence in Mergers and Acquisitions

Over the last several years, mergers and acquisitions have become increasingly popular. As common vehicles for raising capital, many companies see growth potential as attractive. (Read more about the growth potential mergers and acquisitions holds in this Bold story.) But all too often, various startups and even mature businesses rush into these deals without proper due diligence. Unfortunately, when this happens, weaknesses and gaps are not recognized early in the process. And the lack of effective oversight and review gives off a bad impression to potential buyers and investors. Ultimately, this can lead to a failed deal and a lot of wasted effort.

The importance to performing a thorough due diligence has always existed when contemplating mergers and acquisitions. But today, these efforts have expanded to include additional considerations. Certain company insights remain essential in this process, including financial, management, and process data reporting. But more modern aspects of a comprehensive due diligence now includes technology assessments and cybersecurity analyses. For businesses thinking about mergers and acquisitions today, not only must they be proactive in their company evaluations. They must also expand their perspectives to encompass a broader view of their potential.

”Sell-side due diligence is your chance to catch a red flag before an investor or potential buyer does. This is not to say that your company needs to be pristine, but if you miss key challenges on your end, it could jeopardize the deal, impact the valuation of your company, or result in monies held in escrow.” – Alex Castelli, Managing Partner of the Emerging Markets Industry Group, CohnReznick

Aligning Due Diligence Efforts with Company Stage

When it comes to mergers and acquisitions, different companies consider these strategies for different reasons. Some pursue these transactions in an effort to raise needed capital in an effort to scale their business. Others see these activities as a means to minimize the challenges of going public. Regardless of the reason, however, due diligence should be performed in every instance to increase the chances of success. But the extent and type of due diligence performed can vary with a company’s stage and its intentions.

To expand on this point, consider an early-stage company seeking venture capital support for continued growth. In these instances, those involved in mergers and acquisitions will want to clearly understand revenue models and customer pipelines. Due diligence metrics should include recurring and non-recurring revenues, margins, customer acquisition costs, and long-term value propositions. In contrast, late-stage companies who are about to go public, will need more extensive information reporting. In addition to the above, detailed information about decision-making and leadership choices will be required. Advisors and consultants are often helpful when conducting due diligence at this juncture.

The Importance of Tech Audits with Due Diligence

As technological advances have occurred, one of the important due diligence areas to consider involves tech audits. When thinking about mergers and acquisitions, it is important to evaluate existing IT infrastructures. Does existing hardware need to be replaced in the near future? How far advanced is the company’s digital transformation and are they modernized? (Read about the importance of digital transformation in the post-COVID world in this Bold story.) Is company information sharing efficient and provide strong business continuity? Each of these areas should be included in today’s due diligence efforts when mergers and acquisitions are being contemplated.

A group of business people reaching an agreement
Due diligence is a vital component of successful mergers and acquisitions.

When a company merges with another, technology costs can be substantial if a coordinated plan is not in place. Unless a business performs a thorough tech audit with its due diligence, then the ease of this coordination remains unknown. Eventually, this information will be revealed before mergers and acquisitions are finalized. But being able to identify such issues early saves time and money for all. Plus, it can save companies a great deal of embarrassment along the way. For modern mergers and acquisitions, tech audits are essential part of the due diligence process.

“CISOs understand how a data breach can negatively impact the valuation and the underlying deal structure itself. Leaving cyber out of that risk picture may lead to not only brand and reputational risk, but also significant and unaccounted remediation costs.” – Deborah Golden, U.S. Cyber and Strategic Risk Leader, Deloitte Risk & Financial Advisory

Cybersecurity and Data Privacy Evaluations

In today’s world, the average cost of a data breach is roughly $4 million. Understanding this, it’s not wise to enter into mergers and acquisitions without due diligence in this area. Modern times demand that an assessment of existing cybersecurity practices be evaluated. Likewise, data privacy protections, data collection procedures, and general data practices must be researched thoroughly. This goes beyond a simple assessment as to whether a company is compliant with general cybersecurity regulations.

Beyond general compliance issues, due diligence efforts should assess a business within its specific contexts. For example, industry-specific cybersecurity practices may be standardized and require this in considering cybersecurity risks. Geographic locations, for example in the U.S. or Europe, can also affect company compliance assessments. And prior cybersecurity and data breaches must be revealed along with measures taken to mitigate future ones. Mergers and acquisitions might look great from a financial and growth perspective. But failure to appreciate cybersecurity risks can lead to an overestimation of value.

Upfront Efforts in Due Diligence Goes a Long Way

Resources are limited for any business, and this includes personnel time and effort. Before contemplating mergers and acquisitions, it’s therefore essential that comprehensive due diligence efforts be pursued. Not only does this make a company look more professional and organized. But it also helps identify issues ahead of time that can be proactively addressed. Thus, when an actual merger or acquisition inquiry takes place, weaknesses and shortcomings are minimized. By conducting such an audit in advance, while addressing modern concerns, companies will enjoy much greater success in their endeavors.

 

Explore your mergers and acquisitions options with the experts experienced in helping corporate buyers and middle-market private equity source and close acquisition opportunities.